In a decision dated May 11, 2015, the Conseil d'Etat ruled in favor of the French tax administration (FTA), in a situation in which the availability of the participation exemption (Exemption) was challenged.

A French financial institution (Parent) had received dividends from a Dutch subsidiary (Sub) and had taken the position that they were 95 percent exempt under the Exemption rules (ownership of at least 5 percent of the distributing entity for a minimum period of two years).

The FTA had denied the Exemption on the basis of the so-called "abuse of law" procedure, i.e., that the Sub had no other purpose than to "transform" taxable income into quasi tax-exempt dividends.

The FTA, in effect, argued that the Sub had no economic substance, in that (i) its assets were composed solely of bonds funded by the share capital provided upfront by the Parent, (ii) the income generated by the Sub consisted solely of interest and capital gains on the bonds, and (iii) its investment policy was decided once and for all upon its incorporation, i.e., the Parent did not control the subsequent management of the Sub.

The FTA thus argued that the Parent was in exactly the same position as if it had held the bonds directly—that the interposition of the Sub had no other purpose than to obtain the quasi exemption of the income and capital gains generated by the bonds. The Parent argued that the Sub was liable to Dutch corporate tax, and the transaction could not be viewed as purely tax-motivated.

The Conseil d'Etat decided in favor of the FTA and took the view that the Dutch corporate tax liability, while reducing the tax benefit of the transaction, did not modify the facts that (i) the Sub did not have any economic substance, and (ii) the Parent was not able to evidence any non-tax motivation in the intermediation of the Sub.

This case law follows on from older cases, such as the Sagal case (in 2005) in which, again, the lack of substance of the subsidiary, and the absence of any control by the parent over its actual management, played in favor of the FTA.

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