The present French Tax Update will focus on an overview
of several noteworthy French tax court decisions issued during the
past few months, in particular in relation with VAT, the 3 percent
tax on distributed income, and some long-awaited corporation tax
disputes.
APPLICATION OF VAT RULES TO TRANSACTIONS BETWEEN HEAD
OFFICE AND PERMANENT ESTABLISHMENT
For French corporation tax purposes, a French permanent
establishment (PE) of a non-French tax resident
corporation is treated as a separate taxable person including,
generally, in its dealings with its head office. International tax
treaties, signed by France, define how income and expenses
(including those borne by the head offices for the purposes of the
PE) should be allocated to the PE.
For VAT purposes, the French case law generally considers that the
"transactions" between a head office and its PE are not
within the scope of the tax (i.e., because they take place within
the same legal entity). The French tax authorities
(FTA) generally follow the same approach. The
European Union case law (FCE Bank, September 23,
2006) arrives at the same conclusion when the PE lacks autonomy
vis-à-vis the head office. There is, also, one recent EU law
case (Skandia, September 17, 2014) where it was
decided that if the head office or the PE belongs to a "VAT
group", then the internal dealings between the head office and
the PE should be treated as in scope (NB: France
has not introduced the VAT grouping in its legislation). Also, in a
separate EU law case (Crédit Lyonnais,
September 12, 2013), the concept of a worldwide pro-rata (i.e., a
computation of the aggregate VATable activities of the head office
and its PEs) was rejected.
In a decision dated January 27, 2015, the Administrative Appeal
Court of Versailles (Appeal Court) deals with the
situation of a French PE (of a UK law-governed entity) with two
separate activities: financial transactions with French clients
where the PE has elected to be liable to VAT, and services provided
to the UK head office regarding certain "equity and fixed
income sales". The PE had decided to deduct the full VAT
charged to it on its own expenses, whether the expenses were borne
for the clients' activities or for the dealings with the head
office.
The FTA had challenged the position of the PE by taking the view
that the expenses borne exclusively for the dealings with the head
office may not, in principle, result in a deductible VAT, although
the FTA had accepted to take into account the pro-rata of the head
office (i.e., the percentage of its VATable transactions) as a
reference for the VAT deduction of the PE regarding the dealings
with the head office. As for the mixed expenses of the PE (i.e.,
borne for both clients' activities and head office's
dealings), the FTA had taken the view that the related VAT was
partially deductible, again based on the head office's pro-rata
corrected by the VATable turnover of the PE. The bank had appealed
after losing at the administrative tribunal level.
The Appeal Court starts its reasoning by referring to the FCE Bank
case law and the related conclusion that the dealings between a
head office and a PE should be disregarded in the absence of
autonomy of the PE. Thus, the Appeal Court observes that since the
taxpayer does not argue for the autonomy of the PE vis-à-vis
the UK head office, the amounts received from the latter (i.e., as
remuneration for the equity and fixed income sales) may not be
treated as in scope, and, accordingly (i) the VAT borne on the
related exclusive expenses is not deductible, and (ii) the VAT
borne on the "mixed" expenses is deductible for the
pro-rata of the sum of the underlying services and goods and for
the VATable activities of the PE. The Appeal Court thus confirms
the FTA's position in respect of the "exclusive"
expenses, adding that the latter has taken a liberal view by
accepting that the PE could, nevertheless, use the pro-rata of the
UK head office to obtain a partial VAT deductibility.
In respect of the "mixed" expenses, given the
Crédit Lyonnais case law, the Appeal Court takes the view
that the FTA has no legal grounds to compute the VAT deductibility
on the basis of the head office's pro-rata corrected by the
VATable turnover of the PE. This being said, the Appeal Court
observes that the PE has not been able to evidence that the method
used by the FTA has resulted in less deductible VAT compared to the
lawful method where such deductibility would have been computed
simply on the basis of the VATable activities of the PE.
Accordingly, it sides again with the FTA.
VAT TREATMENT OF ACQUISITION COSTS RECHARGED TO OTHER ENTITIES OF
A GROUP
On January 23, 2015, the Conseil d''Etat issued a
decision on whether the turnover attributable to the recharge to
other entities of a group of acquisition costs generated within the
course of a corporate reorganization could be taken into account
for the purposes of the determination of a holding company's
VAT recovery rights.
The facts of the case were, in summary, as follows:
- The holding company of a French media group (HoldCo) qualified as a so-called mixed holding company (i.e. a company that, aside from its VAT-exempt activities, performs activities subject to VAT such as the provision of advisory and managerial services to its subsidiaries) ;
- Within the course of a corporate reorganization of the group, HoldCo charged back without margin to its subsidiaries the legal and advisory fees pertaining to acquisitions that were finally carried out by its subsidiaries (Chargeback) ;
- HoldCo included the turnover attributable to the Chargeback in order to determine its VAT recovery ratio.
The FTA challenged HoldCo's VAT position by considering that
the turnover attributable to the Chargeback should not be taken
into account within the course of the computation of the
company's VAT recovery ratio, insofar for the purposes of the
latter one should take into account only the turnover generated by
the taxpayer itself within the course of its own operations.
The Appeal Court of Versailles had sided with the FTA by ruling
that the turnover attributable to the Chargeback could not be taken
into account in order to compute the VAT recovery ratio since the
acquisition costs were borne only on a temporary basis,
notwithstanding the fact that the turnover attributable to the
Chargeback was (i) found to be within the scope of VAT, and (ii)
generated within the course of a corporate reorganization initiated
and designed by HoldCo.
In its January 23, 2015 decision, the Conseil d'Etat
took a different view and ruled in favor of the taxpayer by
considering that nothing precludes a taxpayer from including the
turnover attributable to the recharge without margin of acquisition
costs in the computation of the VAT recovery ratio.
ILLUSTRATION OF THE VAT RECOVERY PRINCIPLES APPLICABLE TO SALES OF
SHARES
The Conseil d'Etat has already had the opportunity to
rule on the recoverability of the input VAT attached to the costs
pertaining to an acquisition of shares.
In a 2010 decision, the Conseil d'Etat had
distinguished between (i) costs pertaining to an acquisition that
does not occur (the corresponding VAT being recoverable as a
general expense), and (ii) costs pertaining to an acquisition that
does occur (the corresponding VAT then being entirely or partially
recoverable, except where (a) the profits arising from the sale of
the shares are upstreamed to the seller's holders, or (b) the
corresponding costs are incorporated into the acquisition
price).
In a 2013 case, the Conseil d'Etat ruled that
acquisition costs borne by a non-passive holding company form part
of its general costs, and the corresponding input VAT is
recoverable in proportion to the company's general VAT recovery
ratio, provided inter alia that the company is able to
demonstrate that the acquisition was part of a strategy to increase
the profits arising from the services provided to the newly
acquired subsidiaries.
In a decision dated March 31, 2015, the Appeal Court of Versailles
reviewed several invoices sent by service providers to the taxpayer
in connection with several sales of shares. The Appeal Court
applied both the principles provided by the Conseil
d'Etat decisions above and the general so-called direct
link principle whereby (i) input VAT may be recovered to the extent
that it pertains to expenses that are directly linked to operations
that are subject to VAT, although (ii) input VAT pertaining to
general expenses remains recoverable notwithstanding the absence of
a direct link.
As a result, the Appeal Court reviewed each invoice together with
the context of the relevant sale of shares, and inter alia
ruled:
- Legal fees invoices that do not specify the nature of the legal services provided: The corresponding input VAT may not be recovered by the taxpayer to the extent that it does not demonstrate that the corresponding costs have not been incorporated into the sale price;
- Consulting fees invoices pertaining, according to other contextual elements, to the preparation and analysis of the conditions and consequences of the sale (i.e., services that would have also been rendered had the sale not occurred): The corresponding input VAT was recoverable to the extent of the fraction of the sale that was subject to VAT (i.e., the fraction of the sale corresponding to the sale of assets, excluding shares and real estate assets whose transfer was not subject to VAT), on a pro rata basis;
- Legal fees invoices sent to a subsidiary of the taxpayer: The corresponding VAT was recoverable provided that the taxpayer was able to demonstrate that (i) the relevant sale of shares allowed a reorganization of its own subject-to-VAT activities (i.e., thereby making the corresponding fees general expenses) and (ii) the FTA did not evidence that the profits arising from the sale of shares were upstreamed to the seller's holders.
FRENCH 3 PERCENT TAX ON DISTRIBUTED INCOME - NONCOMPLIANT WITH EU
LAW?
For distributions paid out from 2012 onward, France has introduced
a 3 percent tax due, with certain exceptions, by corporate
taxpayers (including under certain conditions French branches of
foreign companies) that distribute dividends. Given that the French
corporate tax is based on a territorial basis (rather than a
worldwide basis), the introduction of the 3 percent tax was a way
for the government to effectively tax income that would otherwise
have been out of its reach. NB: No 3 percent tax
is due, inter alia, on distributions made within the
members of a French tax grouping or if (subject to certain
anti-evasion rules) the relevant dividends are paid in the form of
additional shares of the distributing entity.
The European Commission has launched an infringement procedure
against the 3 percent tax as being noncompliant with the relevant
EU rules.
The two potential grounds of breach are as follows:
(i) Violation of the EU parent-subsidiary rules:
If the 3 percent tax may be assimilated to a withholding tax (which
the 3 percent tax is not formally), or as a form of additional
taxation of a French parent company on the dividends received from
an EU subsidiary.
(ii) Violation of the freedom of establishment:
Given that the intra-group dividends, within a French tax grouping,
are exempt from the 3 percent tax, the application of the 3 percent
tax to distributions made by a French entity to an EU entity (which
would be eligible to be part of the French grouping if it were not
for its non-French tax residency and establishment) may be
discriminatory.
As with any infringement procedure, the Commission may,
eventually, request France to amend its 3 percent legislation, and,
in case of noncompliance, refer the case before the European Union
Court of Justice.
DEDUCTION OF FINAL TAX LOSSES
On April 15, 2015, the Conseil d'Etat ruled on the
French treatment of the tax losses incurred by a non-French
subsidiary of a French parent.
The basic facts were as follows:
- The French parent was the head of a French tax grouping with French subsidiaries;
- The French parent was requesting (on the basis of EU Marks & Spencer case law) that the tax losses of Polish and Italian subsidiaries could be imputed against the taxable results of the French grouping; the argument for such a request was that the relevant Polish and Italian legislations did not allow their subsidiaries to carry forward their losses any further locally;
- The administrative court and the appeal court had sided with the FTA on the basis that the French tax grouping is limited to French qualifying entities.
The Conseil d'Etat first reminds that, under the X
Holding BV case law (dated February 25, 2010), the principles of
free establishment and equal treatment of domestic and foreign
entities do not prevent a Member State from establishing
legislation where the tax grouping is reserved to entities which
are residents of such jurisdiction, and where the entities which
are not liable to tax in the jurisdiction are not eligible for such
grouping.
Accordingly, the Conseil d'Etat decided that the
system of the French tax grouping is not violating the EU
principles. The Conseil d'Etat also took the view that
if the legislation of other countries (in this case Poland and
Italy) include provisions whereby the local subsidiaries are no
longer in a position to carry forward their losses locally, it is
not for the French legislation (jurisdiction where the parent
company is based) to accommodate the consequences of such foreign
legislations.
CARRIED-FORWARD TAX LOSSES MAY BE OFFSET AGAINST TAX PROFITS ONLY
AFTER ALL EXPENSES HAVE BEEN DEDUCTED
Pursuant to the French tax code, corporation income tax is applied
on the net accounting profits, as adjusted for French tax purposes.
Tax losses available for carry-forward are deemed to constitute an
expense for corporation income tax purposes, even though they do
not constitute an expense from an accounting standpoint.
Under certain specific circumstances, and in particular since the
introduction of a limitation to the amount of tax losses available
for carry-forward (whereby, in a nutshell, tax losses may be used
only to the extent of 50 percent of the relevant profits that are
in excess of 1 million euros), several disputes thus arose between
taxpayers and the FTA as to when tax losses available for
carry-forward could be deducted from the net accounting
profits.
Taxpayers argued that, on the basis that tax losses available for
carry-forward were deemed to constitute an expense for corporation
income tax purposes, they could be deducted from the net accounting
profits before other similar tax adjustments are made to such net
accounting profits (such as amortizations and depreciations). The
FTA however considered that tax losses available for carry-forward
could be deducted (subject, where relevant, to any limitation
applicable) only once all expenses have been deducted, including
those arising from the French tax code (such as amortizations and
depreciations).
In an April 2015 decision (Conseil d'Etat, April 10,
2015, Fayat), the Conseil d'Etat has confirmed the
position taken by the Appeal Court of Versailles in an April 2013
decision: Carried-forward losses may be offset against the net
accounting profits only once all expenses, including those provided
for by the French tax code (such as amortizations and
depreciations), have been deducted. As a result, amortizations and
depreciations must be deducted from the net accounting profits
before finalizing that amount and offsetting (subject, where
relevant, to any limitation applicable) any tax losses available
for carry-forward.
TAX EXEMPT TEMPORARY EXPATRIATION ALLOWANCES
Pursuant to article 81 A of the French tax code, a
favorable tax regime applies to temporary expatriation allowances
paid out to French employees sent abroad for business trips
exceeding 24 hours. This regime is inter alia subject to
the condition that these allowances do not exceed 40 percent of the
employees' base compensation (40 Percent
Cap).
If the relevant conditions are met, these allowances are not
subject to personal income tax but are taken into account only to
determine the average tax rate applicable to the employees'
other income fully taxable in France.
The FTA took the view in their official guidelines that for the
purposes of the computation of the 40 Percent Cap, the
employees' base compensation should be prorated by reference to
the actual number of days spent abroad on eligible temporary
assignments, thus considerably restricting the scope of this
regime.
The Conseil d'Etat ruled in an April 10, 2015,
decision that the 40 Percent Cap of temporary expatriation
allowances must be computed by reference to the employees'
global base compensation.
It will be interesting to follow whether the relevant French tax
legislation will be amended in the near future in order to either
confirm the historical position of the FTA or to uphold the
favorable interpretation of the Conseil d'Etat.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.