The French tax authorities have just submitted for public consultation draft tax regulations interpreting the anti-hybrid loan provision that was passed into law last December.
The Finance Act for 2014 introduced a new restriction on the deduction of interest paid to related companies where such interest is not subject to a minimum taxation.Pursuant to the new rules, interest paid to a related lending company is deductible only if the French borrowing company proves that the lending company is subject to corporate income tax of an amount at least equal to 25% of the corporate income tax liability as determined under French standard rules. This proof is to be provided upon request of the tax authorities (see our previous Tax Alert).In practice, the new restriction applies to interest paid to a related entity not subject to minimum taxation on such interest, either because it is considered as non-taxable dividend (qualification mismatch resulting from a genuine hybrid loan) or because the interest income is taxed at a low rate (favorable tax regime).
The (draft) tax regulations, which are not definitive and remain subject to further changes, are accommodating and preserve the deduction of most interest paid to foreign affiliates. It can be summarized as follows:
- The foreign tax rate to be taken into account, when assessing whether it exceeds 25% of the French corporate income tax rate, is the statutory tax rate (and not the effective tax rate);
- Only the inclusion of gross interest in the taxable profits of the company would be relevant, to the extent that the tax rate levied on interest income exceeds 25% of the French corporate income tax rate that would have been levied in France. Qualification of interest under the laws of the State where the lender is based – such as dividend or other income - would be ineffective;
- Interest charges and other expenses could be deducted from the taxable profits of the foreign company, without jeopardizing the deduction of interest in France.
As a result, and subject to anti-abuse rules:
- The new rules should not apply for the sole reason that the foreign lender is in a loss-making or break-even situation, including after using tax loss carry forward;
- Back-to-back loans through an intermediate entity subject to statutory tax rates above 8.5% to 9.5% (depending on additional contributions levied on the French borrowing entity) should not result in the application of the new restriction, even where the secondary loan is a hybrid loan or where the secondary lender is subject to low tax rates;
- Notional interest deduction regimes allowing lenders to deduct interest calculated on their equity funding should not trigger the new restriction;
- Favorable tax rulings should not trigger the new restriction so long as the combination of the amount of interest income booked in the lender's taxable profits and the statutory tax rate levied on this piece of income, represent at least 8.5% / 9.5% of interest paid by the French debtor.
On the other hand, a foreign regime that permits a foreign lender to include in its taxable profits only a certain percentage of interest received from France could be caught by the new rules if the nominal tax charge on the combination of the amount of interest income booked in the lender's taxable profits and the statutory tax rate levied on this piece of income, represent less than 8.5% / 9.5% of interest paid by the French debtor.
The restriction should apply to interest paid to tax-transparent entities (including investment funds) only if the shareholders of the tax-transparent entity (i) are related to the French borrowing company and (ii) are not subject to minimum taxation. However, the draft tax regulation has an all-or-nothing approach whereby, if the restriction applies due to a related shareholder not subject to minimum taxation, no interest expense will be deductible, even though there are other shareholders to which the provision should not apply (either because they are not related or because they are subject to minimum taxation).
The public consultation process should end this month, so we may expect to see the final tax regulations in mid-May.
Comments – Even though the anti-hybrid provisions apply irrespective of the jurisdiction of the lender (France, EU member State or any other State), their compatibility with EU legislation is highly debatable. Nevertheless, by relaxing the rules as voted by the Parliament, the proposed tax regulations open significant restructuring possibilities to be analysed before engaging any court action.
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