France: Focus On The New French Restrictions Applicable To The Tax Deduction Of Interest Incurred On Debt Financings Contracted In Connection With Certain Leveraged Acquisitions

Last Updated: 17 January 2012
Article by Olivia Rauch-Ravisé, Jérôme Commerçon and Xavier Renard

Article 40 of the 4th Amended Finance Act for 2011 introduces new restrictions to the deduction of financial expenses (i.e., mainly interest) for French corporate income tax purposes in cases where the corresponding debt financings can be deemed contracted in relation to artificial acquisitions of shares. Several aspects of this anti-abuse measure are quite unclear and raise numerous issues.

Overview of the new legislation

Under the new legislation — which is generally referred to as the "Carrez Amendment" — the deduction of interest expenses incurred in France by a company for purposes of the acquisition of shares qualifying for the French participation-exemption regime will be subject to restrictions, unless it can be demonstrated that:

  1. the decisions relating to such shares are actually taken by the company having acquired them (or, as the case may be, by one of its affiliates within the meaning of Article L233- 3 of the French Commercial Code that is located in France), and
  2. where the group exercises control (or an influence) over the acquired company, such control (or influence) is exercised by the French acquirer (or here again, as the case may be, by one of its affiliates located in France).

For this purpose, satisfactory evidence is required to be provided for the fiscal years running over the twelve-month period following the acquisition of the shares or, as regards acquisitions completed in the course of a fiscal year opened before 2012, for the first fiscal year opened after January 1, 2012.

Where such a demonstration cannot be properly made, the company owning the shares is required to recapture a portion of its financial expenses incurred during each fiscal year running over the eight-year period following the year during which the acquisition took place. For transactions to be closed in 2012, the new rules may thus affect the deduction of financial expenses incurred during the fiscal years running until the end of 2020. Moreover these new rules may affect the deductibility of interest expenses incurred by companies having completed share deals since 2004 Should the shares be transferred later on to another company in the course of a reorganization such as a merger, a de-merger or a similar transaction, the recapture requirement will be transferred to the recipient company.

For each fiscal year, the portion of financial expenses which deduction shall be disregarded for corporate income tax purposes is based on a non-deduction ratio equal to:

Purchase price of the acquired shares qualifying for the participation-exemption regime



Average amount of debt for the relevant fiscal year in the books of the company owning the participation

This portion of the financial expenses is deemed related to the debt financings contracted for purposes of the acquisition of said shares.

These restrictions do not apply to participations held in real estate companies or if the overall value of the shares qualifying for the participation-exemption regime held by the French entity is less than €1 million. Moreover, as a safe harbor, no recapture of financial expenses will apply if it can be evidenced either that the acquisition of the shares was not financed with any debt financing or that the acquiring company has a lower debt-to-equity ratio than the group to which it belongs (within the meaning of Article 212-III of the French tax code).

Scope of application

Even though the initial goal for the introduction of these rules was to prevent the artificial use by a foreign group of a French vehicle for the leveraged acquisition of foreign entities, the terms of the newly enacted law are sufficiently broad to apply to any kind of transactions performed by a French vehicle, including the acquisition of French targets.

Moreover, as for the possible demonstration that the rights over the shares and, as the case may be, the control and/or influence, are exercised from France to avoid any recapture of interest expenses, it might be required in practice that:

  • both the decisions relating to the acquisition of the shares and the decisions relating to their management with respect to the fiscal year of the acquisition (or the fiscal year opened after January 1, 2012 for acquisitions made during a previous fiscal year) be taken by the French acquisition vehicle (or a French affiliate, as the case may be); and
  • the French acquisition vehicle (or its French affiliate) be provided with appropriate substance evidencing that the rights over the shares and the control or influence are genuinely exercised from France.

At this stage, there is unfortunately very limited information available and no formal or informal guidance issued by governmental authorities regarding the way these new provisions should be construed. Therefore, the exact level of substance that will be required at the level of the French entity to fall outside the scope of the new legislation, as well as the level of influence over the French vehicle (and, indirectly, its subsidiary) and the type of approval rights that may remain in the hands of a foreign parent in this respect are uncertain.

Furthermore, since the new rules would only affect foreign investors using French acquisition vehicles, their compliance with certain EU rules (namely, the free movement of capital and the freedom of establishment) might be questionable for transactions carried-out by EU investors located outside France.

Disallowance for deduction of interest expenses

Where applicable, these new rules will give rise to a recapture of financial expenses incurred on the debt financing deemed contracted in connection with the acquisition of the relevant shares. However, as currently drafted, the application of the non-deduction ratio may lead to overburdening effects under certain circumstances.

First, absent any clear safe harbor in this respect, the new rules may lead to a recapture of financial expenses that already fall otherwise within the scope of other French restrictions applicable to the deductibility of interest, including French thin capitalization rules. As a result, the indebted company might suffer twice a recapture of the same financial expenses for the determination of its taxable income.

Second, the new rules do not provide for any cap on the non-deduction ratio. As a result, if an acquisition of shares is financed with both debt and equity financings, the disallowance for deduction could extend to financial expenses relating to debt financings that were not contracted in relation to the acquisition of shares, or even to a full non-deduction of interest expenses incurred by the relevant company.

Third, as the non-deduction ratio is computed by reference to the initial purchase price of the shares, if the debt contracted to finance such transaction is amortizing, the non-deduction ratio of the French vehicle would deteriorate over the time which, here again, may negatively affect the deduction of interest incurred on debt financings that were not contracted in relation to the acquisition of shares.

Fourth, there seems to be a resilient effect under these new restrictions since the recapture of financial expenses remains apparently applicable during the eight-year period despite (i) any disposal during such period of the participation at stake by the French vehicle, (ii) any change in the nature of the company acquired by the French acquisition vehicle, which might become a real estate company excluded from the scope of the new rules, or (iii) any transfer to the French acquisition vehicle (or a French affiliate) of the actual power to exercise rights over the shares/the control or influence, after the twelve-month period following the acquisition. On the opposite, where sufficient substance has been provided to the French vehicle (or a French affiliate) evidencing that the rights over the shares as well as the control or influence are exercised from France for the fiscal year(s) running over the twelve-month period following the acquisition (or, for transactions completed before 2012, for the first fiscal year opened after January 1, 2012), the new restrictions would — theoretically — continue not to apply over the following fiscal years even though the power to exercise such rights/control or influence was subsequently transferred to a foreign entity (subject to application of French anti-abuse of law rules).

Finally, the question arises as to whether interest expenses paid to foreign lenders could be recharacterized as deemed dividends subject to French withholding tax if they proved to be disallowed for French corporate income tax deduction under these new rules. In addition, it is quite unclear, under such circumstances, how the non-deductible portion of interest should be allocated between the lenders in circumstances where the indebted company is granted loans by several lenders and only a portion of its interest expenses is disallowed for tax deduction and thus how the withholding tax might apply in practice.

Therefore, pending further guidance to be released by the French tax authorities, the application of such new rules will with no doubt raise many practical issues within the next months.

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.

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