France: French Tax Update - Early 2015 Noteworthy Case Law And Tax Transparency Package

Last Updated: 10 April 2015
Article by Nicolas André and Alexios Theologitis

The present French Tax Update will focus on (i) several noteworthy French and European Union court decisions issued in the last months of 2014 and in the first months of 2015, and (ii) the recent presentation by the European Commission of a package of tax transparency measures. 


France has signed a number of tax treaties with a so-called "tax spare" mechanism, i.e., a provision whereby a certain flow of income from a foreign source (e.g. interest, dividends, royalties) is deemed to have suffered a foreign withholding tax (WHT), and, as per the terms of the relevant treaty, the French recipient of the income is entitled to a tax credit equal to the deemed WHT.

The actual availability of the tax credit depends on the exact wording of the relevant treaty. In a landmark decision in 2006, the Conseil d'Etat had decided, in the case of the Brazilian-French treaty, that the tax credit would be available only if the relevant income had been subject to Brazilian WHT (be it a de minimis one), i.e., the Supreme Court had decided that no tax credit would be available in the total absence of WHT. The decision had been criticized as it seemed that it had been against the spirit of the tax spare mechanism, i.e., to encourage French investors to invest in the Brazilian economy.

On February 25th, 2015, the Conseil d'Etat issued a new ruling on the interpretation of the tax spare mechanism in various tax treaties, namely those with Argentina, China, India, Indonesia and Turkey. The wording of the tax spare mechanisms in these treaties is different from the Brazilian one, and the Conseil d'Etat decided that the tax credit may be available even if no WHT has been levied in the source country.

However, on the basis of the actual wording of the treaties, a distinction was made by the Conseil d'Etat between the Chinese treaty and the other treaties. In the case of the Chinese treaty, the Conseil d'Etat ruled that the taxpayer is automatically entitled to the tax credit, as the relevant income is deemed to have been subject to the WHT. In the case of the other treaties, the Conseil d'Etat decided that the tax credit is available only if the exemption from WHT is the consequence of a specific local legislation which enacts such exemption to encourage the investment by French investors in the local economy (i.e., the WHT would have been due in the absence of such legislation).

Accordingly, a practical issue arises, which is one of proof that the exemption from WHT is, indeed, the result of a specific legislation to encourage foreign investment. The Conseil d'Etat decided that it is for the French resident investor to provide such proof, and that if no such proof is provided, no tax credit would be available. Thus, contrary to the classic situation where the taxpayer has to prove that it has suffered a WHT and is entitled, accordingly, to a tax credit, the application of certain tax spare mechanisms implies that the investor has to prove that the exemption of WHT was the consequence of a specific local legislation. 


A PEA is an individual investment plan where, subject to certain conditions, the relevant individual taxpayer enjoys an income tax exemption in respect of any capital gain and/or income derived from the eligible equity securities managed within the PEA. Among other conditions, the transfers made to the PEA may not exceed a certain amount, e.g., currently a maximum of € 150,000 (€ 300,000 for a couple) for the standard type of PEA (PEA Cap).

The Conseil d'Etat had to deal with a situation in which the French tax authorities (FTA) used the abuse of law procedure to argue that the relevant individual should not be entitled to the PEA exemption.

The facts were, in summary, as follows: the individual had purchased the shares of an entity (in which he was acting as a managing director) from the parent company of the entity, and transferred the shares to a PEA. Approximately nine months later, the shares were sold to a third party for a sale price of nearly eight times their acquisition cost, and the individual claimed the PEA exemption in respect of the resulting capital gain.

The FTA argued that the individual had purchased the shares for an amount significantly lower than their fair market value, and maintained that the difference should be taxed as salary (the Conseil d'Etat agreed with the taxpayer that the FTA had not evidenced that the purchase price from the parent company was lower than the market value given the characteristics of the transaction).

The FTA also argued that, at the time of transfer of the shares to the PEA, their value exceeded the PEA Cap, and, accordingly, they were not eligible to the PEA. More precisely the FTA argued that the individual knew that the PEA Cap had been exceeded, and by transferring the shares to the PEA, he had no other motivation than to avoid the taxation which would have taken place outside of the PEA upon the subsequent sale of the shares. The Appeal Court had decided in favor of the individual, arguing that the individual was not aware, at the time of transfer of the shares to the PEA, of the fact that the third party was negotiating the subsequent purchase of the shares and, accordingly, he had not used the PEA with a tax motivation. The Conseil d'Etat sided with the FTA by determining that the Appeal Court should have verified whether the individual, at the time of the initial purchase, knew the fair market value of the shares and, accordingly, had deliberately circumvented the PEA Cap rules upon the transfer of the shares to the PEA.

For the Conseil d'Etat, the abuse of law does not consist in the use of the PEA by the individual (i.e., the PEA, by definition, has been enacted in order to provide a tax-exempt environment), but rather in the possible undervaluation of the shares, at the time of their transfer to the PEA, in order to avoid the PEA Cap.


Article 57 of the French tax code (FTC), which is basically the transposition of Article 9 of the OECD Model Tax Convention, provides that, in order to determine the income tax owed by companies that either depend on or control enterprises outside France, any profits indirectly transferred to those enterprises are added back into the taxable income of such companies. Such Article may be applied only in relation to cross-border transfer pricing issues, and its enforcement requires that the FTA prove that (i) a dependent relationship existed between the relevant parties (except where the non-French enterprise is located in certain low-tax jurisdictions), and (ii) a transfer of profits effectively occurred.

In principle, the burden of the proof rests with the FTA. However, in practice, once the FTA have demonstrated the existence and amount of an advantage provided to a non-French related enterprise, the transfer of profits is deemed characterized. In a recent decisions (CAA Nancy, March 5, 2015, n°13NC01875), the Nancy Court of Appeals has provided a practical illustration of the elements that have to be gathered in order for the taxpayer to overturn the transfer presumption.

A French company had paid the salary of the manager of its wholly owned Chinese subsidiary. The FTA considered that such payment should not have to be borne by the French parent company (but rather by the Chinese subsidiary), and thus challenged the deductibility of the salary for tax purposes under Article 57 of the FTC.

The French company argued that its Chinese subsidiary had been created in order to take advantage of a growing market and that it was in its own interest to financially assist its start. However, both the Châlons-En-Champagne Lower Administrative Court and the Nancy Court of Appeals ruled that, while it is possible for the French company to demonstrate that the indirect transfer of profits was justified by a normal management and gave rise to a significant consideration, the elements produced by the taxpayer were not sufficient, in the case at hand, to establish that the payment of the salary of the Chinese subsidiary's manager was required in its own interest. 


Under Article 256 of the FTC, any delivery of goods or provision of services by a VAT-person and for a consideration is subject to VAT. In particular, the first paragraph of Article 256-IV of the FTC specifies that the undertaking to refrain from doing something or to bear with a certain situation may be regarded as a provision of services.

For the past few years, the French tax authorities have consistently held that a commercial lease agreement – whereby the parties agree to a rent adjustment and a waiver of the legal right to terminate the commercial lease agreement (after every period of three years) – actually amounts to an exchange of services under Article 256-IV of the FTC. The FTA thus reassess taxpayers on the basis that (i) the lessor provides a service to the lessee when it grants the rent adjustment, and (ii) the lessee provides a service to the lessor when it grants the waiver (the value of such service being the same as the rent adjustment).

Few case law decisions have so far been issued on this point in order to provide taxpayers with comfortable arguments.

In a March 2013 decision (CE, March 30, 2013, n°346990), the Conseil d'Etat had ruled, in the context of the early termination, by the lessee, of a long-term car lease, that the indemnity paid by the lessee (equal to the difference between the lease payments remaining due under the lease and the fair market value of the car as at termination) was not subject to VAT.

In a February 2015 decision (CE, February 27, 2015, n°368661), the Conseil d'Etat followed a different approach, this time in connection with the early termination of a real estate lease by the lessor.

A real estate partnership (SCI) had acquired a building that was leased out to another company (Lessee). SCI and Lessee entered into an agreement whereby the lease was terminated in exchange for an indemnity to be paid to Lessee. The FTA considered that SCI could not recover the input VAT attached to such indemnity. The Paris Court of Appeals considered that this indemnity had been paid with the sole purpose of indemnifying Lessee from the early termination. As the indemnity did not amount to the price of a provision of services, the corresponding input VAT could not be recovered.

The Conseil d'Etat took a different view and ruled that the vacating of the building that followed the termination of the lease in exchange for an indemnity should be regarded as a provision of service for VAT purposes (the associated consideration being the opportunity for SCI to find a new lessee and to charge a higher rent). As a result, the indemnity had to be subject to VAT and the corresponding input VAT could be recovered by SCI.

Although not entirely clear, the decision seems to draw an artificial distinction between lease terminations that are decided by the lessee (not subject to VAT in the absence of any service provision), and terminations that are decided by the lessor (subject to VAT as the early vacating of the building allows the lessor to find a new lessee and to charge a higher rent).


In two decisions dated January 23, 2015, the Conseil d'Etat illustrated the risks to which corporate taxpayers are exposed with regard to the so-called abnormal act of management doctrine (acte anormal de gestion), under which the FTA are entitled to reassess from a tax standpoint the consequences of corporate decisions resulting in expenses or losses not justified by the corporate interest of the company.


The first decision (SAS Rottapharm, nº 369214) involved a French pharmaceutical product distributor (Distributor) that had incurred significant costs related to the promotion of a drug.

The FTA had taken the view that these promotional costs, and the financial expenses incurred in order to cover them, were not justified by the corporate interest of the Distributor and hence needed to be disallowed. The decision was based on the fact that the promotional costs represented 40 to 55 percent of the turnover attributed to the sale of the promoted product, exceeding as such the average level of 12 percent experienced by companies in the pharmaceutical industry.

The FTA had also challenged the fact that the recharge of the promotional costs borne by the Distributor to its Italian parent company was made on a cost price basis. Consequently, the taxpayers' taxable income was adjusted in order to apply a profit margin that was deemed appropriate by the FTA.

Based on the abnormal act of management doctrine, the lower courts had sided with the FTA with regard to the excessive risk taken by the Distributor by incurring the promotional costs, highlighting inter alia that scientific reports had been published during that period calling into question the promoted drug's safety. In addition, the lower courts had taken the view that the recharge of the promotional costs on a cost price basis was not justified by the corporate interest of the company, since the Distributor was unable to establish the existence of an economic or commercial benefit to this absence of profit margin.

Notwithstanding the arguments advanced by the FTA, the Conseil d'Etat ruled in favor of the Distributor and asked the Court of Appeal to reexamine the case, by reaffirming the principle of non-interference. Under that principle, within the limits of the abnormal act of management doctrine, it is not up to the FTA to decide on the appropriateness of the decisions made by the management of companies.

Moreover, and interestingly, the Conseil d'Etat added that the burden of proof with regard to the abnormal act of management doctrine lay with the FTA, the absence of profit margin not being sufficient per se to assume this decision was not taken in the interest of the company.


The second decision (Société Ferrari et Cie, n° 365525) illustrates the difficult dilemma often faced by the Conseil d'Etat, pertaining to the application of the abnormal act of management doctrine in situations involving a parent company and its subsidiary.

While French courts consistently have supported the FTA in refusing to accept the concept of a group interest as the sole justification for a particular advantage granted to a subsidiary, this principle is tempered in cases in which this advantage is justified by business reasons such as the avoidance of the liquidation of the subsidiary or the safeguard of important market opportunities (see our French Tax Update for March 2015 for an illustration).

In the case at hand, the FTA had reassessed the taxable income of a French advertising agency, by disallowing, on the basis of the abnormal act of management doctrine, the deduction of a provision for bad debt pertaining to an interest-free loan granted to its subsidiary.

The Conseil d'Etat sided with the FTA by ruling that the interest-free loan granted by the parent company to its subsidiary constituted an abnormal act of management. The mere fact that the parent company benefited from its subsidiary's customers was not deemed to constitute a sufficient counterpart to such an interest-free loan, since (i) the amount of the loan was obviously disproportionate compared to the commercial benefit arising from the business relationship of the two companies, and (ii) the parent company had not established whether customer loyalty was originated by the subsidiary.

Consequently, the provisions for bad debt pertaining to the interest-free loan granted to the subsidiary could not be deducted from the parent company's taxable income.


Pursuant to the relevant French tax rules, nonresident individuals are subject to social contributions (CSG and CRDS) at a 15.5 percent rate on French-source investment income (such as rental income or real estate capital gains).

A Dutch individual had challenged the application of these French social contributions on his investment income on the basis that pursuant to EU Regulation nº 1408/71 (now replaced by EU Regulation nº 883/2004) a European individual should be subject to only one social security regime and pay social contributions only in that Member State (Unity Rule).

In a February 26, 2015 landmark preliminary ruling (de Ruyter, C-623/13), the European Court of Justice (ECJ) found that the Unity Rule applies not only to social contributions pertaining to employment income, but also to social contributions related to investment income since they contribute to the financing of the French social security regime.

This ruling essentially prevents France from levying social contributions on investment income of individuals already contributing to foreign social security regimes.


As part of its ambitious plan to tackle corporate tax avoidance in the EU, the European Commission presented on March 18, 2015 a package of tax transparency measures (Transparency Package). These proposals will soon be submitted to the European Parliament for consultation and to the Council for adoption, and the European Commission is calling upon Member States to agree on these measures by the end of 2015.  


One of the key measures of the Transparency Package is a proposal for Member States to be required to automatically exchange information on their cross-border tax rulings. Under this measure, national tax authorities will have to share with the tax authorities of other Member States a quarterly report on all cross-border tax rulings that they have issued.

In addition to this quarterly report, the Transparency Package would also introduce an obligation for Member States to issue a report on cross-border tax rulings issued since 2005.

The standard information that Member States would have to include in their reports would include: the name of the taxpayer and group, a description of the issues addressed in the tax ruling, a description of the criteria used to determine an advance pricing arrangement, the identification of the Member States most likely to be affected and the identification of any other taxpayer likely to be affected.

Pursuant to the Transparency Package, Member States will not be able to use commercial secrets as a reason for not automatically exchanging information. If a Member State were not to comply with these rules, the European Commission would be entitled to open an infringement procedure against it. 


In addition to this measure, the Transparency Package outlines a number of other initiatives, such as (i) the public disclosure of certain tax information by multinationals, (ii) the review of the Code of Conduct on Business Taxation in order to take into account sophisticated corporate tax avoidance schemes, (iii) the precise quantification along with Eurostat of the scale and impact of tax evasion and avoidance, and (iv) the repeal of the Savings Tax Directive which has been overtaken by more ambitious EU legislation.

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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Nicolas André
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