France: French Tax Report June 2018

Last Updated: 11 June 2018
Article by Siamak Mostafavi

We are pleased to provide you with a summary of certain recent French tax case law and would be glad to discuss with you in more details any of these matters which may be of specific interest to you. Please also let us know if anyone else within your organization would be interested to receive our periodic French Tax Reports.

1. Tax treatment of Interest Rate Swaps (IRS)

The French tax legislation provides various rules to limit the deductibility of interest and financial expenses.

One of these rules, the so-called "rabot," consists in limiting the deduction of the "net financial expenses" (NFE) i.e. the positive difference (if any) between the interest type items paid by the corporate taxpayer and the interest type items received by it. The limitation operates if the NFE amounts to at least €3 million, in which case 25 percent of the NFE would not be deductible (special rules apply in case of tax groupings).

One of the various questions, about the "rabot," is the exact definition of financial expenses and financial income.

Interestingly, the administration had taken the view, in its related published regulations, that the amount paid/received under an IRS should be assimilated to, respectively, financial expenses and financial income.

In a first case decided by a lower court (TA Montreuil 18/01/2018 no. 1702561, Etablissement public régional Espinorpa), the above position of the administration has been rejected.

The court indeed took the view that, in a typical IRS, there is no actual exchange of the underlying national amount between the parties, and, accordingly, the amounts paid or received may not be analyzed as the remuneration for actual advanced funds.

The court specifically underlined that the fact that a given IRS is used to hedge a given borrowing does not result in the IRS payments being treated as financial income / expenses.

Obviously, depending on market conditions, the above decision may be in favor of the taxpayer or may create a disadvantage. It should be noted, however, that as long as the above regulation has not been modified, it remains binding for the administration, and the taxpayer may rely upon it when it is in its favor.

2. Dividends Participation Exemption (PE)

French resident corporate tax payers may benefit from the PE in respect of certain dividends received from French and foreign sources. The PE is, inter alia, conditional upon the full ownership of the shares in the relevant subsidiary, the absence of certain transactions over such shares (e.g. repo, stock lending, collateral) and the non-application of general and specific anti-abuse rules.

The extent of the PE depends, inter alia, on the percentage of participation in the relevant subsidiary:

  • The dividends are 99 percent exempt if they are distributed by a subsidiary which is part of a French tax grouping (i.e., inter alia, the parent owns at least 95 percent of the voting and financial rights in the subsidiary).
  • The 99 percent exemption applies also to dividends received from EU subsidiaries (plus subsidiaries in Norway, Iceland and Liechtenstein) to the extent the relevant subsidiary could have been part of a French tax grouping if it was a French corporate taxpayer (i.e., inter alia, the above 95 percent ownership is met).
  • If the 99 percent exemption is not available, the dividends are still 95 percent exempt if they are distributed by a subsidiary in which the parent owns at least five percent of the share capital (certain specific rules apply when the parent company is controlled by not for profit organizations).

Under the above rules, dividends distributed by non-EU subsidiaries would never be entitled to the 99 percent exemption even if they are 95 percent owned by the French parent.

The constitutionality of this difference of treatment, between French and EU subsidiaries on the one hand and non-EU subsidiaries on the other hand, was challenged before a lower court, and the question was sent before the Conseil constitutionnel.

The Conseil constitutionnel decided that the above difference was justified on the basis, inter alia, that the French tax legislation on French tax grouping was pursuing an objective of general interest, i.e. the constitution of French national groups subject to the 95 percent ownership test (Cons. const., 13/04/18, n° 2018-699, QPC, Sté Life Sciences Holding France).

The justification is debatable, especially since it suggests that the development of French groups outside of the EU would not be an objective of general interest.

Accordingly, for the time being, the effective PE discrimination against non-EU sourced dividends continues.

3. Charasse Amendment

The so-called Charasse Amendment (derived from the name of the French Minister who implemented it) is a specific rule related to the French tax grouping.

In essence, the rule provides that if an entity, member of the tax group, purchases from a person who is not part of the group and who controls the group (or from an entity controlled by such person), the shares of an entity which is or which becomes part of the group, a certain defined fraction of any financial expenses of the group becomes non-deductible (whether or not such financial charges are related to the above purchase) for a defined period (generally until the end of the eighth year following the year of acquisition of the shares).

The application of this rule is automatic, i.e. if the above conditions are met, the relevant financial expenses become non-deductible; the non-deductible financial expenses are obtained by multiplying the aggregate financial expenses of the group by the ratio of the purchase price to the average debts of the group.

It is precisely that automaticity which was challenged before the Conseil constitutionnel, i.e. it was argued that, under the Constitution, the relevant taxpayer should be entitled to provide the evidence that the transaction was not tax motivated and, if it does so, the Charasse Amendment should not be applicable.

The Conseil constitutionnel rejected the position of the taxpayer, by considering that the Charasse Amendment was not creating any presumption of fraud or tax evasion (in which case the taxpayer should have been indeed entitled to evidence the contrary) but rather was just a method to avoid the deduction of financial charges in a case of "sale to itself" (Cons. const. 20/04/18, n° 2018-701 QPC, Sté Mi Développement 2).

In fact, the automatic application of the rule, combined with the non-correlation with any actual financing of the relevant purchase, indicate pretty clearly that the legislation is aimed at preventing tax evasion, i.e. a different court outcome would have been possible.

4. Waiver of debt

Under the relevant French tax rules, a waiver of debt by a French corporate taxpayer may or may not be deductible depending on certain specific criteria. In general a "financial" waiver is not deductible, whereas a "commercial" one is deductible to the extent it amounts to a normal act of management.

Interesting questions are raised when the beneficiary is a non-French tax resident entity. In a case before the Conseil d'Etat, the waiver was treated, in the country of the beneficiary of the waiver, as a contribution of capital accounting wise and non-taxable. The French tax administrative had taken the view that, given the above foreign treatment, the waiver should not be deductible for the French parent.

The Conseil d'Etat sided with the tax payer by considering that the French tax qualification should not be derived solely from a foreign accounting treatment, and in any case the non-taxation under foreign tax law is not relevant, i.e. the waiver and its deductibility should be analyzed by using the standard French tests (CE, 9ème et 10ème ch., 13/04/2018, n° 398271, min. c/LVMH, Moët Hennessy Louis Vuitton).

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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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