France: French Tax Report - October 2018

Last Updated: 15 October 2018
Article by Siamak Mostafavi

We are pleased to provide you with a summary of the most important provisions of the draft French Finance Bill for 2019 (Draft) which is currently before the French Parliament.

1. Limitation on the deductibility of the "net financial expenses" for corporate tax purposes

1.1 Background

The Draft proposes to introduce, from January 1, 2019, certain limitations (Limitations) on the deductibility of the "net financial expenses" or NFE as per the EU ATAD Directive.

Our understanding is that the French Government obtained the right to defer the introduction of the Limitations until 2024 from the EU Commission; nevertheless, it has decided to implement the Limitations starting from 2019 with the official explanation that it will simplify the current various rules on the non-deductibility of interest and assimilated items.

Indeed the current rules, which would be eliminated from 2019, provide different angles to limit the deduction (specific rules apply to French tax groupings):

  • Under the so-called "rabot" rule, 25 percent of the NFE is not deductible, i.e. 25 percent of the excess, if any, of the interest paid by the taxpayer over the interest received by the same; the rabot kicks in if the NFE equal or exceed €3 million.
  • Under the thin capitalization rules, the interest paid by the taxpayer to its affiliates is partly non-deductible if all the following conditions are met:

    • i) The ratio of affiliate debts to own funds exceeds 1.5 times
    • ii) The interest received from the affiliates is less than the interest paid to affiliates
    • iii) the interest paid to the affiliates exceeds 25 percent of the EBITDA of the taxpayer; there are certain exceptions to the above limitation, one being that if the debt to own funds ratio of the consolidated group to which the taxpayer belongs is higher than the latter's one, no limitation would apply; where the limitation does kick in, the deductible amount is the highest one obtained under (i) to (iii) above.
  • Specific non-deductibility rules apply in case of certain acquisitions of participating securities (see below).

1.2 Limitations

The Limitations consist of two sets of rules:

  • The principal rule which limits the deductibility of the NFE at 30 percent of the EBITDA
  • The exception anti-abuse type rule which reduces the deduction to 10 percent of the EBITDA 

1.2.1 Limitation at 30 percent of the EBITDA

The basic rule is that the taxpayer may deduct the NFE up to 30 percent of the EBITDA; no limitation applies if the NFE do not exceed €3 million.

The definition of the NFE is based essentially on the interest paid and received in respect of all forms of money borrowed and lent, but it also includes, inter alia, the following items:

  • Amounts paid under derivative agreements and contracts hedging the borrowings of the taxpayer
  • Currency exchange gains and losses in respect of the loans, borrowings and related agreements
  • Fees related to the guaranties of financing transactions
  • Certain payments under finance leases
  • Any cost or income which may be assimilated to interest or financial income

The EBITDA definition starts with the income liable to corporate income tax (before imputation of any previous tax loss) to which one would add i) the relevant NFE, ii) any amortization (with certain adjustments), iii) any depreciation (with certain adjustments) and iv) gains and losses subject to specific corporate tax rates of 15 percent or 19 percent.

Any NFE, which would not be deductible under the above Limitation, would be 75 percent deductible if the taxpayer has a ratio of own funds to assets which is equal to or lesser than (but not by more than two percent) the one of the consolidated group to which it belongs (Equity Ratio Deduction).

The fraction of the NFE which is non-deductible, in respect of a given financial year, may be carried forward and, during any relevant financial year, deducted up to an amount equal to 30 percent of the EBITDA of such financial year minus the NFE of such financial year. In addition, the unused 30 percent EBITDA portion of a given year may be used during the following five financial years.

A few examples below give an idea of the impact of the 30 percent EBITDA Limitation (the examples do not include any application of the Equity Ratio Deduction.)

Example of a holding entity

Non taxable dividend income 10

Interest paid 10

Interest received none

Under the rabot rule, the entity has an NFE of 10, of which 2.5 is not deductible.

Under the new rule, the entity would also have an NFE of 10, but the EBITDA would be zero1 , i.e. the whole of the NFE would be non-deductible.

Accordingly, the holding, with exempt dividends, was better off under the rabot rule.

Example of a commercial entity

Taxable commercial income 20

Interest paid 10

Interest received 2

Under the rabot rule, the entity has an NFE of 8, of which 2 would not be deductible.

Under the new rule, the holding would also have an NFE of 8, but the EBITDA would be 20 2, and the deductible NFE would go up to 6.

Accordingly, a commercial or industrial activity with EBITDA may be better off under the new rule.

Example of a financial entity

Taxable fee income 1

Interest paid 10

Interest received 8

Under the rabot rule, the entity has an NFE of 2, of which 0.5 is not deductible.

Under the new rule, the entity would also have an NFE of 2, but the EBITDA would be 1 3, i.e. the non deductible NFE would be 1.7.

Accordingly, a financial entity may to worse off under the new rule, although, in principal, these entities are expected to have more financial income than financial expense.

1.2.2 Limitation to 10 percent of the EBITDA

When the taxpayer has borrowed moneyfrom affiliated entities, and such borrowings represent more than 1.5 times its own funds, the Limit is reduced from 30 percent to 10 percent of the EBITDA (fully deductible up to € 1 million).

So, interestingly, while the thin capitalisation rules, mentioned above, are eliminated from 2019, the government is proposing to keep one of its 3 criteria and use it effectively as an anti-abuse rule by dividing by 3 the Limit of deduction.

The 10 percent EBITDA Limitation would not benefit from the Equity Ratio Deduction; it may be avoided only by credit institutions, and for financing transactions belonging to a centralized treasury pool or related to certain finance lease operations.

The ATAD Directive does not provide for such an anti-abuse rule, and it will be interesting to see whether the administration would keep it in the face of mounting lobbying.

1.2.3 French tax groupings

The rules described above would also apply within French tax groupings, the group's NFE being equal to the aggregate of the NFE of each member, and the EBITDA being computed on the basis of the taxable result of the group.

The Equity Ratio Deduction would be available to the tax group, using the group's own funds / assets ratio.

The 10 percent EBITDA limitation may also apply to the tax group using the group's affiliate debts to own funds ratio.

The carry forward of the non deductible NFE would be also available at tax group level, it being said that a new member entering the tax group may not use its previous carry forward NFE within the group.

2. French tax grouping

The Draft proposes various changes to the current French tax grouping rules, in order, generally, to make them compatible with the EU environment.

2.1 Distributions of dividends within the tax grouping

Currently, the dividends which are distributed within the group may have two different treatments:

  • Either they are eligible to the participation exemption privilege in which case they are 99 percent exempt;
  • Or they are not eligible to the participation exemption privilege, in which case they are 100 percent deducted from the group's taxable result (except the dividends distributed by an entity the first financial year it becomes part of the group).

Under the Draft, the above difference effectively would disappear from 2019, since those dividends distributed by an entity within the group (after one year of presence) which are not eligible to the participation exemption privilege, would be deducted from the group's taxable result for only 99 percent of their amount. The same treatment would apply to dividends received, by an entity belonging to the group, from EU entities (plus Iceland, Norway and Lichtenstein) which are liable to a tax equivalent to the French corporate tax and which could have been part of the group if they were liable to French corporate tax.

Finally, the dividends distributed by EU entities (plus Iceland, Norway and Lichtenstein) to a French entity which does not belong to the grouping) would be 99 percent exempt if the French entity and the EU entity could have been part of the same French tax grouping if the EU entity was liable to French corporate tax.

2.2 Taxation of long term capital gains

Currently, any capital gain derived from the sale, within a tax grouping, of certain equity securities entitled to the so-called long term treatment (participating securities) 4  is fully neutralized (until the purchaser or the seller or the securities leave the group). In the absence of the neutralization, such capital gains would have been 88 percent exempt.

The Draft proposes that the above neutralization is eliminated from 2019, and the relevant capital gains are 95 percent exempt.

Conversely, any capital gain on the sale of participating securities, outside a tax grouping, would be 95 percent exempt (rather than 88 percent exempt as currently).

2.3 Waivers of debts and subsidies within the tax grouping

Currently, these waivers and subsidies are neutralized within the group, until one or both of the two entities involved leave the group.

The Draft proposes to eliminate these neutralizations.

The Draft also proposes the neutral treatment of the sale of goods and provision of services within the group (except for the sale of fixed assets).

3. New anti-abuse rule

The Draft proposes to introduce, from January 1, 2019, a new anti-abuse provision applicable to corporate income tax. As with the limitation on the deductibility of the NFE (see 1 above), this provision consists in the implementation of the EU ATAD Directive.

Under the current French rules, the so called "abuse of law" procedure (applicable to various types of taxes) may be used if, inter alia, the tax administration may prove that a given transaction is purely motivated by a tax benefit which is against the purpose of the underlying rules (or that the none tax motivation is de minimis).

Under the new proposed rule, the relevant criteria is the tax benefit as the principal purpose or one of the principal purposes of a given transaction (Tax Purpose), i.e. a more manageable criteria than the abuse of law one (form the administrative perspective).

The consequences of the new proposed rule and the abuse of law are partly different: the latter may result into penalties of up to 80 percent of the tax avoided, whereas the former would not generate any penalty (i.e. the taxpayer would be liable only to the tax and interest).

More precisely, the new rule would entitle the administration to disregard, for corporate income tax purposes, arrangements (or series of arrangements with one or more steps) which have been put in place to achieve a Tax Purpose, and which are not genuine.

Whether a transaction is genuine or not is decided on whether it has been put into place with an economic justification.

Thus, going forward from 2019, a given transaction, liable to the corporate income tax, may be challenged under the abuse of law or under this new anti-abuse rule; the administration would probably use the former where it believes it has a very good case which may result into penalties, and the latter for the cases where the outcome is more doubtful and the Tax Purpose easier to evidence.

4. Patent income

Currently, inter alia, French corporate taxpayers benefit from a reduced 15 percent corporate income tax rate that applies to:

  • Any income resulting from the licensing of patents and patentable rights
  • Any capital gains realized on patents and patentable rights held for at least two years, except when the disposal takes place among affiliated entities

The Draft proposes to modify this favorable tax regime, as from 2019, in an effort to make it compatible with BEPS rules, i.e. conditioning its application to the actual performance by the taxpayer of research and development (R&D) activities in France.

The reduced 15 percent rate would apply, on an election basis only, to any net income derived from the licensing of qualifying patents, after deduction of R&D expenses, and after the application of a ratio comparing: (i) the R&D expenses incurred for the creation, the development, or the acquisition of the qualifying patent, either by the taxpayer or by non-related parties to (ii) the total R&D expenses incurred for the creation, the development, or the acquisition of the qualifying patent. The same treatment could apply, also on an election basis, to any net income derived from the sub-licensing of qualifying patents, and to the net gains derived from the transfer, to unrelated parties, of qualifying patents, two years or more after their acquisition.

The favorable regime would cover exclusively patents.

Footnotes

1 Taxable income = -10 to which one would add the NFE of 10 to arrive at an EBITDA of zero.

2 Taxable income = +12 to which one would add the NFE of 8 to arrive at an EBITDA of 20.

3 Taxable income = -1 to which one would add the NFE of 2 to arrive at an EBITDA of 1.

4 The participating securities refer to an accounting concept, but they include also the equity securities which are eligible to the participation exemption privilege. The long-term treatment is available after a holding period of two years.

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