In order to develop tax strategies which limit, if not eliminate, the cost of these timing differences, it is necessary to take into consideration the context in which the enterprise operates:
2. Tax context of the group in France
- the French tax context;
- the organisational and financial context;
- and, the international context.
As a first point, optimising the position of a tax profitable company or group of companies would not be achieved using the same methods as for a company or group with structural losses.
Similarly, the method of optimisation would also depend on whether the enterprise had opted for the tax grouping regime or not.
In this perspective, a loss making company should not opt to defer the taxation of gains if significant losses are at risk of expiring.
Similarly, a French group with loss making subsidiaries not forming part of the tax group, or with subsidiaries with pre entry losses, could benefit from locating foreign exchange hedging transactions or long term interest rate hedges in these companies, in order to avoid the immediate payment of tax and to rejuvenate losses of these subsidiaries.
3. Operational and financial context
When the operational context is considered, it becomes evident that the existing tax rules favour companies which operate using long term contracts with their customers or suppliers.
Consider the case of a tax paying French company which does not use long term contracts with its customers or suppliers : if such a company hedges future flows on the basis of projected future cash payments over more than two years it could not benefit from the mechanism of deferring taxation since such a deferral is conditional upon the hedged transaction having originated from a precise and measurable agreement with a third party.
Hence the idea of using a contract with a foreign subsidiary, as an alternative to simply hedging predicted future flows.
If a French company signs a long term contract with one of its subsidiaries in an exporting or importing country, it could argue that a long term contract exists and could therefore validly opt for deferral of gains.
On a different note, also related to the nature of the financial instruments used, it is always preferable for a company seeking to defer the taxation of latent gains to use a financial instrument rather than using cash strategies since the latter does not benefit from tax deferral.
Similarly, it can be beneficial for a company to use insurance mechanisms instead of financial instruments or specific instruments that are difficult to value at the year end.
For example, optional instruments carrying a specific barrier, or forward contracts subject to particular conditions could be considered.
4. International organisational context
The French tax context is not always favourable to companies seeking to actively manage their interest rate or exchange rate risk.
In this perspective, the enterprise should not rule out the possibility of delocalising all or part of the exchange risk abroad.
In fact, the diversity of tax systems in force in the different countries in which the enterprise is likely to operate can enable the company to optimise its global tax position. For example, in some countries (Belgium, Netherlands, Germany, Denmark) latent gains are not taxed whilst losses are deductible.
In this case, the enterprise should consider locating exchange risk in its foreign subsidiaries or locating the hedging transaction there.
Subject to the Section 209-B provisions, it may also consider locating hedging transactions in ad hoc structures (Belgian co-ordination centres, Irish IFSC, Dutch BV with Swiss branches).
5. Tax optimisation
As we have seen, French companies can encounter a certain number of difficulties in achieving tax neutrality with their hedging strategies.
However, financial instruments can also be an excellent means of tax optimisation.
As an example, loss making companies can renew their losses by using symmetrical positions reversed at the year end ( purchase / sale of the same "future" or the same option).
Tax profitable companies can similarly use their hedging instruments to reduce their taxable profits.
They can take opposite financial positions on instruments which are outside the scope of the mark to market rule and the rule of deferring the deduction of losses. For example, by operating on the commodities markets. The same would be the case for hedging against the risk on shares in foreign subsidiaries.
To finish, it should be noted that financial instruments have traditionally been little used in France as strategies for optimising withholding tax. Indeed, French domestic law exempts most interest payments made to non resident beneficiaries from withholding tax.
However, equity swaps have recently been used in place and instead of the famous "usufruct transactions" as a mean of continuing to realise transactions which transfer the avoir fiscal between residents and non residents, or between non residents.
On the other hand, credit institutions may improve their VAT pro rata ratio and therefore their annual VAT deductions in using swaps contracts with non-EC counterparts. Doing so, they are able to benefit from the favourable provisions of the 6th Directive relating to financial transactions effected with counterparts outside the EC.
6. In conclusion
France has a modern tax system which is well adapted to market techniques, even though the rules of this system are not always favourable to companies which actively manage their exchange rate and interest rate risk.
The cost caused by the lack of tax neutrality of hedging transactions can be minimised by using adapted strategies either in France or abroad.
Financial instruments can also form the basis of tax optimisation strategies.
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. For additional information contact Claire Acard on +33 (1) 55 61 10 10. The members of ARCHIBALD ANDERSEN Association d'Avocats (S.G. Archibald and Arthur Andersen International) are registered with the Hauts-de-Seine Bar.
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