The last 10 years have witnessed an unprecedented transformation in global financial and banking spheres. Legal and regulatory environments, both domestic and international, have been gradually liberalised and the EU has had a profound effect as exchange controls have been abolished. New markets have been created in France.
A STRONGLY REGULATED ACTIVITY
Banking activities are strongly regulated in France. They are governed by the 24 January 1984 Act, commonly referred to as 'the Banking Act', which also specifies the means of supervision of the 2,000 or so institutions making up the French Banking System.
The Banking Act gives an extensive definition of the banking operations and consequently of the 'credit institutions' which need a licence and which are subject to a specific supervision. It defines the framework in which the banking business operates and divides the regulatory and supervisory functions between three distinct bodies.
The Comite de la Reglementation Bancaire (The Banking Regulatory Committee - CRB) is chaired by the Minister of Economy and Finance, with the Governor of the Banque de France as vice-chairman. The Committee consists of four other members appointed for a three-year term, one of whom represents the French Credit Institutions Association (AFEC).
The CRB has very broad statutory power to lay down general regulations applicable to all credit institutions. It is entitled to define the capital requirements, the conditions applicable to banking operations, management standards, accounting rules, reserves requirements and so on.
The Comite des etablissements de Credit (The Credit Institutions Committee - CEC) has statutory powers to take individual decisions affecting credit institutions. It grants licences to new institutions and authorises main changes in the licence conditions (such as changes in the legal form, ownership or type of activity).
Criteria taken into account include the business program of the company, its proposed technical and financial resources and the suitability of the persons investing capital and their eventual guarantors. It will also assess whether the required minimum of two directors have the necessary integrity and experience for their duties.
The Committee is chaired by the Governor of the Banque de France; it consists of the Directeur du Tresor (Head of the Treasury at the Ministry of Finance) and four other members appointed for a three-year term. When it examines the situation of an individual institution, the Committee is also attended by a representative of the professional association or central organ to which that institution is either affiliate or eligible to belong.
The Commission Bancaire (The Banking Commission - CB) is responsible for the supervision of the credit institutions. It has statutory powers to take disciplinary actions against any contravention to the Banking Act and to the regulations established by the Banking Regulatory Committee.
It examines the operations of the credit institutions and monitors the soundness of their financial situation through periodic reports transmitted by the credit institutions and through on-site examinations.
The reporting requirements, such as BAFI reports, are onerous. The Commission Bancaire also requires the reporting of a whole set of ratios such as: European solvency ratio, liquidity ratio, high risks division ratios, compulsory reserves (reserves obligatoires), etc. Some of them stem directly from European Directives.
The Commission Bancaire is chaired by the Governor of the Banque de France and consists of the Directeur du Tresor (Head of the Treasury) and four other members appointed for a six-year term.
BUSINESS ORIENTED ACCOUNTING REGULATION
Accounting regulation relies on the principle of nominalism and prudence. Assets and liabilities are generally recorded on the balance sheet at their nominal value or purchase price and results are registered as a profit or loss on an accruals basis. An allowance for losses is made where the value of assets falls below cost price or nominal value.
However, as credit institutions have expanded their role in the activities of financial markets, so general regulation has proved to be somewhat inadequate. As a result, a new set of specific rules has been released. Bonds, securities, off-balance sheet commitments (such as swaps, caps, floors, futures and options) may under certain circumstances be accounted for either on a market-to-market basis, at a lower of cost or market basis or on an accrual basis. The accounting mode will vary depending upon the liquidity of the market and the management goal (hedging or trading).
A GLOBALLY FAVOURABLE TAX ENVIRONMENT
The ordinary tax rate is currently fixed at 33.33% having been progressively reduced recently. Capital gains on certain fixed assets held for more than two years may benefit from a reduced rate of 19%.
The corporate tax system is not schedular and provides for the offset of different types of income and expenses. Moreover, under French tax law, the deductibility of an expense or a reserve does not depend on whether the proceeds to which it has contributed are taxable or not.
Strictly speaking, French tax law does not provide for any thin capitalisation rules. However, there are some limits on the deductibility of interest on amounts borrowed by a French company from its shareholders.
Regulations also exist to ensure the tax neutrality of mergers, spin-offs or partial contributions of assets or to permit the consolidation of profits and losses inside groups of companies. However, goodwill is not tax deductible.
In respect of other taxes, VAT and business tax may be a burden on French companies engaged in financial and banking activities. In particular, non-deductible VAT can be a significant burden when most of the turnover is VAT exempt.
In respect of the tax authorities, it is not usually possible to obtain advance rulings other than in specific cases provided for by law. However, when financial and banking transactions are involved, there may be a departure from this practice. Additionally, transactions that are either fictitious or carried out only with the objective of tax evasion may be reclassified.
Finally, the tax regime relating to financial institutions is characterised by the co-existence of outdated provisions and new texts. In this respect, recent regulations have aimed to reconcile taxation and accounting rules (eg, securities portfolios, financial derivatives etc) to enable tax neutrality for certain specific transactions and to prevent domestic tax evasion (eg, deep discount securities, UCITS units etc). Indeed, whilst the French legislation appears flexible in permitting the adaptation of direct taxation to market innovations, it has not neglected the risks of tax evasion. For this reason, anti-avoidance measures have recently been strengthened.
A SPECIAL APPROACH TO CROSS-BORDER BANKING AND FINANCIAL TRANSACTIONS
French tax law uses a domestic law or tax treaty territorial principle which means that relations between head office and foreign branches of banks are treated in the same manner as transactions between two distinct legal entities. Profits yielded outside France by French enterprises are not taxable in France. Conversely, the losses sustained in foreign branches cannot be deducted from French tax, unless a ruling is obtained to apply the worldwide consolidation regulations. Intra-group transactions, whatever their nature, are subject to taxation.
In fact, the diversity of tax principles is likely to mean a lack of tax neutrality for traditional banking transactions and for more sophisticated transactions such as global trading operations.
Indeed, the refusal of foreign tax authorities to accept certain items as deductions is unlikely to prevent the corresponding proceeds being taxed at the French head office level. But the deduction of certain expenses at a foreign branch level does not systematically entail their taxation at French head office level.
ADVANTAGES OF ENGAGING IN FINANCIAL TRANSACTIONS IN FRANCE
The French financial and banking taxation system enables France to play a central role in the organisation of international banking groups and to participate in the creation and structuring of financial products and complex techniques.
Particular advantages include the taxation of dividends, the deduction of financial expenses, the reduced rate applicable to long term capital gains and the absence of withholding tax under domestic law on interest paid abroad. France may therefore be an attractive site for holding companies.
In addition, in the context of France-US structures, the use of French partnerships which have opted for corporate tax may be beneficial for a loss-making activity. Use of tax credits is also flexible and France offers considerable possibilities for optimisation in the context of double-dip leasing transactions.
CONCLUSION
Within a strict regulatory framework designed to ensure a reliable and uniform banking system, accounting has evolved towards a more business-oriented mode of registration of financial market activities. However, it remains based upon the respect of the principle of prudence.
Despite remaining difficulties in achieving tax neutrality and complete harmonisation between tax and accounting methods, the fiscal environment is relatively well adapted to the technical nature of the financial and banking transactions carried out by financial enterprises established in France.
For further information contact Olivier Drion on +33 1 49 01 37 85.
The context of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.