An extract from The Corporate Tax Planning Law Review, 2nd Edition
The most significant recent changes in the determination of the French corporate tax base focus on the implementation of EU tax rules and amendment of domestic rules to better comply with EU law and implement BEPS recommendations: for example, the limitation of interest deductibility including a full denial in the event of cross-border hybrid mismatch, and the compulsory disclosure to the tax authorities of potentially aggressive cross-border tax structures.
In addition, France has introduced a controversial 3 per cent turnover tax on profits derived by large multinational enterprises of the e-economy from their activities involving French internet users.
i Entity selection and business operationsEntity forms and tax treatment
The French income tax system comprises two main types of business entities: corporate income taxpayers and flow-through entities. Members of corporate taxpayers are exposed to economic double taxation (first at entity level and second through dividend taxation at members’ level), which is somewhat alleviated for individual members through the flat rate taxation of dividends and quasi-eliminated for corporate members through a participation exemption regime. French flow-through entities are not fully disregarded or totally transparent for income tax purposes: they file their own income tax returns based on the tax basis rules applicable to their members (corporates or individuals, or a combination of the two), and, despite the fact that their income is taxed at the level of their members, they retain a certain level of separate personality from a French income tax standpoint. For instance, they are generally considered as tax residents of France under French tax treaties, while non-resident members of French flow-through entities are subject to tax in France on their income share, irrespective of whether the activities of the entity characterise a permanent establishment in France.
Entities organised under the form of société anonyme (SA), société en commandite par actions (SCA) or société par actions simplifiées (SAS) are always treated as corporate taxpayers (except small businesses, which may opt for the flow-through regime for their first five years). Sociétés à responsabilité limitée (SARL) are likewise generally subject to corporate income tax except if fully owned by an individual or by the members of a close family group. By contrast, sociétés en nom collectif (SNC) are generally treated as flow-through, as well as sociétés civiles (unless they carry out commercial activities), but they may elect for corporate income tax. From 2019, such election is not final and can be reversed before the end of a five-year period. Finally, sociétés en commandite simple (SCS) are a kind of hybrid entity: the share of their taxable income inuring to general partners is subject to tax at partner-level (pass-through), whereas the income share of limited partners is subject to corporate income tax at entity level and distributed in the form of taxable dividends. The French tax treatment of foreign law entities is determined on the basis of their legal features by way of comparison with French law entities; the domestic tax treatment in their home jurisdiction is generally irrelevant and no election is permitted to voluntarily change their French tax characterisation.
Qualifying charities and other not-for-profit institutions are exempt from corporate income tax as well as most collective investment vehicles and funds.
Domestic income tax
Corporate income tax is levied at a relatively high rate compared to neighbouring and competing countries, but is planned to decrease from 33.33 per cent to 25 per cent between 2017 and 2022 (the decrease is progressive and slower for large businesses). The rate is generally set at 28 per cent for fiscal year 2020, but temporarily maintained at 31 per cent for large companies. It is assessed on the taxable income, which deviates from the accounting profits by a series of specific tax rules.
The tax losses of corporate income taxpayers may either be carried back and offset against the profit of the prior year (within a limit of €1 million) or carried forward. The carry-forward is not limited in time nor in amount, except if the entity experiences a material ‘change of activity’ leading to forfeiture of its carried-forward tax losses. The offsetting of carried-forward losses against the taxable income of any subsequent year is limited to €1 million plus 50 per cent of the excess of the relevant year’s taxable income over €1 million.
The French corporate income tax system is a territorial one: income generated by foreign permanent establishments of French corporate taxpayers is generally exempt (losses generated abroad are consistently non-deductible in France), whereas dividends from foreign subsidiaries are exempt under the same conditions as domestic dividends.
The territorial corporate income tax principle includes anti-abuse rules to avoid the relocation of activities to low-tax jurisdictions. Profits generated by subsidiaries established in low-tax jurisdictions may be recaptured at the level of their French parent: their income is deemed to be distributed to the French parent and is excluded from the parent-subsidiary exemption. The targeted subsidiaries are those controlled directly or indirectly at more than 50 per cent by the French parent (or at 5 per cent if the foreign entity is controlled by French corporate taxpayers), the profits of which are subject to foreign taxation in an amount lower than 60 per cent of the French tax they would bear if their activities were performed in France. A similar rule applies to foreign permanent establishments enjoying such privileged tax regime. The recapture does not apply with respect to subsidiaries or permanent establishments within the EU (unless if part of an artificial arrangement aimed at circumventing French tax laws), and with respect to other foreign permanent establishments and subsidiaries if their formation or ownership is not principally tax-driven (e.g., if the foreign entity carries out a genuine industrial or commercial activity in its home jurisdiction).
Despite its relatively high corporate income tax rate, France has historically been known for having rather generous tax basis rules, and foreign investors or multinational groups have often structured their operations so as to take advantage of the following:
- No general limitation of the deduction of interest expenses incurred in connection with the ownership of subsidiaries: despite the fact that it produces largely exempt income and capital gains, the acquisition of foreign subsidiaries by a French corporation may be debt-financed and the related interest expense remains deductible from the taxable income of the acquirer (in respect of its tax consolidated group). The erosion of the French tax base through the debt-financed acquisition of foreign subsidiaries has been used as a tax-efficient tool by multinational groups, provided that the resulting group structure has a valid business rationale.
- R&D tax credit: enterprises conducting qualifying R&D operations in France are entitled to a corporate income tax credit equal to a fraction of the corresponding expenses (based on the yearly amortisation of dedicated R&D assets, the wage costs of researchers and certain subcontracting expenses). The credit is equal to 30 per cent of qualifying expenses (5 per cent for the fraction exceeding €100 million); it can be offset against corporate income tax and is eventually refunded after three years.
- Reduced tax rate for IP income: royalty income and gains from the disposal of qualifying patents, software and assimilated IP rights (excluding trademarks) enjoy a reduced 10 per cent corporate income tax rate, even in intra-group situations, thus creating an incentive for multinational groups to locate their IP in France. The fraction of the net income derived from royalties or gains eligible for the 10 per cent tax rate is reduced in the proportion of the related R&D expenses and acquisition costs that are paid to affiliates of the French company outside of France (the ‘nexus approach’).
- A variety of industry-specific corporate income tax credits are available: for example, for the film and music industry, electronic games and live entertainment.
- Tax depreciation: yearly depreciation allowances for industrial assets are allowed for tax purposes in excess of those recognised for accounting purposes, including massively for certain favoured investments such as industrial robots, 3D printers or low-emission vehicles.
Deductibility of interest expense
France is limiting the deductibility of net interest and assimilated expenses to the higher of €3 million or 30 per cent of the adjusted tax EBITDA of the entity (those limitations are reduced to €1 million and 10 per cent for the interest paid on loans granted by affiliates in an undercapitalised entity). Excess interest is denied but may be carried forward indefinitely, while an excess deduction capacity can be carried forward for five years. Under a safe harbour rule, 75 per cent of the denied interest may be deducted if the entity is not more leveraged than the group to which it belongs (defined as the group of French and foreign entities filing consolidated financial statements) or if it does not belong to a group filing consolidated financial statements and has no foreign permanent establishment (a ‘stand-alone’ entity).
Interest paid to affiliates may be deducted to the extent it does not exceed the rate that would be applied by a bank lending in the same conditions (failure to provide proper evidence results in deduction being capped to a statutory rate based on bank rate statistics – e.g., 1.32 per cent for the fiscal year ending 31 December 2019).
From 2020, France has implemented the ATAD II Directive and enacted measures to avoid hybrid mismatches, in particular to deny the deduction by French borrowers of interest that is not included in the taxable income of a foreign lender and to ensure taxation at the level of a French recipient of income that was deducted as interest by the foreign payer, in particular where the mismatch is caused by a difference in characterisation between France and the relevant foreign country of the financial instrument itself (hybrid instrument) or of the entity paying or receiving the interest (hybrid entity). The rules also prevent the double deduction of the same interest expense by two separate taxpayers in France and abroad. Although those measures generally focus on intragroup payments, their scope includes third party payments under certain structured arrangements. They also include provisions (imported hybrid mismatch rule) to limit the deduction of interest paid by a French borrower to a foreign lender that is taxable on such interest but borrows in turn under a hybrid mismatch arrangement whenever the home jurisdiction of the foreign lender does not itself prevent deduction under similar anti-hybrid rules.
ii Common ownership: group structures and intercompany transactionsTax treatment of income from subsidiaries
The economic double taxation of a subsidiary’s profits is avoided through the parent-subsidiary regime, which exempts dividends received from a qualifying subsidiary in which the parent holds and keeps for at least two years a participation representing at least 5 per cent of share capital. The same applies to dividends received from foreign subsidiaries (as a corollary, no foreign tax credit is available for the underlying foreign corporate income tax or dividend withholding tax). However, a lump-sum amount (a ‘service charge’) shall be recaptured into the taxable income of the parent company, which represents the expenses that it is deemed to have incurred in connection with the receipt of the dividend. That service charge is equal to 5 per cent of the dividend, reduced to 1 per cent for dividends paid within a consolidated tax group (or received from a subsidiary established in another EU Member State, which could have been tax consolidated with the recipient had it been French).
Domestic tax consolidation of affiliated corporations was initially available only to French corporate taxpayers and their 95 per cent subsidiaries held directly or through an uninterrupted chain of other group members. Consistent with the territorial principle of corporate income tax, the tax consolidation system does not extend to foreign subsidiaries or permanent establishments. It has been progressively enlarged to now include 95 per cent French subsidiaries held through an intermediate entity established in another EU Member State and to allow for the formation of a French consolidated tax group between the French direct or indirect 95 per cent subsidiaries of a single foreign parent established in another EU Member State. Specific measures have been introduced to allow consolidated tax groups involving a UK entity as parent or intermediate entity to restructure, with a view to preventing Brexit from triggering automatic termination of the French tax consolidation regime.
The main benefit of tax consolidation lies with the pre-tax combination of the individual profits and losses generated by group members, with the parent company paying corporate income tax on the net combined amount (or reporting, and carrying forward, combined net losses). The tax burden may be contractually shared among group companies as they wish, subject only to individual corporate benefits constraints. Domestic transfer pricing rules are somewhat relaxed within consolidated tax groups: sales at cost are allowed. Capital gains and losses on intra-group transfers of assets (other than shares in subsidiaries) are neutralised.
Most other historical benefits of the tax consolidation regime have been eliminated effective 2019 in an effort to secure compatibility with EU law. The removed features include the full exemption of dividends received from consolidated subsidiaries without any ‘service charge’ recapture, the neutralisation of intra-group subsidies and debt forgiveness and the deferral of gains on intra-group transfers of subsidiaries’ shares.
Tax consolidation comes with some drawbacks: in particular, most thresholds for unfavourable tax measures targeting large businesses are assessed globally at the level of the tax consolidated group (e.g., for the limitation of net interest deductibility, the €3 million allowance applies at group level and not at the level of each consolidated subsidiary). The use of flow-through entities may therefore be more tax-efficient than tax consolidation in certain instances. This is particularly true where tax consolidation is not available (e.g., for the formation of joint ventures where the 95 per cent ownership threshold may not be reached).
Tax consolidation is widely used for leveraged acquisitions. Provided that at least 95 per cent of a target corporation is acquired, investors would typically form a dedicated debt-financed acquisition vehicle in France that would subsequently elect to form a consolidated tax group with the target. As a consequence, the tax losses of the acquisition vehicle (consisting of interest expenses) may subsequently be deducted on a pre-tax basis from the operating profits of the target subsidiary. Reaching the 95 per cent threshold is therefore key to the efficient tax structuring of a leveraged acquisition in France: activists are known for interfering in tender offers on French-listed target companies and acquiring shares with a view to reaching the 5 per cent threshold and blocking the formation of a tax consolidated group. They are subsequently in a position to resell their shares at a premium to the acquisition vehicle in view of the tax savings resulting from tax consolidation.
A specific anti-abuse rule aims to avoid tax optimisation through intra-group leverage or releverage transactions. If the controlling shareholders of the acquiring entity and the historic controlling shareholders of the target company are ‘related’, the interest deduction of the consolidated tax group as a whole is limited for eight years in the proportion that the purchase price paid for the target shares bears to the total liabilities of the members of the consolidated tax group.
International intercompany transactions
French source dividends paid to non-residents are subject to withholding at source at 12.8 per cent for individuals and 28 per cent for corporate taxpayers, subject to tax treaties. Dividends paid to a 10 per cent parent company within the EU are exempt under the EU Parent-Subsidiary Directive.
The profit generated by the operations of the French permanent establishment of a foreign corporation is subject, on top of regular corporate income tax, to a ‘branch profit tax’ levied at the same 28 per cent rate. This tax is, however, eliminated under most tax treaties and with respect to the French permanent establishments of EU corporations.
French source interest payments are generally free from withholding at source.
Payments made by a French enterprise to a non-resident in consideration for services provided or used in France are subject to withholding at source at the rate of 28 per cent. With the exception of payments qualifying as royalties, such withholding is avoided under most tax treaties provided that the foreign beneficiary does not maintain a permanent establishment in France where the services are performed.
By way of exception, dividends, interest and fees paid to a resident of, or on a bank account opened in, a non-cooperative state or territory, are subject to withholding at 75 per cent.
Commercial transactions between domestic affiliates generally may not deviate from market prices or valuations, or they may be challenged by the French tax authorities under the general ‘act of abnormal management’ theory. Belonging to the same group of companies is not a valid excuse, except within a consolidated tax group where most transactions at cost are respected. Taxable income may be corrected by the tax authorities for identified pricing excesses or shortfalls that are, further, treated as constructive distributions, including for dividend withholding tax purposes.
The same principles apply in a cross-border context pursuant to the broadly equivalent transfer pricing rules embedded in domestic and treaty laws. To ensure proper enforcement and efficient auditing of transfer prices, large enterprises or groups must prepare and keep available (or even yearly attached to their tax returns) comprehensive transfer pricing documentation. Country-by-country reports must also be prepared by multinational groups.
In addition, payments for services of any nature made to beneficiaries established in a low-tax jurisdiction are deductible only under satisfactory evidence that the service was actually provided and that its remuneration was not excessive.
iii Third-party transactionsSales of shares or assets for cash
Except within a consolidated tax group, capital gains on the disposal of corporate assets are subject to corporate income tax at the ordinary rate, while capital losses are deductible from the income taxable at the same rate. France does not apply a general tax deferral to like-kind exchanges of assets.
However, qualifying long-term capital gains on the disposal of shares of subsidiaries are exempt from corporate income tax. A lump-sum, equal to 12 per cent of the exempt gain, which is deemed to represent the expenses borne by the corporate seller to generate the exempt gain (the ‘service charge’), is recaptured in the taxable income. As a corollary, long-term capital losses are non-deductible. This exemption regime applies to shares in qualifying subsidiaries (generally requiring a minimum 5 per cent shareholding) held for at least two years before disposal. Certain investments are excluded from the long-term capital gains exemption regime: for example, shares in investment funds or real-estate predominant entities.
Gains from the disposal of shares in a subsidiary held for less than two years are not eligible for the exemption, but capital losses are not tax deductible if the purchaser and seller are related (unless and until the target shares are eventually sold to an unrelated buyer before expiry of the two-year period).
Tax-free or tax-deferred transactions
Tax deferral is generally available for gains recognised in a reorganisation transaction, both at corporate level (latent gains on corporate assets) and at shareholders’ level (latent gains on exchanged shares). It only applies to transactions involving corporate income taxpayers (flow-through entities are excluded from the tax-favoured reorganisation regime).
The tax-favoured reorganisation transactions include:
- legal mergers, whereby an absorbed entity is dissolved and transfers all its assets and liabilities to another (absorbing) entity, in exchange for the direct remittance to the shareholders of the absorbed entity of shares of the absorbing entity;
- legal demergers, whereby a demerged entity is dissolved and transfers all its assets and liabilities to two or several receiving entities, in exchange for the direct and pro rata remittance to the shareholders of the demerged entity of shares of each of the receiving entities;
- partial contributions, whereby a contributing entity transfers to another entity assets and liabilities forming a complete and autonomous branch of activity, in exchange for the remittance to the contributing entity of shares of the receiving entity. Partial contributions may be followed by the distribution or attribution to the shareholders of the contributing entity of the shares it received from the receiving entity; and
- share-for-share exchanges: the partial contribution regime also applies where the transferred assets consist of a controlling interest in another entity (which need not be a corporate income taxpayer).
The above cases apply provided that the consideration consists only of shares or boot in cash not exceeding 10 per cent of the nominal value of the received shares.
At corporate level, latent gains on the transferred assets are deferred with a roll-over of tax basis resulting, if the transaction is recorded at fair market values pursuant to compulsory accounting regulations, in a permanent tax/book difference and a tax recapture of the excess fraction of the yearly depreciation allowances. The holding period of transferred assets, whenever relevant for tax purposes, is also carried over.
The corporate tax deferral is further subject, in the case of a legal demerger, to the condition that each of the receiving entities receives from the demerged entity at least one complete and autonomous branch of activity.
Tax losses carried forward by an absorbed or demerged entity are generally forfeited, unless a tax ruling is obtained for their transfer to the receiving entity. Such ruling is granted provided that the transaction benefits from the tax-favoured reorganisation regime, that the loss-making entity did not experience a material change in its operations during the loss-generation period and that the receiving entity commits to maintain the received activity unchanged for three years. Losses generated by holding activities or from the ownership of real estate may not be transferred. In a partial contribution, the fraction of the tax losses of the contributing entity germane to the contributed branch may likewise be transferred.
Tax losses carried forward by the receiving entity itself may be forfeited if, as a result of the transaction, it experiences a significant change of activity. The same applies to entities transferring a branch of activity in a partial contribution. In such cases the losses may, however, be preserved under a tax ruling if the transaction is not tax-driven and is necessary to safeguard the activity and preserve employment.
At shareholders’ level, the share-for-share exchange is subject to compulsory tax deferral with roll-over of tax basis for individuals and may be deferred upon election by corporate income taxpayers. If, after a partial contribution, the shares of the receiving entity are distributed or remitted by the contributing entity to its own shareholders, these do not recognise any taxable income or gain provided that they occur within one year from the contribution and that the contributing entity retains at least one complete branch of activity.
A similar share-for-share tax deferral is available to shareholders of public companies tendering shares in an exchange offer.
Capital gains derived by non-residents from the disposal of their participation in a French company are subject to French tax only if: (1) the value of the target company derives principally from the direct or indirect ownership of French real estate, other than real estate used for its own business activity; or (2) the seller owns a participation in excess of 25 per cent (dividend rights only) in the target entity.
Tax deferral in the above reorganisation transactions is also available at shareholders’ level to non-residents if their latent gains would otherwise fall within the territorial scope of French capital gains taxation, and to the French-resident shareholders of foreign entities experiencing foreign law reorganisation transactions similar to French tax-favoured ones.
The tax-favoured reorganisation regime also applies at corporate level to cross-border transactions involving both French and foreign corporate taxpayers, provided that these transactions have the same legal features and that the foreign entity is established either in the EU or in a foreign jurisdiction that has concluded with France a tax treaty providing for administrative assistance. This covers for instance the merger of a French corporation into a foreign absorbing entity or the partial contribution of a branch of activity by a French corporation to a foreign receiving entity, as well as symmetrical transactions. Foreign entities receiving a French branch of activity in those transactions must, however, form and maintain a permanent establishment in France to preserve the French tax base.
Finally, the transfer of the registered seat of a French entity to a foreign jurisdiction generally entails the same consequences as a corporate wind-up (taxation of latent gains, recognition of liquidation proceeds by the shareholders). However, whenever the transfer is to another EU Member State, it generally triggers no tax consequences provided that all assets remain booked in a French permanent establishment of the migrating entity. If some assets are not maintained in a permanent establishment but, rather, transferred from France to the new foreign head office, the corresponding latent gains are immediately taxed (the payment of the corresponding tax may be spread over five years).
From 2020, the payment of corporate income tax on latent gains recognised with respect to isolated assets of a French corporate taxpayer that are transferred outside of France to a foreign permanent establishment of the same taxpayer located within the EU may likewise be spread over five years.
iv Indirect taxesRegistration duties
Direct sales of business assets located in France (asset deals) qualify as sales of a going concern insofar as they imply the transfer of a customer base and, as such, trigger transfer duties at 5 per cent. Real assets attract higher duties and notary fees (reaching almost 7 per cent if combined). Asset transfers occurring within the scope of one of the tax-favoured reorganisation transactions are generally either exempt from or subject only to a small, fixed registration duty.
By contrast, sales of shares of an SA, SAS or SCA are generally subject to transfer duty at 0.1 per cent. By way of exception, sales of shares of a listed French company are subject to financial transaction tax (FTT) at 0.3 per cent if its market capitalisation exceeded €1 billion on 1 December of the previous year. Sales subjected to the FTT are expressly exempt from registration duty.
Sales of SARL units as well as interests in SNC, SCS or SCI are generally subject to registration duties at 3 per cent.
By way of exception, a specific 5 per cent registration duty applies to the transfer of shares or equity interest in any unlisted French or foreign legal entity the assets of which consist principally, directly or indirectly, of real estate located in France.
Outside the real estate industry, the higher rate of transfer duties applying to asset deals may call for pre-sale repackaging of the targeted assets into an SPV to convert an asset deal into a share deal. Such a reorganisation shortly before implementation of a share deal may, however, be successfully challenged by the tax authorities if it appears to be principally tax-driven.
VAT applies at the ordinary rate of 20 per cent on most business transactions. Input VAT incurred by a business entity on the acquisition of goods and services directly related to a VAT-able activity is deductible from the VAT collected from customers. The excess input VAT, if any, is refundable. With regard to business transactions and reorganisations, the following rules are of particular interest.
France has elected to disregard, for VAT purposes, asset transactions consisting of the transfer or partial transfer of a business activity. Those transactions do neither attract VAT on the value or consideration paid for the transfer, nor any repayment obligation of the input VAT attached to the transferred assets that was previously deducted by the transferor.
Sales of shares are exempt from VAT and dividends are viewed as passive investment and therefore do not attract VAT. As a corollary, input VAT incurred in connection with the acquisition or disposal of shares in a subsidiary (e.g., acquisition fees paid to banks and advisers) is not directly related to a VAT-able activity since the target shares do not generate VAT-able income, which may jeopardise its recoverability. Such input VAT may, however, be deducted pursuant to current case law provided that various conditions are met, as follows.
- Input VAT on the acquisition of shares in a subsidiary may be deducted provided that the acquiring entity subsequently provides services to the target company for which it charges fees with VAT. This may call for the localisation of various intra-group services at purchaser’s level.
- Input VAT incurred in connection with the disposal of shares in a subsidiary may generally be deducted provided that this VAT is not economically recharged to the buyer through the sale price of the shares and that the sale proceeds are used by the seller for its own VAT activity instead of being distributed to its shareholders. The conditions for the deduction of VAT are stricter for input VAT on services directly related to the transaction (e.g., agency fees) than for input VAT on services that are only of a preparatory nature (e.g., vendors’ due diligence costs).
Those rules are still not fully settled and are quickly evolving as a reaction to moving European and domestic case law.