In a decision on January 20, 2016, the Paris Administrative Court of Appeal concluded that a group cash pooling entity lending money to related entities at a rate which does not cover its own costs incurred in the process commits an abnormal management act.
A company, Passire (the appellant), was the cash pooling entity of a group. Accordingly, Passire borrowed funds to the group's companies in excess of treasury, before lending the funds to other group's companies. Those two transactions were performed at the same rate, i.e. the weighted average of overnight Euro Interbank Offer Rates for inter-bank loans (the “Eonia” rate).
The French tax authorities disputed this position, pointing out the absence of any financial consideration for the charges and overheads borne by the appellant, which would necessarily result in a structural loss-making situation that does not constitute a normal commercial management.
The Court of Appeal confirmed this analysis, pointing out that using a single rate which does not generate any profit necessarily constitutes an abnormal management act, because such practice can only result in structural loss-making situation.
Therefore, the structural loss-making situation appears to be the cornerstone of the reasoning behind the decision of the Court of Appeal. Indeed, the Court refused all the arguments of the appellant attempting to prove the company’s own interest in performing the disputed transactions—whether based on the preferential lending terms obtained by the beneficiary companies, the management convenience of using a single rate or the reciprocity expected from the companies receiving the advances.
This decision, which has not been appealed, seems in line with a recent inflexion of the case law pertaining to the normality of the financial compensation received for loans granted by a company.
According to the traditional case law of the French Administrative Supreme Court on this matter, the analysis of the normality of the rate asked by the lender must be assessed by comparison to the potential financial compensation received by the lender for the deposit of a similar amount, under analogous conditions, with a financial institution or a similar organization (cf. French Administrative Supreme Court, Oct. 7, 1988, No. 50256, Sté Etablissement Pierre Deveugle, and, more recently, French Administrative Supreme Court, Jul. 31, 2009, No. 301935, SARL Jean-Marc Brocard).
In other words, according to this traditional position, the rate available on the market should be the sole reference used to determine a normal financial compensation for loans, disregarding financing the rate paid by the lender. As a practical rule, the French administrative guidelines allow to refer to the average marginal lending rate, as used by the Bank of France (cf. BOI-BIC-PDSTK-10-20-30, No. 60).
However, a growing number of court decisions make a direct comparison between the financial compensation received from a borrower company and the financing costs incurred by the lender company (cf. in particular: French Administrative Supreme Court, Nov. 28, 2012, No. 340971, Sté Camefi, and Paris Administrative Court of Appeal, May 27, 2014, No. 13PA01773, Sté Seurlin Immobilier, involving a loan at a rate significantly lower than the rate paid by the lender company for its own financing).
This new case law trend, if confirmed, would probably require to evidence a profit margin at the level of the lender company where the loan is itself financed by debt. This outcome would automatically raise the issue of determining the applicable margin rate.
In the case at hand, the tax authorities increased the loaning rates by 0.1%, decreased the borrowing rates by 0.1%, and added back into SAS Passire’s earnings the amount of these modifications, i.e., a 0.2% margin. However, this flat rate method seems to have been approved by the Paris Administrative Court of Appeal only insofar as the company did not challenge it.