Legal background: In France, financial expenses borne by companies are deductible from their taxable result (subject to the limitations set at Article 212 bis of the French Tax Code). Some foreign territories authorize the deduction of a notional interest calculated on the amount of equity of the companies which are established there.
Scheme in place: Company A, a French resident, contracts a loan agreement with a bank to proceed to an equity contribution in favor of its subsidiary, Company B, established abroad. Company A deducts the loan interest from its tax base. Company B can deduct a notional interest calculated on the amount of its equity, in application of the legislation of the State in which it is established.
Thus highly capitalized, Company B provides a loan to Company C, a French resident and a subsidiary of Company A. Company C pays interest to Company B which pays little tax due to the deduction of notional interest. The profits realized by Company B are then distributed to Company A as dividends and 95% exempt from taxation in application of the Parent-Subsidiary regime.
It is assumed that this structure was implemented solely for tax purpose.
Outcome of audit: This structure allows a group to deduct twice the interest in France:
- At the level of Company A when it contracts a loan in the market;
- At the level of Company C when it contracts a loan with Company B.
Simultaneously, the global profit of this operation is exempted in France due to the application of the Parent-Subsidiary regime. The operation allows Company A to receive exempted dividends from Company B. The FTA will challenge the benefit of the Parent-Subsidiary regime. A penalty up to 80% of the avoided tax will be applied.