The Carrez Amendment is a new mechanism disallowing interest deductibility for qualifying participations acquired by a French company where the French company is not in a position to demonstrate that:
(i) The decisions relating to these participations are effectively made by the acquiring company itself, or by a company established in France that "directly or indirectly" controls the acquiring company under the meaning of the French Commercial Code, or by a company established in France that is "directly" controlled by the same company as the one controlling the French acquiring company under the meaning of the French Commercial Code and,
(ii) Where "control or influence" is actually exercised over the acquired company, this control or influence is effectively exercised by the acquiring company, or by a company established in France that "directly or indirectly" controls the acquiring company under the meaning of the French Commercial Code, or by a company established in France that is "directly" controlled by the same company as the one controlling the French acquiring company.
According to the draft guidelines, the new limitation aims at preventing abusive debt structuring in France, in particular, in situations where debt is artificially incurred at the level of French entities acquiring shares of companies located outside of France. However, the current wording of the draft guidelines creates some degree of uncertainty as to the precise scope of this measure and its possible application to the acquisition of shares or interest in French entities.
The draft guidelines provide a few interesting elements:
On the scope of the new Carrez limitation: the acquisition of shares in listed and non-listed real estate companies is excluded from the scope of the new provision, which was not resulting from the law.
On the acquisition of shares: the draft guideline also targets share capital increase in certain abusive situations when a French company controlling the purchaser of the shares is financed with debt and contributes the cash to fund the acquisition to the latter.
On the elements of proof to be evidenced: the tests on the decisions relating to these shares and on the control or influence over the target are cumulative, which was not clearly stated in the law.
The FTA gather both tests under a common concept referred to as "autonomous center of decisions". They also mention that the application of group governance rules does not jeopardize the existence of an autonomous center of decisions.
The draft guideline provides a few examples of the type of elements that may be used as part of this demonstration: the autonomy of the decision made in France to acquire the participations and the ability to use and dispose freely of such participations (pledge, loan, etc. subject to certain requirements). However, a contractual arrangement which would restrict the prerogatives of the owner of the participations, such as a non-transferability agreement, would be considered as a lack of autonomy (unless such decision results from the group's internal governance or from specific requirements imposed by the banks).
With respect to the effective and active participation to the decision process in the acquired company, the FTA provide the following examples: documents relating to the functional, organizational and hierarchical links with the subsidiary such as organization charts, minutes of shareholders and board meetings showing the effective attendance of the members of the representative bodies of the acquiring company in the acquired entity, the possibility to appoint its managers, officers or directors or the ability to decide upon distributions.
According to the law, the control or influence has to be effectively exercised by the acquiring company, or by a company established in France that directly or indirectly controls the acquiring company under the meaning of the French Commercial Code, or by a company established in France that is directly controlled by the same company as the one controlling the French acquiring company. The draft guideline specifies that the requirement of the establishment in France only applies to the company exercising control and influence; this means that in the case of a sister company exercising such control and influence, there is no requirement of establishment in France of the common parent of the two companies.
On the period during which the demonstration must be made: the timing of the demonstration of the two tests applies as follows:
- with respect to acquisitions made before January 1, 2012, the demonstration must be provided during the first financial year opened “after January 1, 2012”, i.e. financial year 2013 for companies following calendar financial year,
- with respect to acquisitions made from January 1, 2012, the demonstration must be provided during the financial year of acquisition or one of the financial years covering the 12-month period following the acquisition of the shares.
The demonstration is required only with respect to the above periods and not with respect to the entire disallowance period provided by the Carrez Amendment (i.e. 8 years).
On financial expense amounts subject to disallowance: the amount of disallowed interest expense is determined annually and computed as follows:
Click here to view formula.
The draft guideline provides that when the acquisition price of the shares is higher than the average debt, the ratio is 1 and the whole interest expense is disallowed.
The acquisition price is the one agreed by the parties as recorded in the balance sheet of the purchaser. This amount is therefore not subject to variation as opposed to the debt amount which can vary annually.
It is further admitted that the debt which can be allocated to another purpose than the acquisition of shares is excluded from the above ratio.
Pursuant to the guideline, the disallowance of interest expense under the new rule would not give rise to deemed distributions qualification: no French withholding tax should therefore apply.
On the disposal of the participation during the disallowance period: in such a case, the FTA agree to consider that the company would not be subject to further disallowance of the financial expense. In case of a merger, spin-off or similar transactions, the disallowance remains applicable at the level of the new entity holding the participation.
On the combination of the Carrez Amendment with French thin capitalization rules and the "Charasse"Amendment: the draft guideline indicates that the new Carrez limitation is not exclusive of the French thin capitalization rules and the "Charasse" Amendment (interest deduction limitation applicable to related party acquisitions of French entities in the context of a French fiscal unity). The draft guideline specifies that the Carrez limitation applies first and that the overall disallowance cannot exceed the total amount of the company's financial expenses.