Legal background: Loan interest payments are deductible provided that the debt was incurred for the needs or the benefit of the company and entered on the balance sheet.

Scheme in place: Bonds redeemable in shares (Obligations Remboursables en Actions, “ORA”) are issued by a French company simultaneously with a dividend distribution of a similar amount and to the benefit of the same foreign shareholder. In practice, the foreign shareholder pays up its subscription to the ORAs by set off with the dividend debt held against the French company, and therefore no cash flows result from these operations.

Outcome of audit: In the French tax authorities’ opinion, these operations should be viewed as an artificial scheme aiming at allowing the French company to deduct interest paid to its foreign shareholder in respect of the ORAs, whereas such interest should actually be characterized as non-deductible dividends. Accordingly, the tax authorities mentioned that they would apply the 80% abuse of law penalty to any relating reassessments.

It should be noted that the French Lower Administrative Court of Montreuil already ruled in favor of the FTA in a similar case, but the taxpayer lodged an appeal against this decision before the Versailles Administrative Court of Appeal.