Relevant Sections of the Revenue Code
Other Regulations
General Comments
Many high-tax jurisdictions have adopted laws that are designed to create a strong disincentive against the use of tax havens by their residents. At the instigation of the Ministry of Finance and the Revenue Service the French legislature has now developed one of the world's most stringent anti-tax haven systems.
In France the emphasis is to place companies and individuals that are resident in France for tax purposes and that might be tempted to use tax havens in a position where non-compliance with statutory reporting obligations is grounds for taxation under the relevant code section, plus heavy fines (interest and penalties). Compliance with these obligations is intended to balance any benefit that could be derived from the use of low-tax jurisdictions.
In addition, certain violations may also attract criminal sanctions based on the tax code (eg, under Sections 1741 or 1743 of the French Revenue Code) or on the basis of French anti-money laundering laws.
In order to understand the strategy against tax havens it is necessary to define a few basic French tax concepts.
Territoriality
This word summarizes the French general approach to tax liability. The basic attitude is that a person becomes liable for tax in France if he has material points of contact with the country. As regards French personal income tax, Section 4(b) of the Revenue Code provides that individuals who are tax residents of France are subject to income tax on their worldwide income in the absence of any domestic law or treaty exceptions. Individuals who are not resident in France for tax purposes are only subject to French income tax on their French-source income. An individual is regarded as resident in France he fulfils any of the following conditions:
- has his home in France;
- has his main place of abode in France;
- carries out business in France; or
- has the centre of his economic interests in France.
As regards companies, under Section 209(i) of the code French corporate tax is only levied on companies that are engaged in business in France. When a tax treaty applies, French corporate tax is only charged on foreign companies that have a permanent establishment in France. As for French companies the principle of territoriality excludes profits that result from activities carried out outside of France through foreign branches from tax. Similarly, the undistributed income of foreign subsidiaries is not taxable in France.
When a tax treaty applies to a given set of facts, treaty rules always override domestic law if a conflict arises.
Privileged tax regime
An individual or a legal entity enjoys a privileged tax regime in the jurisdiction other than France where it is established, whenever such jurisdiction:
- imposes no tax on the profits generated by the relevant individual or entity;
- imposes no tax on foreign-source income of the relevant individual or entity; or
- imposes a rate of income tax that is substantially lower than that which would be imposed in France (French Revenue Service Instruction, June 26 1975).
The French Revenue Service considers for practical purposes that a 'substantially lower rate' means an income tax rate that is at least one-third less than the corresponding tax would have been in France for the same income. In 1975 the French Revenue Service established a list of countries that are regarded as having organized a privileged tax regime. The list is not a law and is thus purely indicative. In fact, tax courts require that the French Revenue Service not only prove that a privileged tax regime exists in the relevant jurisdiction, but that the legal entity resident there actually enjoys the privileged tax regime in question. A privileged tax regime may exist in high-tax jurisdictions where specific exemptions apply (including temporary exemptions).
Low-tax jurisdiction
This is a jurisdiction where the relevant individual or legal entity is located and enjoys a privileged tax regime. French overseas territories (as opposed to French overseas départements (administrative districts)) are regarded in some respects as low-tax jurisdictions.
Directly or indirectly
This expression, which is often used in the Revenue Code, generally includes not only a chain of participations but also, with respect to individuals, participations in the relevant entity by the taxpayer and members of his immediate family.
Relevant Sections of the Revenue Code
Section 209(b)
This section generally provides that where a French resident company (or the French branch of a foreign company when the relevant rights are reflected on the balance sheet of the branch) either (i) controls, directly or indirectly, more than 10% of the voting and/or financial rights of a non-French subsidiary (or owns an interest valued at over Ffr150 million), or (ii) operates a branch located in a jurisdiction where it enjoys a privileged tax regime, then the controlling company must report its share of the controlled company's undistributed profits (in addition to any dividend received), or the profits of the branch. Such profits are then taxable in France at normal rates.
The 10% holding is to be estimated at the end of the foreign subsidiary's financial year. If that threshold is not crossed at that date the 10% test is considered to be met if it was reached and maintained during any 183 days of the company's financial year.
When Section 209(b) applies the French parent company is subject to French corporate tax on the profits of the foreign subsidiary (or branch). Such profits are computed and taxed in accordance with French tax rules but in a category that is separate and apart from the parent's other profits. Losses of the foreign subsidiaries or branches are carried over and may be offset only on such subsidiaries or branches' future profits for up to five years following the loss year.
Section 209(b) will not be applied if the French parent company demonstrates that the main effect (as opposed to motivation) of the foreign subsidiary's or branch's location is not tax driven. This is presumed to be the case when the foreign entity or branch is principally and effectively engaged in business or industrial activities in the local market. However, according to French Revenue Service regulations this presumption does not apply to foreign subsidiaries or branches located in a country that is a member of the Organization for Economic Cooperation and Development.
Section 209(b) provides for various mechanisms that, in most cases, avoid double taxation where foreign tax is levied and/or whenever profits of the foreign subsidiaries or branches are distributed to the French parent company (and therefore taxed in France).
Finally, the French Revenue Service considers that Section 209(b) is compatible with the network of French tax treaties and EU rules (notably free enterprise and freedom of financial movement). Conversely, French courts have ruled that Section 209(b) is not compatible with French tax treaties unless these include specific provisions to that effect. However, since this position has not yet been confirmed by the highest administrative court the issue is still undecided.
Section 123
Section 123 generally provides that where a French resident controls, directly or indirectly, more than 10% of the financial and/or voting rights of an entity enjoying a privileged tax regime, then the controlling individual must report its share of the undistributed profits of the entity (in addition to any distributed dividends). Such share is then taxable in France at normal rates.
The question of whether the 10% threshold is attained is decided using rules similar to those under Section 209(b).
The list of entities subject to control within the meaning of Section 123 includes not only legal entities about which it is usual to speaks of a participation expressed as a percentage (eg, companies and partnerships), but also legal structures for which it is not (eg, trusts and comparable bodies). This begs the question of what a 10% or more interest (voting and/or financial rights) in one of those structures entails. Specifically as regards trusts, Section 123 has introduced great uncertainty, particularly as regards irrevocable and discretionary trusts.
Currently, the main exception to the rule is where the assets of the foreign entity or structure are predominantly in the nature of assets other than securities and indebtedness from third parties. Here the word 'predominantly' refers to a proportion where the non-financial assets exceed 50% of total assets, using as a reference their net book value calculated in accordance with French accounting principles. A caveat is necessary here, because the French Revenue Service considers (relying on Section 529 of the Civil Code, which sets a presumption that shares are 'movables') that holdings of non-financial assets through voting and/or financial rights in an underlying legal entity are to be regarded as financial assets for the purposes of Section 123.
Where Section 123 applies the French resident individual must report his share of the total undistributed profits of the entity or structure (in addition to profits distributed). This is then characterized as income from securities. Losses of the entity or structure may not be used by the French resident and may only be offset against future profits of the entity or structure (up to a maximum of five years). Where the relevant structure is established in a jurisdiction that has not entered into a tax treaty with France the profits to be reported may not be less than the taxpayer's share in the net assets multiplied by a specific rate identified in Section 39(1.3) of the Revenue Code. The amount computed may not be reduced on the basis of foreign tax paid.
In addition a mechanism exists to eliminate double taxation, including a tax credit system that takes into account foreign withholding taxes providing the original jurisdiction has entered into a tax treaty with France. A second mechanism is also in place to avoid double taxation, notably where both Sections 120(9) and 123 or both Sections 209(b) and 123 would otherwise apply together to the same set of facts.
An implicit consequence of Section 123 is that if an individual who is a French resident is deemed to have control of a structure established in a low-tax jurisdiction such as a trust, his or her share of the structure's assets should be reported for wealth tax purposes.
A debate relating to the compatibility of Section 123 with French tax treaties and EU rules exists in similar terms as that for Section 209(b).
Section 238(a)
This section generally provides for a rebuttable presumption in favour of the French Revenue Service, under which any commission, interest, royalty or other payment, notably payments for services rendered, actually paid (or incurred) by a French resident individual (if subject to business income tax rules) or by a company, to a non-resident individual or company enjoying a privileged tax regime, is presumed to be unjustified, and therefore must be added back into the taxable base of the French resident payer or debtor.
In order to rebut the presumption the payer or debtor of the commission or royalty must establish not only that a reciprocal payment or debt exists (in other words that the payment is not a distribution of profits or an unjustified transfer of funds in disguise), but also that the underlying transaction was effected at arm's length. The burden of proof, which rests on the taxpayer under Section 238(a), is onerous because it is not sufficient for him to prove the existence of, for example, a contractual obligation in order to escape the consequences of Section 238(a). Indeed, such a contract will be presumed not sincere. Therefore the taxpayer must prove the actual substance of the underlying transaction.
Section 238(a) also applies to payments (but not to accrued debts) made by a French resident to an account opened with a financial institution (an institution may be an individual) based in a low tax jurisdiction by a person who resides in a high-tax jurisdiction.
A sometimes overlooked issue is that the French Revenue Service considers that any debt disallowed under Section 238(a) is also disallowed for the computation of deductible liabilities for inheritance tax purposes.
Section 155(a)
Section 155(a) is designed to fight the use of so-called 'interposed companies'. An example of this is where a service is rendered by a French resident but the corresponding payment is made to a person established abroad, notably in a low-tax jurisdiction.
Pursuant to Section 155(a) payments received by a non-French resident company or individual that enjoys a privileged tax regime for services rendered by one or more persons (individual or companies) established in France are subject to tax in France. The nature of the service is immaterial and French tax is charged on the person who provides the services.
Such payments are subject to French personal income tax if the service provider is an individual or to French corporate tax if the provider is a company.
Under certain conditions the same rules may apply when the service provider is a foreign resident but the services are effectively rendered in France.
Other non-specific sections in the French Revenue Code are relied upon by the French Revenue Service in connection with low-tax jurisdictions.
Section 120(9)
Section 120(9) of the Revenue Code provides that products of trusts received by a French resident beneficiary must be added to the resident's income tax basis. A debate exists as to whether 'products' includes distributions of principal by the trustees to the French resident beneficiary. Whatever may be the respective merits of the arguments for or against inclusion of capital distributions within the ambit of Section 120(9), the problem of establishing the capital nature of a given distribution to the satisfaction of the French Revenue Service is usually so difficult that it is in and of itself a hindrance that deters trustees from risking capital distributions. Even assuming that one would win the capital distribution argument, another risk exists that the distribution would be characterized as a gift (subject to the very high French rates).
Section 57
Section 57 of the Revenue Code is meant to enable the taxation of transfers from so-called dependent or controlling French corporate taxpayers (transfer pricing regulations). When the French Revenue Service intends to rely on Section 57 it must establish that the French transferor (i) is affiliated with the transferee and (ii) granted an undue benefit to the transferee affiliate on the occasion of the transfer. However, the condition of dependence need not be established by the French Revenue Service when the transfer is to an entity established in a low-tax jurisdiction.
Section 57 applies to income directly or indirectly transferred to foreign affiliates through an economically unjustified increase or reduction in the purchase or sale price of goods and services.
When the French Revenue Service considers that it has assembled sufficient evidence that the French taxpayer is in a Section 57 situation, it is entitled to claim further specific information and justification concerning the nature of its relationship with the controlling or controlled foreign entity or entities and the transfer prices agreement with such entity or entities (Section L 13(b), Livre des Procédures Fiscales). The answers provided by the French taxpayer must be to the point and fully documented.
Any discrepancy between transfer prices and arm's length prices is added back to the French taxpayer's taxable income.
Section 750(3)
Since the introduction in 1999 of Section 750(3) of the Revenue Code a French resident who receives a gift or a bequest originating from abroad is subject to French inheritance or gift tax at normal rates, subject only to deduction of any taxes paid in the country of residence of the deceased or donor. Those rules also apply to gifts or bequests originating from low-tax jurisdictions (ie, a jurisdiction that has no (or a low rate of) inheritance or gift tax). One limitation to the rule is that subjection to French gift or inheritance tax only arises if the donee or legatee has been a French resident for tax purposes for six out of the 10 years preceding the gift.
Section 167
Section 167 of the Revenue Code provides that if a French resident decides to transfer his tax residence abroad, then the value of any latent capital gains relating to a direct or indirect participation in a company (wherever it is situated) in excess of 25% of the outstanding capital stock must be assessed. One limitation to this rule is that the taxpayer must have been resident in France for tax purposes for six out of the 10 years preceding his departure.
On the basis of that assessment the taxpayer must then either pay capital gains tax or provide collateral to the French Revenue Service guaranteeing payment of the tax.
If the taxpayer requests a deferment of the exit capital gains tax (subject to collateral) the tax eventually payable upon the sale of the participation is then compared with the tax deferred upon exit from France, and any discrepancy is then adjusted. Also, if the taxpayer returns to France within five years (or remains outside of France for longer than this), the tax paid upon exit is refunded or the collateral returned to him.
Similar provisions apply to capital gains realized before the transfer of one's tax residence abroad but that enjoyed a deferral (Section 167(1) of the Revenue Code).
Section 990(d)
Section 990(d) of the Revenue Code provides that any legal entities (including partnerships, corporations and foundations) holding, directly or indirectly, real property in France (or rights on French real property), are subject to an annual 3% tax of the market value of the property. Several exceptions apply, the purpose of which is to restrict the scope of the 3% tax to legal entities located in low-tax jurisdictions.
The main exceptions concern the following:
- legal entities in which French property represents less than 50% of their total French assets;
- legal entities established in a jurisdiction that is a party to a tax treaty with France, provided that the treaty includes an administrative assistance clause or a non-discrimination clause. In order to benefit from this exception, the legal entities concerned must disclose spontaneously (or must disclose upon first request) specific information to the French Revenue Service concerning their French real property and their shareholding (including ultimate beneficiaries); and
- listed companies and certain retirement funds and charities.
More generally, the French Revenue Service may rely on Section 64 of the Livre des Procédures Fiscales, which enables the service to re-characterize any apparently lawful transaction. This procedure may be used by the service in combination with Section 123. However, relying on Section 64 is cumbersome for the French Revenue Service in that the rules of protection of the taxpayer are very strict.
None of the rules discussed in this update include a prohibition against the use by French resident companies or individuals of vehicles established in low-tax jurisdictions. Instead they are designed to result in taxation in the hands of the French resident company or individual. This approach usually results in a departure from the general principle of territoriality (in particular Section 209(b)).
It is also a clear exception to the general rule according to which a person, be it an individual or a non-transparent legal entity, must be taxed individually on the basis of its own income.
The effect of the anti-tax haven body of laws is generally to give preference to substance over form, which is not the traditional approach in France.
In many instances the sections discussed (with the notable exception of Section 57) operate a reversal of the burden of proof rule, with the result that it is up to the taxpayer to supply evidence to try and disprove the position taken by the French Revenue Service.
For further information on this topic please contact Laurent G Chambaz at Uettwiller, Grelon, Gout, Canat & Associés by telephone (+33 1 56 69 70 00) or by fax (+33 1 56 69 70 71) or by e-mail ([email protected]).
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