On April 15 2014, the French Tax Administration released its draft guidelines commenting on the new anti-hybrid financing rules enacted in Section 22 of the French Finance law for 2014 dated December 29 2013 (BOI-IS-BASE-35-50-20140415 and BOI-IS-BASE-35-10-20140415). These comments, that currently bind the French Tax Administration, were opened for public consultation until April 30 2014. The final guidelines will then be issued.
The French finance law for 2014 has indeed created a new rule limiting the deduction of interest by a French borrower which is directly or indirectly related to a lender. Under this new limitation, a French borrower is not allowed to deduct interest when the lender is not liable on this interest income to a corporate income tax equal at least to 25 percent of the ordinary French corporate income tax (i.e. 33.33 percent) plus additional corporate surtaxes (i.e. the social security surcharge of 3.3 percent due by legal entities whose corporate income tax exceeds EUR763,000 and the temporary contribution of 10.7 percent due when the turnover of the creditor company exceeds EUR250 million) that would have been due under French tax rules (i.e. 8.33 percent, 8.61 percent or 9.5 percent depending on whether the lender is liable or not to these additional surtaxes).
It must be underlined that the position of the French Tax Administration is very rigorous regarding the additional surtaxes that must be added to the ordinary corporation tax rate in order to determine the reference tax from which the minimum taxation of the creditor company is calculated. And this interpretation does not comply with the current wording of Section 212-I of the French Tax Code as discussed during the debates before the French Parliament.
The minimum tax rate is the reference rate for assessing the tax level of the gross interest income corresponding to financial expenses paid by the debtor company.
The guidelines state that the interest income should not necessarily lead to an actual payment of tax. In addition, the French Tax Administration indicates also that neither the expenses that could reduce the amount of the taxable interest income nor the legal characterisation of the interest income received are taken into account.
Besides, the mere fact that the creditor company is in a loss position is not relevant for the application of this new rule if the debtor company can prove that the gross interest income is actually included in its taxable basis.
Where the creditor related company is established outside France, the taxation is assessed according to the ordinary rules that would have been applied if it has been located in France.
It is therefore necessary to compare the effective tax rate of interest in the result of the creditor's business with the one applicable in France. To make this comparison, it is necessary to determine the effective tax rate on this interest income, taking into account the foreign rules applicable for the determination of the taxable basis of the foreign lender.
Only the effective taxation of the gross interest income is relevant and not the global taxation of the lender. When the foreign legislation provides for a specific rebate, deduction or exemption on the interest income, it is important to compare the effective tax rate actually applicable to the gross interest income with the French tax rate that would have been applied if the lender had been located in France.
The French guidelines provide also that it is up to the debtor to prove that the creditor company is liable to the minimum required corporate tax on the gross interest income. The proof can be done by any means.
The debtor company must demonstrate that:
- Given the laws of the country in which the creditor company is located, the taxation of the gross income is greater than or equal to the minimum reference rate for the period in question
- The corresponding interest income was actually recorded in the result of the creditor company under the reference period
The evidence must be made only at the request of the tax authorities. Companies do not have to include them with their corporate income tax return. In practice, although the evidence of minimal taxation of interest income in the creditor company will have to be provided only on request of the French Tax Administration, it is recommended that companies ensure compliance with this requirement before practising deduction.
Where the borrower and the lender companies have different financial years or where accounting or tax rules of the foreign jurisdiction are different from the French one, the new rules apply to the tax year during which the gross interest income is taxed in the hands of the lender at the minimum tax rate as provided by French law.
In this case, unlike the general case, the debtor company must attach evidence of the taxation of the interest income in the result of the creditor in support of its corporate income tax return.
The guidelines provide also that where the lender is a transparent structure or a collective investment fund, the new rules apply only if, on one hand, the debtor company is related to the creditor transparent entity or the creditor collective investment fund, and, on the other hand, the creditor transparent entity or the creditor collective investment fund is related to one or one or more of its partners or unit holders of the transparent entity or collective investment fund.
If this double condition is not met (for example, just one of the two is satisfied), the new rules do not apply. Where the double condition is met, the minimum taxation rate is applied at the level of the related partners or unit holders and only on the gross interest income paid to these latter. If the minimum taxation rate is not met at the level of the non-related partners or unit holders, it has no adverse consequence on the tax deductibility of the interest at the level of the borrower. Thus, the French Tax Administration considers that the full amount of interest is not deductible and does not allow a prorata deduction up to the part of shares or units held by the non-related partners or unit holders.
When the overall taxation of interest in the hands of the partners or unit holders related to the transparent entity or collective investment fund is lower than the reference rate, all financial charges are not deductible for the borrower.
By contrast, when the creditor transparent entity or the creditor collective investment fund is also related to the transparent entity or a collective investment fund (in cases when the partners or the unit holders are also a transparent entity or a collective investment fund), the condition for the minimum taxation rate cannot be fulfilled. In this case, the debtor company is not allowed to deduct the financial interest.
Lastly, the guidelines provide details for the combination of this new rule with the other French interest limitation rules.
The new rules apply after the rules under which interest paid by a company to a related company is deductible within the limit of interest calculated pursuant to the maximum legal interest rate or the market interest rate if higher as applied by independent financial institutions.
However, this new rule applies before all the other limitations rules, such as:
- The thin-capitalisation rules
- The Charasse amendment which limits the deduction of interest on debt related to the acquisition of shares of a target company which becomes a member of the same tax consolidated group from a person controlling directly or indirectly the group)
- The Carrez amendment which limits the deduction of interest expenses related to the financing of the acquisition of shares
- The general limitation of deductibility of financial expenses under which companies liable to corporate income tax are required to add back to their taxable income 25 percent of the net financial expenses for fiscal years beginning on January 1 2014 when such amount exceeds EUR3 million