The French tax rules currently provide that, in principle, interest expenses paid are fully deductible in the year they accrue provided that the debt is incurred in the business interests of the company and duly recorded in the company's accounts. This is subject to certain limitations designed to prevent implementation of abusive tax planning and structures. Some of the most recent limitations enacted in France are more wide-ranging and uncertain in scope than those in force in other jurisdictions.
Additionally, the draft Finance Bill for the financial year 2013 currently under discussion in Parliament (which should be voted before the end of December 2012), is likely to add a new limitation on the full tax deductibility of interest. Further details of this are set out below.
French tax law provides for thin capitalisation rules to limit the tax deductibility of interest paid to shareholders or related parties. These rules prevent companies from taking advantage of shareholders' loans in order to transfer excessive profits to their shareholders or to related parties.
Any interest paid by a company on shareholders' loans may be deductible from the company’s taxable income provided that certain conditions are met, notably:
- the share capital is fully paid-up; and
- the interest does not exceed the annual average of the banks' rates for loans with an initial two-year minimum period (eg the rate was fixed at 3.99% for the financial year 2011).
A higher interest rate may be applied only if the borrowing company can prove the rate applied is on an arms length basis.
In addition to the interest rate limitation, the tax deductibility of any interest paid to shareholders may also be restricted by the thin-cap rules designed to control the deductibility of interest paid to related parties.
The deduction of the interest paid by a French company on indebtedness owed to "related parties" is limited to the highest of the following three ratios:
- interest accruing on an amount equal to 1.5 times the company's shareholders equity (the debt-to-equity test);
- 25 per cent of the taxpayer's adjusted ordinary income (defined as current income before tax, related-party interest, depreciation and amortization, and certain lease payments) (the interest coverage test); and
- interest received from related parties (the related-party interest test). Disallowed interest may be carried forward indefinitely to subsequent tax years, subject to a reduction of five per cent per year after the first taxable year.
If the above three ratios are exceeded, the company is considered to be thinly capitalized and any interest exceeding the highest ratio set out above cannot be deducted over the financial year they are incurred but may be carried forward into the following financial years.
The thin-cap rules usually apply to loans granted directly or indirectly by controlling shareholders, sister companies or subsidiaries.
Since 2011, it may also apply to any financing in which a related party grants a guarantee or security. Financing guaranteed by a third party may also be caught if that third party's undertaking is in turn guaranteed by an enterprise related to the borrower.
The rules provide for certain exceptions allowing a borrowing company to treat interest paid to related parties as fully tax deductible, notably:
- if the annual amount of interest paid by a borrowing company to related parties is less than €150,000; or
- if the borrowing company can prove that the overall debt-to-equity ratio of the group to which it belongs is equal to or higher than its own overall debt-to-equity ratio.
Specific rules for tax consolidated groups
A specific scheme known as "Amendement Charasse" limits the interest deductibility on debt incurred to acquire related party shares following the inclusion of both entities in the same French tax consolidated group.
When the shares of a target company which becomes a member of the tax group are purchased from shareholders, who directly or indirectly control the group (non-group parents), or from non-group companies that are controlled by non-group parents (non-group sister companies), a portion of the interest expenses incurred by the tax group will not be deductible from the group profits during a nine year period.
The "Amendement Charasse" does not apply:
- when the shares of the new member of the tax group are sold between two companies that are already members of the same tax group; or
- when the shares of the new member were previously acquired by a controlling shareholder from a third party and were immediately sold again to another company within the group.
Anti "debt push down" rules
Introduced in 2011, an anti-avoidance rule commonly known as the Carrez Amendment aims to limit the deductibility of interest expenses relating to an acquisition of shares when the acquiring company cannot prove that:
- It, or a company established in France controlling it, or a company established in France directly controlled by the same controlling company, effectively takes decisions related to those shares; and
- When the control or influence is exercised over the company which the shares are held, it, or a company established in France controlling it, or a company established in France directly controlled by the same controlling company, effectively exercises this control or influence.
For acquisitions made after 1 January 2012, evidence of decisions made by or the control or influence of a French company will have to be provided for the 12-month period following the acquisition. For acquisitions completed before 1 January 2012, such evidence will be required for the first year beginning on or after 1 January 2012.
If the acquiring company cannot demonstrate that the above conditions are met, a portion of interest may be treated as non-tax deductible.
The rules do not apply if:
- the total fair market value of the shares owned by the French acquiring company does not exceed €1,000,000;
- the acquisition of the shares has not been financed by debt either at the level of the French acquiring company or at the level of a French or foreign company of the same group; or
- the debt-to-equity ratio of the group is to equal or higher than the debt to equity ratio of the acquiring company.
In the draft Finance Bill for 2013, currently before the French Parliament, the French Government intends to amend the general principle of tax deductibility of interest for French tax resident companies, to include a cap on interest deductibility similar to those of Denmark, Italy and Spain.
The current draft of the proposal provides that deduction of finance expenses incurred by companies liable to corporate income tax would be capped at 85% of their net amount as from financial year 2013 and further reduced to 75% as from the financial year 2014.
This new limitation would apply to financial years closed on or after 31 December 2012 and would apply to both related and third party financing regardless of the purpose of the financing.
The proposed change in legislation would provide for a permanent disallowance as there would be no carry-forward mechanism of the disallowed interest. However, the cap would not apply if the total finance charges incurred are below €3,000,000 per financial year.
In order to avoid double taxation arising from the combination of the rules on deductibility, the proposal contains rules intended to prevent this. Although, the combined application of these different tax regimes is unclear, it appears that the thin-cap rules would apply first, followed by the Carrez rules and then the cap of 85%/75% would be applied.