The French Tax Authority has recently confirmed that the management in France of a foreign alternative investment fund does not lead to that fund being taxable in France.
Following a request by the French private equity association (Association Française des Investisseurs pour la Croissance – AFIC), the French Tax Authority (Direction de la Législation Fiscale – DLF) has recently confirmed that the management, in France, of a foreign alternative investment fund (AIF) as defined by the AIFM Directive (1), does not lead to that AIF being taxable in France.
As background, current regulations – in particular Article 209 I of the French General Tax Code (Code Général des Impôts) – provide that entities operated in France are subject to French taxation. A number of issues have arisen with respect to these regulations, including the risk that a foreign investment vehicle that is wholly or partly managed in France may be treated as having a permanent establishment in France (2), leading to the taxation of that French source profits of that entity. In practice, there has always been a risk that the French Tax Authorities might consider there to be a permanent establishment in France, if a management company made binding investment decisions for a foreign investment vehicle on whose behalf it acted, directly or in the context of delegated management (3).
The question of whether such a permanent establishment might arise has become a major issue in the field of asset management since the adoption of the UCITS IV Directive (4) and the AIFM Directive. In particular, these Directives authorise the cross-border management of investment funds, namely the management of a European fund (and, with effect from 2015, a non-European fund in the framework of the AIFM Directive) by a management company that is domiciled in another Member State of the European Union (5) .
Although the aim of these Directives is to promote the development of a pan-European market for investment funds, the Directives do not address the tax laws applicable to these cross-border structures, and no European legislation is likely in the near future to specify the tax treatment for such structures. As a consequence, there are many uncertainties as to the tax treatment in France with respect to such investment vehicles.
That said, before the DLF’s position, various factors may lead to the expectation that such foreign vehicles, managed from France, will not be subject to French taxation.
Indeed, in order to induce French investors to place their savings in collective investment vehicles managed by professionals (investment funds), French investment funds currently benefit from a special tax status designed to prevent a double taxation of fund income. French regulations expressly provide that French investment funds formed as a commercial company (sociétés d'investissement à capital variable – SICAV) are exempted from corporation tax (impôt sur les sociétés) (6). Similarly, funds created in the form of a mutual fund (fonds commun de placement – FCP) are contractual structures that are not subject to corporation tax (7). Consequently, French investment funds, both UCITS and AIFs, are not subject to corporation tax and do not generate an additional level of taxation: fund investors are placed in the same position as if they had invested directly in the underlying assets, with investment through the fund being tax-neutral for such investors. In the absence of this tax status, investment funds would have been subject to corporation tax on the fund’s income, and then investors would have been taxed on the income distributed by the fund. This double taxation, more than any other commercial activity, could have placed a major brake on investment in financial markets and, generally, in financial assets.
Based upon this reasoning, it may be argued that a foreign UCITS or AIF that is managed in France should not be taxable in France as a contrary position may be discriminatory and not compatible with European law. However, doubts on this may persist due to the lack of an express provision in French domestic law concerning the taxation of foreign investment vehicles, based upon their form of organisation. Indeed, under internal French tax regulations or when applying a tax treaty to which France is a party, it may be particularly difficult to make a determination as to whether a foreign entity is to be treated as “tax exempt”, “tax transparent” or taxable as a corporate entity .
In the recent Santander case, the Court of Justice of the European Union found that the French withholding tax – levied on dividend payments by French-resident companies to non-resident investment vehicles – constituted a restriction of the free movement of capital and was not compatible with EU law (8). This decision places the importance of the general principle of non-discrimination among taxpayers back into the spotlight.
The DLF’s position, as stated above, clarifies a substantial portion of the uncertainties concerning the tax treatment of a foreign AIF managed from France, insofar as it clearly affirms that this arrangement “ is not such as to characterise the operation of the AIF in France within the meaning of I of Article 209 of the General Tax Code, whether it is a fund which does not have legal personality or an investment company with legal personality”. It is now settled that the cross-border management of a foreign AIF will not lead to that AIF’s income being taxed in France, no matter what its corporate form or internal tax status.
The only forms of income that are subject to tax in France in such cross-border management arrangements are therefore: income distributed by foreign AIFs to French-resident investors; fees received by the French management companies; and remuneration received by management team members residing in France.
The scope of the DLF’s position is limited to foreign AIFs as defined in Articles 33 and 34 of the AIFM Directive. Article 33 provides the opportunity for a manager located in an EU Member State (including France) to manage an AIF established in another EU Member State (EU AIF), once that manager has been authorised for this purpose. Article 34 provides this same possibility for an AIF established in a country outside the EU (non-EU AIF), provided that (i) the manager complies with all the requirements set forth in the AIFM Directive (9) and (ii) the non-EU AIF is located in a non-EU country whose regulator has entered into a cooperation agreement with the manager’s regulator in order to ensure, at least, an efficient exchange of information allowing the manager’s regulator to carry out its duties under the AIFM Directive.
However, it may be argued that the framing of this analysisdoes not have to be construed narrowly. Indeed, nothing would justify a different reasoning:
- for foreign UCITS funds managed in France not covered by the AIFM Directive; or
- for foreign funds (EU or non-EU AIFs) where the manager does not comply with requirements of the AIFM Directive (due to the manager’s not meeting the conditions for being subject to the AIFM Directive, and in particular the managed assets thresholds of €100m or €500m).
In addition, Article 34 of the AIFM Directive refers to non-EU AIFs that are not marketed in Europe. However, this provision should not affect the applicability of the tax analysis for non-EU AIFs marketed in Europe, or even for funds that do not meet all of the conditions of Article 34.
Therefore, the DLF position appears to be a major step forward to encourage asset management professionals who wish to entrust all or part of the management of their various investment vehicles to French management companies, whether specialising in the management of alternative funds or in the management of traditional funds. The position reflects a heightened international promotion of the Paris financial market.
The DLF position may be considered as a first stage in a more general movement to clarify the domestic and international tax treatment related to investment funds. A number of countries, particularly in Europe, have clearly committed to providing this clarification, and such countries now have prominent and active financial markets. Hopefully France will be able to meet the needs of the industry and keep pace with these tax challenges.