Acquisitions (from the buyer’s perspective)Tax treatment of different acquisitions
What are the differences in tax treatment between an acquisition of stock in a company and the acquisition of business assets and liabilities?
Except for the acquisition of real-estate companies or contributions constituting a full line of business within the meaning of the tax-deferral regime applicable to mergers and spin-offs, the transfer tax on the acquisition of stocks in a company is lower than the transfer tax on the acquisition of business assets (see question 6).
The buyers of business assets and liabilities receive a step-up in the tax basis of the acquired business assets, whereas they are not allowed to obtain a step-up in the tax basis of the target corporate entity’s assets for an acquisition of stock (see question 2).
In the case of acquisition of stock in a company, the tax losses of the company can continue to be carried forward regardless of the percentage of shares capital the buyer acquires. The acquisition of the business assets and liabilities may create a permanent establishment in France for a foreign buyer, provided that all the conditions are met. In such a case, the permanent establishment is taxed in France on the taxable profit deriving from the activity performed in France. However, if the seller previously realised tax losses linked to the business assets and liabilities sold, such tax losses cannot be transferred with the business assets except in the case of a contribution considered as a full line of business within the meaning of the tax-deferral regime applicable to mergers and spin-offs, where the tax losses linked to the transferred activity can also be transferred upon specific authorisation from the French tax administration subject to certain conditions. On the contrary, the seller can continue to offset the tax losses (if they have not been transferred) against its future taxable benefits, provided that the contribution of business assets and liabilities did not trigger a change in the nature of the seller’s activity.
The buyer will acquire the tax history of the target company. Any potential tax risk is transferred with the company. The acquisition of stock will require a more in-depth audit of the company’s tax situation and the negotiation of tax guarantees in order to prevent any side effect in the event of a tax audit for a period when the buyer did not hold the target company.
Depending on their goal, certain buyers might prefer purchasing the assets instead of the stock. The seller will often prefer a share deal since capital gains on the shares will generally benefit from the participation exemption regime under certain conditions, including a two-year holding period (except for the acquisition of real-estate companies, for which the participation exemption regime is not applicable) with an effective corporate income tax rate between 3.36 per cent and 4.13 per cent, whereas capital gains on business assets will be subject to corporate income tax at a rate between 28 per cent and 34.43 per cent.Step-up in basis
In what circumstances does a purchaser get a step-up in basis in the business assets of the target company? Can goodwill and other intangibles be depreciated for tax purposes in the event of the purchase of those assets, and the purchase of stock in a company owning those assets?
When they acquire a French target company, acquiring entities are not allowed to obtain a step-up in the tax basis of the target company’s assets without any tax consequences for the target company. Therefore, the latent capital gains on the target company’s assets they acquired will be taxed in the future when these assets are sold and it will not be possible to depreciate the target company’s assets on their actual value when the corporate entity (holding those assets) was acquired. In practice, some buyers may claim for a discount for built-in capital gains tax in relation to the target company’s asset when they determine the price of the shares in a target company.
There was a market practice under which a purchaser of a transparent company holding real estate properties could achieve a tax-free step-up of the underlying real-estate assets base by winding-up the company shortly after acquisition owing to the specific rules of taxation of transparent entities as stated in the Quemener Case Law (CE 16 February 2000 No. 133296, 8e et 3e s-s). Such practices were stopped by the Lupa Case Law (CE 6 July 2016, min c/ SARL Lupa Immobilière France et min c/ SARL Lupa Patrimoine, No. 377904 and No. 377906), following which the Supreme Court reversed its decision. However, the Supreme Court overturned its own ruling and validated again the Quemener position on 24 April 2019 (CE 24 April 2019, SCI Fra No. 412503). This latest ruling again offers the possibility of a tax-free step-up strategy in the acquisition of pass-through entities (especially real-estate pass-through entities), provided that such an operation cannot be qualified as an abuse of tax law.
Intangible assets can be amortised if it can be proved that the benefits such assets have for the company will cease at a certain date. They are, in principle, depreciable over their period of normal use. As an example, patents can be amortised on a straight-line basis over a minimum period of five years, provided that the same depreciation accounting is retained. Development costs and software development costs must be amortised on a straight-line basis over a maximum period of five years.
Goodwill cannot be depreciated. Stock in a company cannot be depreciated. However, a provision for depreciation can be booked if the stock’s market value is lower than the booked value. This provision is not deductible for tax purposes on stock subject to the participation exemption tax regime. The deduction is subject to limitations for stock in real-estate companies.Domicile of acquisition company
Is it preferable for an acquisition to be executed by an acquisition company established in or out of your jurisdiction?
Whatever the acquiring company is, the transfer tax on the acquisition of French assets will, in principle, be due in France.
If the acquisition is debt-financed and leveraged in France, a French holding company can be relevant. Indeed, the French holding company and the target company may constitute a tax-consolidated group if they are both established in France. Forming a tax-consolidated group will enable the two companies to offset the losses of the holding company (deriving from the interest expenses of the acquisition company) against the profits of the target company. A tax-consolidated group requires a minimum, direct or indirect (ie, via other members of the tax group), ownership of 95 per cent of the target company. Such a minimum shareholding can be achieved via one or several EU subsidiaries.
Distributions between the companies in the same tax-consolidated group are only taxed on 1 per cent of their gross amount. Within a tax-consolidated group, an anti-avoidance provision may, however, deny, for a nine-year period, the deduction of (part of) the interest charge borne by a tax-consolidated group with respect to the acquisition, by a member of the tax-consolidated group, of shares in another member of the tax-consolidated group that were previously held by an entity (or an individual) that ultimately controls the tax-consolidated group. There are also new limitation rules to the deductibility of the financial charges since 2019, following the implementation of the Base Erosion Profit Shifting Directive measure. For the application of the limitation of the deductibility of net financial charges to 30 per cent of the tax earnings before interest, tax, depreciation and amortization (EBITDA) or €3 million, whichever is higher (10 per cent of the tax EBITDA and €1 million for thin-capitalised entities), the tax-consolidated group is considered as a stand-alone entity with a safe-harbour clause (see question 8).
Aside from the tax-consolidated group regime, the French holding company’s regime is attractive, given its 95 per cent exemption on dividends and 88 per cent exemption of capital gains realised in connection with stock (except for real-estate companies), either French or foreign (subject to a 5 per cent ownership or more for at least two years).
France also has a large network of tax treaties providing for the avoidance of double taxation. The corporate income tax standard rate will be reduced to 28 per cent in 2020, 26.5 per cent in 2021 and 25 per cent by 2022. The French corporate income tax rate will be in the average of corporate income tax rates within EU member states.
However, a foreign company may prefer acquiring the target company directly, especially if the double tax treaty concluded between its state of residence and France prevents France from taxing the capital gain on the sale of the stock and at the same time the foreign buyer can benefit from an exemption of the withholding tax on the dividends paid by the French target company. In case of an asset deal, a French acquisition company may be preferable if the acquired business will likely constitute a permanent establishment of a foreign buyer.Company mergers and share exchanges
Are company mergers or share exchanges common forms of acquisition?
Company mergers or share exchanges are not common for structuring an acquisition, especially between unrelated companies.
A French seller may be interested in a share exchange when it can be carried out on a tax-neutral basis. For French corporate sellers, share exchange transactions as a result of a public tender offer on a French or European stock exchange give rise to a deferral of taxation. In other situations, participation-exemption on substantial shareholdings may apply if the conditions are met.Tax benefits in issuing stock
Is there a tax benefit to the acquirer in issuing stock as consideration rather than cash?
Unless all the condition for the tax-neutral merger regime are met, there is no special tax benefit attached to a share-for-share deal for the acquirer.Transaction taxes
Are documentary taxes payable on the acquisition of stock or business assets and, if so, what are the rates and who is accountable? Are any other transaction taxes payable?
Transfers of stock are subject to a 0.1 per cent transfer tax for a non-listed company or 3 per cent transfer tax after the application of a €23,000 allowance to be prorated, as the case may be, on the basis of the number of shares transferred when the transfer relates to shares in a company, the capital of which is not divided into shares of stock. The acquisitions of real-estate companies’ share is subject to a 5 per cent transfer tax. There is also a financial transaction tax at 0.3 per cent due upon the acquisition of listed companies’ shares when the listed companies have a market capitalisation in excess of €1 billion on 1 December of the year preceding that during which the transfer occurs.
Except for real-estate companies, some operations are exempted from the transfer tax, such as the transfers of shares or participations within the same group of companies (within the meaning of article L.233-3 of the French commercial code or within a tax-consolidated group), or contributions of shares or participations constituting a full line of business within the meaning of the tax-deferral regime applicable to mergers and spin-offs.
Instead of proportional transfer tax, the acquisition of business assets may be subject to VAT in general at the 20 per cent standard rate (for certain isolated assets such as exploited patents or stocks of goods or buildings considered as new for VAT purposes) except if the transfer of the business assets constitute a transfer of a going concern. The transfer of a going concern will be exempted from VAT.
In the event of an acquisition of all the assets and liabilities constituting a going concern, the acquisition is subject to a 3 per cent and 5 per cent transfer tax, except if the transfer can benefit from the tax-deferral regime applicable to mergers and spin-offs where it is exempted from transfer tax.
The acquisitions of buildings are in general subject to a transfer tax between 5.09006 per cent and 6.40665 per cent, depending on the type and location of the building. A reduced rate of 0.815 per cent applies if an undertaking to resell the building within five years is made and met by the buyer.
The acquisition of a building considered as new (when it is acquired less than five years after its completion from a VATable acting as such) or developable lands (where VAT was deducted by the buyer when the initial acquisition was made) are subject to VAT at the 20 per cent standard rate, along with a transfer tax at 0.815 per cent (or a fixed fee of €125 if the buyer commits to erecting a building and completing the construction within a period of four years and complies with such a commitment).
The contributions of business assets and liabilities constituting a full line of business within the meaning of the tax-deferral regime applicable to mergers and spin-offs are exempted from transfer tax.Net operating losses, other tax attributes and insolvency proceedings
Are net operating losses, tax credits or other types of deferred tax asset subject to any limitations after a change of control of the target or in any other circumstances? If not, are there techniques for preserving them? Are acquisitions or reorganisations of bankrupt or insolvent companies subject to any special rules or tax regimes?
A change in control of the target company does not limit the availability of tax losses, tax credits or any other type of differed tax asset.
Tax losses can be carried forward without time limitations, but they can be offset against the company taxable profit up to a cap per financial year of €1 million plus 50 per cent of the taxable profit of the current financial year. Tax losses can be carried back only for the previous financial year, with a €1 million cap. The carry-back of tax loss is forbidden in respect of a financial year in which the following occurs:
- a total assignment or cessation of business;
- a merger or similar transaction; or
- a liquidation following to an amicable settlement or a court-ordered liquidation of the company.
However, the company can lose tax losses if it goes through a significant change in its actual activity, its purpose, its tax regime or the disappearance of its means of production, which entail the cessation of business. This could, for instance, occur if a new line of business is started and the existing one is dropped or if the nature of the activity is changed (for instance, from a manufacturing to a selling activity). The notion of a significant change in the company’s activity leading to the removal of tax losses has been defined by French law as a discontinuance or transfer of an activity that entails, respectively, an increase or a decrease of over 50 per cent (relative to the previous fiscal year) in either revenue or the average headcount and gross amount of fixed assets.
If the target belongs to a tax-consolidated group, deconsolidation charges could increase the tax-consolidated group’s taxable profit if the acquisition leads to breaking the tax group or at least to the exit of the target from the tax group unless they are neutralised by existing tax losses at the level of the consolidating parent.
When the target company is an exiting subsidiary of a tax-consolidated group, it cannot recover the tax losses it incurred during its presence in the tax-consolidated group. In such a case, an indemnity may be considered based on the tax-consolidation agreement.
In the event of absorption of the consolidating company (merger or spin-off), the consolidated group’s tax losses can be transferred in certain proportions, provided that a prior ruling has been granted by the tax administration.
In an acquisition of 95 per cent or more of a company that is a consolidating parent, its consolidated tax group may terminate and deconsolidation charges might be due. The excess tax losses would be available against the profit of pre-listed members of the newly formed tax-consolidated group in proportion to a certain limit on a yearly basis.
If some member companies are sold pursuant to the liquidation of the consolidating company within the course of insolvency proceedings, the exiting member of the group may recover its tax losses transferred to the consolidating company during the tax-consolidation period. The recovery of tax losses also applies if the company leaves the group because it is itself subject to insolvency proceedings.Interest relief
Does an acquisition company get interest relief for borrowings to acquire the target? Are there restrictions on deductibility generally or where the lender is foreign, a related party, or both? In particular, are there capitalisation rules that prevent the pushdown of excessive debt?
An acquisition company may get relief for borrowings to acquire the target company (whether French or foreign) subject to various restrictions:
- the interest rate limitation for interest payments to related parties for intra-group loans to the maximum rate set forth by article 39-1-3 of the French tax code;
- the anti-hybrid rule under which interest on related-party loans is tax-deductible only if the borrower can prove that such interest is subject to income tax in the hands of the lender at a rate equal to at least 25 per cent of the French standard corporate income tax rate (ie, at least 7 per cent for 2020);
- the Charasse amendment, which recaptures part of the financial expenses borne by a tax-consolidated group when:
- a tax-consolidated company acquires the shares of another company from an entity that is not part of the French tax group but that controls the acquiring company or is under common control with the acquiring company within the meaning of article 223B of the French tax code; and
- the acquired company joins the tax group; and
- the interest expense deduction limitation (transposition of the EU Anti-Tax Avoidance Directive by the 2019 French Finance Act), under which exceeding borrowing costs (such as interest expenses, guarantee costs or foreign exchange losses on borrowings) would be deductible only up to the greater of 30 per cent of the tax EBITDA (ie, the taxpayer’s EBITDA restated with tax-exempt income) or €3 million. Such a ceiling would be decreased to 10 per cent (or €1 million, if higher) for thinly capitalised companies (ie, companies for which the average amount of related-party debt exceeds 1.5 times their net equity). Any excess amount of borrowing costs may be carried forward without a time limitation, and unused interest deduction capacity in any given fiscal year may be carried forward for up to five years. For tax-consolidated groups, the above rules (tax EBITDA tests and the group safeguard clause) will be applied at the group level as if it were a stand-alone entity with a general safeguard clause (for example, members of a consolidated group are entitled to an additional 75 per cent deduction when the equity capital-to-assets ratio is higher at the level of the company than at the level of the group, with a 2 percentage points tolerance).
What forms of protection are generally sought for stock and business asset acquisitions? How are they documented? How are any payments made following a claim under a warranty or indemnity treated from a tax perspective? Are they subject to withholding taxes or taxable in the hands of the recipient? Is tax indemnity insurance common in your jurisdiction?
Whether stock or assets are acquired and whatever form it takes, buyers always require comprehensive protection against any tax and social liability relating to the period ending on and before the closing date.
This is usually given by sellers in the form of tax warranties and tax indemnities, under which the seller undertakes to pay back to the buyer all or part of the selling price in cases of disclosure of:
- a debt having its origin prior to the assignment in the accounts of the target company; or
- an overestimate of an asset’s value on the target company’s balance sheet at the date of the transfer (eg, adjustment clause, deferred payments clauses, representation and warranties, guaranties and covenants).
The tax treatment depends on the nature of the guaranty: a price adjustment clause or indemnity clause (in other words, a warranty clause in the restricted sense).
It results from case law that payments made by the seller under warranties or claims subsequent to the sale usually do not affect the capital gain previously computed (or the acquisition cost for the purchaser) but can be offset by the seller against taxable benefits of the financial year during which such payments occur. These will have to be added to the taxable profits of the purchaser.
If part of the indemnity exceeds the amount of the selling price, the courts allow the seller to deduct the excess amount from its taxable profit as damages (Administrative Court in Paris, decision dated 10 June 1993, No. 91-973). If the indemnification cannot be linked to an excess in the selling price, it can be totally deducted from the seller’s taxable profit (Administrative Court in Douai, decision dated 31 July 2012, No. 11DA00407, 3rd Ch).
When a payment is made by application of a price adjustment clause, the payment can be analysed as a reduction of the purchase price. The seller can claim for a reduction of the capital gain and a reimbursement of part of the corporate income tax paid within the statute of limitation, and the acquisition price can be modified by the buyer. In such a situation, the reimbursement of part of the price by the buyer does not constitute a taxable profit for the buyer.
Warranty and indemnity insurance has increased in popularity in recent years (and not only in the context of mergers and acquisitions). Initially viewed as too expensive and inflexible, brokers and underwriters adapted their policy to fit in the deals requirement and to be more flexible.