Must the interest capitalized annually on convertible bonds issued by a company be declared in its imprimé fiscal unique (‘IFU’) filing?
The provisions of article 242 ter of the French General Tax Code (‘GTC’) require that each year and in respect of each taxpayer, entities that have made payments of capital income (in particular, dividends and interest) must make a declaration (called the imprimé fiscal unique or ‘IFU’) detailing the sums that were paid in the preceding year. In theory, any failure to complete an IFU is punishable by a fine representing 50% of the undeclared sums.
Complying with these provisions presents practical difficulties, in particular in connection with LBO transactions, in which part of the acquisition finance is often made up of convertible bonds. It is not clear whether the interest capitalized annually in relation with such bonds must be declared in the IFU filed by the debtor company.
The terms and conditions of convertible bonds obligations typically provide that:
- interest will be automatically capitalized, in accordance with the provisions of article 1154 of the French Civil Code, on each anniversary-date of the issuance of the convertible bonds, and
- interest capitalized and accrued interest will only be paid to convertible bond holders on the date of conversion or repayment of those convertible bonds.
On that basis, it is reasonable to assume that interest capitalized on convertible bonds did not have to be declared each year in a company’s IFU, since the cumulated interest claim on each anniversary-date is neither effectively paid to the convertible bond holder, nor registered in an individual current account in his name. The interest would only be paid at the time of conversion or repayment of the convertible bonds.
However, this approach has not been expressly confirmed by the French tax code or the administrative doctrine and consequently uncertainty remains, and is reinforced by the generally accepted rule that transfer into an account is equivalent to a payment.
The debtor company, which at the time of issuance of the convertible bonds recorded a debt for an amount equal to the convertible bonds’ nominal value, for example 1,000 euros, must automatically increase (i.e., without the convertible bonds holder having to take any decision in this sense) the amount of his debt so as to integrate the accrued interest for the period on each anniversary-date of the issuance of the convertible bonds
For example on the first anniversary-date of the issuance of the convertible bonds, the amount of the recorded debt is equal to 1,000 + (1,000 x 10%) = 1,100 euros. On the second anniversary-date of the issuance of the convertible bonds, the amount of the recorded debt is equal to 1,100 + (1,100 x 10%) = 1.210 euros. And so on.
As a matter of practice, it has been recommended that the interest capitalized should be declared in the IFU, to avoid any risk of the 50% penalty being applied.
However, the tax authorities, in a letter recently sent to our firm regarding this issue, have expressly confirmed to us that (i) only the effective payment of the interest to the convertible bond holder for the first year would result in the establishment of an IFU on the income collected in the first year, and that (ii) it is not necessary to declare annually capitalized interest on the IFU.
This position is justified according to the French tax authorities both by the drafting of articles of the French tax code relating to the IFU (article 242 ter refers to the ‘individuals paying the capital income’ and article 49 E of the Annex III to the GTC refers to ‘the individual collecting the income’) and by the link that must be made between the date on which the interest that must be declared in the IFU arises and the taxation date of such interest received by a convertible bond holder liable to pay income tax (such holder would not be liable to pay income tax under the fiscal year of capitalization as long as the interest is not ’available’ to him within the meaning of article 156 of the French General Tax Code; he would then only be liable to tax either at the time of conversion or repayment of the convertible bonds).
Ideally, the position taken by the French tax authorities should be formalized in order to put an end to the confusion arising from this issue during acquisition tax due diligences