By recent decisions dated April 11, 2014, rendered within the framework of application of the France-Italy (French Administrative Supreme Court, Apr. 11, 2014, no. 346687, Société Banca di Roma SPA), France-Portugal (French Administrative Supreme Court, Apr. 11, 2014, no. 359640, Société Caixa Geral de Depositos) and France-Germany (French Administrative Supreme Court, Apr. 11, 2014, no. 344990, Société Bayerische Hypo und Vereinsbank AG) tax treaties, and using the same reasoning, the French Administrative Supreme Court ruled in favor of a foreign bank’s freedom to choose how to finance its French branch and the possibility for the French branch to deduct all the interests related to loans it had contracted from its taxable earnings.
In the case at hand, a foreign bank (German, Italian and Portuguese) created a French branch and contributed cash to it. Subsequently, the French branch took loans from the head office, other companies in the group and from third-party companies. As a result of a tax audit of the branch, the tax authorities considered that (i) the loans demonstrated that the cash contribution of the head office was insufficient given the shareholders’ equity the branch should have been given pursuant to applicable regulations or, notably, with respect to the risk to which it would have been exposed had it had legal entity status, and (ii) the resulting interest was allegedly not borne by an autonomous company which had activities identical or analogous to the branch’s activity and which dealt with the head office as an independent company. Based on this double argument, the tax authorities rejected the deduction of the portion of loan interest it deemed excessive.
Upholding the Paris Administrative Court of Appeal’s position, the French Administrative Supreme Court rejected the tax authorities’ argument, stating that, although French tax rules allow the tax authorities to challenge deduction of interests paid by a branch if the purpose of the loans is unrelated to the branch’s activity in France or if the loans’ remuneration is excessive, none of the tax rules allow the tax authorities to assess whether or not the choice of the company’s head office to finance its branch’s activity by allowing the branch to conclude loan, rather than making equity contribution.
Additionally, the French Administrative Supreme Court continued noting that neither the purpose nor the effect of the tax treaty provisions applicable to the particular case, allow the country in which the branch is located to attribute to the branch the profits that would have resulted from the contribution to the relevant party of a different amount of shareholders’ equity than the amount which, booked in the accounts produced by the taxpayer, accurately reflect the withdrawals and contributions made between the company’s various entities.
Hence, the tax authorities cannot substitute the shareholders’ equity the branch should have received for this latter amount, pursuant to the applicable regulations or with respect to the risk to which it would have been exposed had it had legal entity status.
On domestic law, the decisions are not innovative because they are the application to the branch of a case law rendered from 10 years ago about French subsidiaries of foreign companies (see, in this respect, French Administrative Supreme Court, Dec. 30, 2003, no. 233894, SA Andritz). However, these recent decisions provide with some new clarifications on the understanding of the minimum tax capital of the bank branches. Indeed, the decisions appear to favor a more flexible and pragmatic approach to branches’ financing means, thereby silencing the tax authorities’ criticism based on a large number of tax treaties, whose article on companies’ profits is drafted based on the versions of the Article 7 OECD model prior to the July 22, 2010 modification.