Applicable to fiscal years closed as from September 25, 2013, interest payments made by a French borrower to an affiliated entity are deductible for tax purposes only if such borrower is able to demonstrate that the lender is subject to an income tax on the corresponding interest income that is at least equal to 25% of the French corporation tax that would have been due had it been computed in accordance with standard French rules ("25% Test"), subject to specific adjustments where the lender is a flow-through entity such as an investment fund or a partnership ("Look-Through Rule").  The language of the Anti-Hybrid Provision being in certain respects unclear, the Draft Guidelines address certain of the issues raised in our French Tax Update for February 2014.   

  • 25% TEST

The main developments provided by the Draft Guidelines pertain to the way the comparison of the tax liabilities should operate (i.e., the actual tax liability of the lender on the one hand and its theoretical liability under French standard rules on the other hand). The Draft Guidelines first provide that the comparison with the French corporation tax that would have been due, had it been computed in accordance with standard French rules, is made not only in reference to the French standard corporation tax rate (33.1/3%) but also taking into account the so-called additional contributions on corporation tax (contribution additionnelles à l'impôt sur les sociétés). While this is not entirely clear, we understand that the FTA thereby intend to encompass both the so-called exceptional contribution (contribution exceptionnelle, which amounts to 10.7% of the basic corporation tax liability arising from the application of the standard 33.1/3% rate for taxpayers with a turnover in excess of €250 million) and the so-called social contribution (contribution sociale, which amounts to 3.3% of the basic corporation tax liability arising from the application of the standard 33.1/3% rate for taxpayers with a basic corporation tax liability in excess of €763,000). The Draft Guidelines further indicate in a much-awaited clarification that the 25% Test comparison basis should be the theoretical taxation of the gross amount of the relevant interest payment, regardless of (i) the lender's effective tax liability on the interest payments, (ii) the existence of expenses reducing the lender's tax liability (i.e., thereby dismissing back-to-back arrangements), and (iii) the lender's overall taxable result (i.e., thereby not penalizing interest payments made to loss-making lenders).  Separately, the position taken by the FTA appears to reduce the declarative burden of the borrowers, as the Draft Guidelines specify that they must provide documentation to demonstrate compliance with the 25% Test only upon request. It seems reasonable, however, that borrowers verify whether such demonstration is possible before making any deduction. The Draft Guidelines moreover address certain of the timing issues by:

  • Indicating that in the particular case of a mismatch between the borrower's and the lender's fiscal year closing dates, compliance with the 25% Test must be demonstrated for the fiscal year in which the lender will receive the relevant interest payment; and

  • Allowing some leniency regarding deferred interest payments and discrepancies of accounting and tax treatment: where, by virtue of specific accounting or tax timing rules, the 25% Test is not satisfied for a given fiscal year, the Draft Guidelines nevertheless allow the borrower to deduct the relevant interest payment during the fiscal year in which such payment is effectively included in the lender's taxable income (provided an additional declaration is filed by the borrower).

Finally, and as suggested by the parliamentary debates, where the lender is a listed REIT-like company (société d'investissements immobiliers cotée, "SIIC"), the borrower will not be subject to the Anti-Hybrid Provision to the extent that it demonstrates that the interest payments received by such SIIC are comprised within its taxable sector (i.e., subject to corporation tax)


Pursuant to the Draft Guidelines, where the lender is a flow-through entity such as an investment fund or a partnership, (i) the Anti-Hybrid Provision limitation applies only to the extent that both the relevant flow-through entity and at least one of its members are affiliated to the borrower, and (ii) the 25% Test is applied at the level of such member(s) of the flow-through entity that are affiliated with the borrower (i.e., notwithstanding the taxation level of the other member(s) of the relevant flow-through entity).

The Draft Guidelines provide that in the case where the 25% Test is not satisfied with respect to a given affiliated member of a flow-through lending entity, the deduction of theentire interest payment made by the borrower should be denied (without taking into account the participation level of the affiliated member failing the 25% Test).

Moreover, the Draft Guidelines elaborate that in the case of a double-tier structure (i.e., where the lender would be a flow-through entity held by another flow-through entity), the 25% Test still applies at the level of the member(s) of the lending flow-through entity (i.e., where such member(s) fail to comply with the 25% Test, the Anti-Hybrid Provision would apply notwithstanding the taxation level of its own ultimate member(s)). In other words, the intermediation of two or more flow-through entities should jeopardize any deductibility.   


As suggested by the Budget Minister during the parliamentary debates, the Draft Guidelines confirm that where the relevant interest payment made to a foreign lender is already subject to corporation tax in France through CFC rules, the Anti-Hybrid Provision should not apply.


Even though it was not the official motivation of the initial proposal, nor the apparent intention of the Parliament, the language of the Anti-Hybrid Provision could effectively result in encompassing hybrid entities (e.g., a same entity being a corporation for tax purposes in one jurisdiction and a partnership or a disregarded entity for tax purposes in another). The Draft Guidelines do not provide any clarification with respect to the situation of hybrid entities.


While the Draft Guidelines organize the interplay of the Anti-Hybrid Provision with the other French provisions limiting the deductibility for tax purposes of interest payments, they do not address the risk of double taxation that could arise from the cumulative application of (i) the Anti-Hybrid Provision at the level of the borrower and (ii) a foreign linking rule at the level of the lender (that would, for instance, deny the application of a participation-exemption regime for dividends in the presence of a hybrid debt instrument, in accordance with the recent OECD and European Commission proposal related to hybrid mismatch arrangements).