(French Administrative Supreme Court, Mar. 12, 2014, no. 352212, Société DGFP ZETA)

In a March 12, 2014 decision,[1] the French Administrative Supreme Court reversed a decision of the Paris Administrative Court of Appeal [2] in which the latter had held that, for application of the France-Japan Tax Treaty of November 27, 1967 (hereinafter the “Treaty”), currency exchange gains from the sale of a building had to be distinguished from capital gains made from the building’s sale.

In this case, the tax authorities had reassessed the company’s taxable earnings the currency exchange gains that the company considers not to be taxable in France and which had been made from the sale of a building located in Japan and upon the repayment of the loan for prior repurchase of the leasehold and from the improvements made by the tenant.

The Paris Administrative Court of Appeal had ruled that these currency exchange gains were not within the scope of the Treaty’s Article 5 regarding profits from real estate sale, but within the scope of the Treaty’s Article 7-1 regarding calculation of companies’ profits. However, as the plaintiff appellant company did not have a permanent establishment in Japan, the Administrative Court of Appeal ruled that these capital gains were to be taxed in France.

The French Administrative Supreme Court was asked to rule only on the issue of the currency exchange gains deriving from the building sale. It ruled that, as there were no specifications in the Treaty in this regard, it was not necessary to make a distinction between the various types of profits resulting from the sale of this property to determine whether they were related to this sale, stating that, “there is no provision in this treaty to be able to distinguish between the currency gaps resulting from conveyances of properties and other profits from conveyances of the same property.

Hence, the French Administrative Supreme Court reversed the Court of Appeal’s decision on this issue and settled the substantive issues of the case.  Insofar as, firstly, this building was not managed by a permanent establishment located in Japan and the company did not have a dependent agent in Japan and, secondly, the currency exchange gains resulting from this building’s sale had to be seen as profits related to the building’s sale in the absence of contrary Treaty provisions, the French Administrative Supreme Court concluded that taxation of these currency exchange gains was attributed to Japan, pursuant to the Treaty’s Article 5.

The French Administrative Supreme Court’s ruling is in line with the outcome adopted in the Sté BNP Paribas decision of October 1, 2013.[3] In this latter case, which involved a somewhat similar context, the French Administrative Supreme Court made a ruling on the categorization of various currency exchange gains related to the financing of a 999-year lease involving a building located in the United Kingdom with respect to the United Kingdom-France Tax Treaty of May 22, 1968. In this particular case, the French Administrative Supreme Court ruled that the currency exchange gains related to the financing[4] of the lease’s acquisition were not directly connected to the building’s operation, but constituted separate financial transactions. Hence, they could be regarded as real estate income within the meaning of Article 5 of the applicable United Kingdom-France Tax Treaty.

In these two decisions, the French Administrative Supreme Court’s approach was to strictly adhere to the letter of the relevant tax treaty:  the conveyance of the building in the present case and the building’s operation in its previous BNP Paribas decision.  When the currency exchange gains were intrinsically related to the real estate transaction itself and the convention does not have any specific provisions, then the building “draws” the taxation of the currency exchange gains to the country in which it is located. On the other hand, when the currency exchange gains result from transactions with only an indirect link to the building, to use the expression used by Vincent Daumas, the public rapporteur in the BNP Paribas case, cited supra, then the tax regime for currency exchange gains is independent of the tax regime for income related to the building. According to the French Administrative Supreme Court, this is the case of loan and swap transactions, which are separated from the fact of owning the building.

Lastly, as regards tax treatment in France for profits resulting from sales of a building pursuant to the Treaty, the French Administrative Supreme Court pointed out that, “when a French tax resident receives income from Japan and this income, pursuant to the provisions of this Treaty, are taxable in Japan, France (…) exempts this income from taxes (…); consequently, the disputed currency exchange gains could not be taxed in France, even if it had not been taxed in the State where the property was located.[5]

This last clarification regarding the absence of taxation on capital gains in France, although Japan does not use its right to tax it, is particularly interesting with respect to the propensity the tax authorities can sometimes have, for cross-border transactions, to include foreign tax treatment in their analysis, although such treatment most often has no incidence on the application of national or treaty provisions.  This clarification, which is based on the principle of territoriality for taxing companies, fully illustrates that, “what is best left unsaid is better yet when said.