As France faces its very own Winter of discontent, the Finance Act for 2019 aspires to reconcile competitiveness and fight against tax avoidance. Yet, this twofold ambition is clearly not a walk in the park…
François Hellio and Rosemary Billard-Moalic, Attorneys-at-law at CMS Francis Lefebvre Avocats, offer an insight into some of the most significant amendments and new measures designed to both secure the compliance of some French key tax regimes with the OECD and EU standards regarding the fight against aggressive tax planning and maintain the attractiveness of France as a place to invest.
Separate from the Finance Act and because of the lack of consensus on the matter at European level, the French Finance Minister, Bruno Lemaire, has recently announced the introduction into French law of a digital services tax. The edges of such a tax yet need to be trimmed – it is rumoured to be a 5% tax assessed on French-sourced turnover where a company’s both global and French turnovers exceed € 750 million and € 25 million - and the question remains as to the constitutional consistency and conformity to international law of such a one-sided action. To be followed...
For the time being, let’s focus on the main provisions of the 2019 Finance Act: Reform of the patent box regime so as to bring it in line with the OECD’s “nexus approach”, substantial revision of the financial expenses limitation rules and tax consolidation and parent-subsidiary regimes to comply with recent ECJ’s rulings, introduction of a general anti-abuse rule in order to implement the 2016 anti-tax avoidance directive. The main tax purpose test also makes a grand debut in the domestic general anti “abuse of law” provision which used to be applicable only to arrangements set up with a sole tax purpose. Finally, regarding individual taxation, rules applicable to newcomers to France have been enhanced.
A ”nexus-friendly” patent box regime
Under prior legislation, French corporations used to enjoy a reduced 15% corporate tax rate with respect to income derived from patent rights – i.e. any income derived from the licensing of patents and patentable rights or any capital gains realized on the sale of patents and patentable rights held for a minimum two years, except where the sale occurred between affiliated companies.
This preferential tax regime was labelled as a harmful practice by the OECD as it did not comply with the so-called “nexus approach”. Basically, it applied regardless of the place where the R&D activities were carried out and of the existence of a direct link between those R&D expenses and income derived from patent rights.
Under the new patent box regime, income covers any income derived from the licensing or sub-licensing of patents or any capital gains realized on the sale of patents held for a minimum two years, except where the sale occurred between affiliated companies. Copyright protected software and non-patented inventions are also covered, whereby in the latter case a patentability certificate must be first obtained from the INPI (‘Institut National de la Propriété Industrielle’ - France patent office).
As of January 1st, 2019, and irrespective of the date of creation or acquisition of patent assets, the preferential tax rate, which is cut down to 10%, is to be applied to a “post nexus” taxable net income defined as follows:
- First, corporations must choose patent assets the income of which will be eligible to the preferential tax rate (on an asset or family of assets basis);
- second, “pre-nexus” taxable patent income is to be defined after deduction of R&D expenses from income derived from eligible patent assets;
- finally, to get “post-nexus” patent income, “pre-nexus” taxable patent income must be multiplied by a “nexus ratio” – i.e. the ratio of R&D expenses incurred, either directly by the taxpayer or outsourced to non-related companies, for the creation and development, or acquisition, of the eligible asset over aggregate R&D expenses incurred for the creation and development, or acquisition, of the eligible asset. Where applying the “nexus ratio” leads to a blatant underestimation of taxable patent income, a safe harbour provision allows for a replacement ratio upon approval by the tax authorities.
Though compliant with OECD standards, the new patent box regime will be complex to implement and will certainly lead to extra formalities and extra costs for companies.
ATAD-compliant financial expenses deduction limitation rules
Implementing the ATAD Directive’s general limitation of financial expenses deduction into French taw law caused the existing rules to be significantly reviewed.
Under prior legislation, net financial expenses were deductible up to 75% of their amount (no limitation applied if they did not exceed € 3 million a year). In addition, deduction of interest paid to affiliated entities (or deemed to be so) was limited under thin capitalization rules. A specific mechanism also applied to limit the deduction of financial expenses incurred for the acquisition of qualifying shareholdings (so-called “Carrez amendment” rule). As of January 1st,2019, these rules are repealed.
Other pre-existing rules remain however applicable:
- interest rate limitation for shareholders’ loans,
- non-deduction rule for financial expenses where the beneficiary is entitled to preferential tax regime (anti-hybrid rule),
- non-deduction rule where a controlled company is transferred into a French tax group (so-called “Charasse amendment” rule).
Since January 1st, 2019, the ATAD Directive’s general limitation has been enforced and thus applies in addition to the existing rules. According to this rule, net financial expenses are deductible up to the highest of two thresholds: either € 3 million or 30% of adjusted EBITDA. Along with this new rule is provided an exhaustive list of net financial expenses. 75% of the so disregarded net financial expenses may still be tax deducted, except where the company belongs to a group filing consolidated accounts and shows a lower equity-to-assets ratio than that of the group, determined on a consolidated basis. Also, the 75% add-back rule is not applicable if the company is thinly capitalized, that is where related-party debt exceeds 1.5 times the company’s net equity.
Where a company is thinly capitalised, that, the deduction of net financial expenses incurred by related-party debt is capped at the highest of € 1 million or 10% of adjusted EBITDA.
Financial expenses that are not deductible any given year may be carried forward indefinitely within the same limitations (except where a company is thinly capitalized) whereas unused deduction capacities (where the total amount of financial expenses for any given year is lower than the set thresholds) may be carried forward for the next five years.
Intra-group transactions: complying with ECJ’s rulings and facing Brexit
The following changes of the French tax group regime (“intégration fiscale”) aim at bringing French domestic law into conformity with European case law and apply as of January 1st, 2019.
The neutralising of some intra-group transactions for the sake of calculating the tax group’s overall taxable income is repealed. Waivers of debt and subsidies are concerned as well as sales of substantial shareholdings eligible to participation-exemption.
In addition, dividend distributions made within the tax consolidated group and which do not qualify for the parent-subsidiary regime (the beneficiary holds less than 5% of the distributing entity’s share capital) are no longer fully neutralised at the tax consolidated group level. A 99% tax exemption applies instead where the distribution is performed within a French tax consolidated group or where the dividend is distributed to a French company from a EU or EEA company which could be included in a French tax consolidated group were it subject to CIT in France.
Further, dividend received from a EU or EEA subsidiary by a French company which is not a member of a tax group, and which qualifies for the participation-exemption regime, will be 99% tax exempt if the foreign subsidiary was to meet the conditions to be a member of a tax group with its French parent, should it be a French resident...
Finally, to face at best the aftermath of Brexit on tax consolidated groups, UK resident companies will remain eligible to the French tax group regime (so-called “horizontal group”)until the end of the financial year even though they will not be EU or EEE companies anymore. Along the same lines, under certain conditions, the merger of the parent company of a tax group into another company of the group will no longer cause the termination of the group.
Anti-abuse provisions as a weapon of mass reassessment
First, the ATAD Directive’s general anti-abuse provision is implemented into French law. As of January 1st, 2019, the tax authorities, as they assess corporate income tax liability, may disregard an arrangement or series of arrangements put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of French tax law and which is not genuine - i.e. the arrangement has not been set up for sound commercial reasons implying economic reality (new article 205 A French Tax Code).
Such a general anti-abuse rule used to be applicable only to specific tax measures such as the preferential tax treatment of capital gains in the context of corporate reorganisations or participation-exemption under the parent-subsidiary regime. It now generally applies to corporate income tax. There are no specific penalties and no procedural safeguards attached to this anti-abuse provision and questions remain as to how it aligns with existing anti-abuse rules.
It is so very much a grey area in the absence of any official guideline on the matter and taxpayers may be well advised to rely on the specific tax ruling introduced by the 2019 Finance Act which enables them to have the tax authorities confirm that they do not fall within the scope of the new general anti-abuse rule (6-month implied consent).
A second new anti-abuse rule is the new main tax purpose test applicable to situations involving all other taxes than corporate income tax (new article L 64 A French Tax Procedure Code). Under prior legislation, the French tax authorities could disregard operations which provided a tax advantage as they were considered as fictitious or driven solely by a tax purpose. Such an operation was labelled an “abuse of law”.
Under the new provision which will apply as of January 1st, 2020, fictitious or solely tax-driven operations will still be constitutive of an “abuse of law”. In addition, the new provision covers operations driven by the main purpose to avoid or reduce the final tax burden. The blur around the definition of the “main purpose” and the lack of specific penalty attached to this “main tax purpose abuse of law” - contrary to the “sole tax purpose abuse of law” which is charged with a 40% or 80% penalty – seem rather harmful to legal certainty. The possibility for taxpayers to seek an opinion by the “abuse of law” committee certainly constitutes a procedural safeguard, but it does not appear sufficient for this new “abuse of law” to be exempt from criticism.
An enhanced regime for newcomers
France has had a preferential tax regime applicable to individuals moving to France under an employment contract for quite some time now. Under this regime, newcomers – i.e. individuals moving to France and who have been foreign tax residents for a minimum 5 years - are entitled to a tax-exemption of any extra-salary paid in return of their move inbound. Yet, employees who were directly hired by a French company could opt out for a flat 30% tax exemption whereas employees on a secondment to France could not. The 2019 Finance Act extends the scope of the flat 30% tax exemption to all employees, be they directly hired or on a secondment. This amendment should promote intra-group mobility to France.
The taxation of foreign carried-interest received by newcoming managers has also been made more enticing. Under prior legislation, foreign carried-interest used to be taxed as salary, under the progressive income tax schedule, which could lead to a 60 to 65% taxation (income tax, social taxes and high income contribution included). Under the new provisions, newcomers who transfer their domicile to France between July 11th, 2018 and December 31st, 2022 and who have been foreign tax residents for a minimum three years, are entitled to a 30% flat taxation (12.8% income tax and 17.2% social taxes) on carried-interest they receive from a fund located in the EU or EEA or in State which exchanges information for tax purposes with France in order to prevent tax avoidance or evasion. This preferential tax regime cannot, though, be combined with another regime applicable to newcomers which consists in exempting, on a 50% basis, foreign passive income received by newcomers.