The French Administrative Supreme Court has confirmed that a contribution of shares to a company under the tax deferral regime, followed one week later by the sale of those shares to a third party, constituted an abuse of law.

The tax authorities reassessed the income tax due by a taxpayer couple because they had concealed capital gains resulting from the contribution of shares to a company, followed by the sale of the shares. In this transaction, the taxpayers effectively deferred taxation on the capital gains from the share contribution, pursuant to Article 150-0 B of the French Tax Code ("FTC), while they effectively disposed of the proceeds of sale of the contributed shares.

The Court found that “the profit from the taxes deferred on capital gains realised by a taxpayer resulting from the contribution of shares to a company, which he controls and which was followed by the company selling the shares, constitutes an abuse of law if it involves an arrangement whose sole purpose is to allow the taxpayer, via a company, effectively to possess the cash obtained from the sale of these shares while he was still the owner of the company’s shares received in exchange at the time of the contribution.” Indeed, the Court pointed out that “the company failed to reinvest the proceeds from the sale in an economic activity.”

This decision clearly exposes that deferring taxation on capital gains from a share contribution to a company controlled by the taxpayer, under the regime of Article 150-0 B of the FTC, when the shares contributed are then sold by the beneficiary company, may constitute an abuse of law.

The French Administrative Supreme Court’s solution was not obvious. Although the Court had given three earlier decisions--on another tax deferral regime that under certain conditions (which is not automatic and for which the capital gain calculation is different), deferring taxation on capital gains could constitute an abuse of tax law--the decision in those cases did not appear to be necessarily applicable to the tax deferral mechanism provided by Article 150-0 B of the FTC, which is automaticy and, in the words of the Court, “does not give the taxpayer the choice between immediate taxation of the capital gains or subsequent taxation.”

In fact, the ruling was expected after the Consultative Committee for Punishment of Abuses of Law (which became the Abuse of Tax Law Committee)--which had previously stated that the use of the tax deferral regime of Article 150-0 B of the FTC could not constitute an abuse of law since it was automatic--later abandoned its position at the beginning of the year with two new opinions.

Focusing on an economic approach to the transaction, several lower courts had ruled that the automatic nature of the tax deferral mechanism in Article 150-0 B of the FTC did not prevent the transaction from being characterised as an abuse of tax law. Therefore, the French Administrative Supreme Court’s decision is consistent with the pragmatic approach of lower courts and the most recent position of the Abuse of Tax Law Committee.