In this second French Tax Update of the year, we will first focus on one of the key provisions of the Finance Law for 2014 (Loi de finances pour 2014, 2014 Finance Law) which essentially aims at combating hybrid debt instruments put in place between French borrowers and affiliated foreign lenders. We will then review a selection of recent official publications (such as guidelines issued by the French tax authorities, case law, and ongoing tax treaty negotiations) which may be of importance from both an inbound or outbound perspective.
FOCUS ON THE ANTI-AVOIDANCE PROVISION TARGETING HYBRID DEBT INSTRUMENTS
As presented in the previous French Tax Update, the 2014 Finance Law has implemented yet another limitation of the deductibility for tax purposes of interest payments made by a French borrower to an affiliated entity (i.e., an entity controlled by the borrower, controlling the borrower, or controlled by the same third party as the borrower), this time targeting more specifically cross-border hybrid debt instruments (Anti-Hybrid Provision or AHP).
The AHP is applicable to fiscal years closed as from 25 September 2013, and may thus have an immediate impact on the corporation tax returns to be filed (and the corresponding corporation tax liability to be paid) during the upcoming months.
In essence, interest payments made by a French borrower to an affiliated entity will be deductible for tax purposes only if such borrower is able to demonstrate that the lender (be it French or foreign, even though the provision was clearly designed to target cross-border hybrid debt instruments) is subject to an income tax on the corresponding interest income which 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). Specific rules are also provided where the lender is a flow-through entity such as an investment fund or a partnership (Look-Through Rule).
Given its broad language and the lack of precise guidance within the parliamentary reports and debates which have preceded its enactment, many issues are likely to arise with respect to the scope of the AHP, the operation of the 25% Test, and the reach of the Look-Through Rule. The guidelines to be published by the French tax authorities are thus eagerly awaited.
- 25% Test
The main uncertainties pertaining to the AHP revolve around the 25% Test, and the way the comparison of the tax liabilities (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) will operate. Whilst the 25% Test is at the heart of the AHP, there is no unequivocal indication as to whether the comparison basis should be:
- the gross amount of the relevant interest payment;
- the net amount of the relevant interest payment and its repayment, if any, by the lender (e.g., in case of a back-to-back financing arrangement);
- the net amount of the overall interest payments received and made, if any, by the lender; or
- the overall taxable result of the lender (i.e., in order to apply every single French tax rule as if the foreign lender was a French tax resident).
Whilst the language of the AHP itself offers little guidance, certain parliamentary debates seem to indicate that the first option (i.e., based on the gross amount) should be followed. Its main upside would be its simplicity; it would nonetheless substantially hurt the efficiency of the anti-avoidance motivation behind the AHP. Another upside would be the correspondingly reduced declarative burden, as the taxpayer is the one bearing the 25% Test burden. There is, however, no guarantee that such option will be followed by the French tax authorities or by courts.
A more conservative approach would even lead to the fourth option (i.e., full analysis of the overall tax situation of the lender), which could turn out to be particularly burdensome with respect to both (i) the computation to be made by the taxpayer in order to determine whether the AHP is applicable, and (ii) the demonstration to be provided by the taxpayer.
Other issues, furthermore, stem from the uncertainty between those four possibilities. For instance, what should be the relevant comparison in the situation where the borrower and the lender have different fiscal year starting/closing dates? Likewise, how should be treated financing arrangements whereby interest payments are either deferred (e.g., deep discount instruments) or subject to a specific accounting or tax treatment, in terms of timing, at the level of the lender (i.e., the overall interest income pertaining to the financing arrangement would satisfy the 25% Test but, by virtue of specific accounting or tax timing rules, the 25% Test would not be satisfied for a given fiscal year)? Although some general French tax principles could provide some guidance, the guidelines to be published by the French tax authorities will have to be closely reviewed in this respect.
In the end, any of the three latter possibilities would most likely allow for the AHP to catch—in addition to cross-border hybrid debt instruments whereby payments would be deductible in France but exempt in the lender’s jurisdiction, the following:
- back-to-back financing arrangements whereby payments would (a) be deductible in France, (b) comply, on a gross basis, with the 25% Test in the lender's jurisdiction, but (c) effectively leave a marginal tax base in such jurisdiction by being eventually up-streamed to a third low-tax jurisdiction (thereby failing the 25% Test on a net basis), and
- financing arrangements placed under a specific accounting or tax regime as described above.
- Look-Through Rule
In essence, the Look-Through Rule provides that, where the lender is a flow-through entity such as an investment fund or a partnership, (i) the AHP limitation applies only to the extent that the borrower and the relevant members of the flow-through entity are affiliated entities, and (ii) the 25% Test is applied at the level of such members.
This being said, the AHP does not cover double-tier structures where the lender would be a flow-through entity wholly held by another flow-through entity. Should the Look-Through Rule then be applied at each level? Should it rather be read strictly so that the first flow-through entity in the chain would be regarded as shielding the ultimate lender from the AHP?
Beyond the uncertainties surrounding the 25% Test itself (see above), the guidelines to be published will also have to address the operation of the AHP in cases where several relevant members of the lending flow-through entity are (i) affiliated to the borrower but (ii) in different situations for AHP purposes (i.e., one satisfying the 25% Test but not the other, because of a different location or a different tax regime despite the same location). Should the deduction of the relevant interest payments then be denied for corporation tax purposes on a combined basis? Should it rather be prorated on the basis of the participation of the sole affiliated entity failing the 25% Test?
- Overlap with CFC legislation
The French CFC rules basically provide that the (relevant portion of the) profits of an enterprise, company, or entity are taxable in France in the following situations:
- if an entity subject to French corporate income tax operates an enterprise outside France or holds, directly or indirectly, 50% or more of a company or entity established outside France, and
- if such enterprise, company, or entity benefits from a so-called privileged tax regime.
Consequently, there is a possible risk that the AHP overlaps with such CFC rules in the case where a non-French lender would not satisfy the 25% Test, but whose profits would ultimately be taxable in France under the aforementioned CFC legislation.
Although it has been confirmed by the Budget Minister during the parliamentary debates that the purpose of the AHP was not to catch amounts already caught by the CFC rules, precise details will be expected from the guidelines to be published by the French tax authorities.
- Hybrid entities
Even though it was not the official motivation of the initial proposal, nor the apparent intention of the Parliament, the language of the AHP could effectively result in encompassing hybrid entities (i.e., a same entity being a corporation for tax purposes in a jurisdiction, and a partnership or a disregarded entity for tax purposes in another).
Indeed, in the case where the French borrower (be it a net borrower or an on-lender of the amounts borrowed) would be disregarded for tax purposes under the tax rules applicable in the jurisdiction of the lender, the AHP could technically kick in as the 25% Test would be regarded as not being satisfied (i.e., if the borrower is disregarded, then the relevant borrowing itself should be disregarded, and it would just not be possible to satisfy the 25% Test).
As the AHP does not provide for any safe-harbor or tie-breaker taking into account the tax regime applicable in the other jurisdictions involved in the 25% Test comparison, one may wonder to what extent the guidelines to be published by the French tax authorities will at all address the situation of hybrid entities.
- Coordination with foreign anti-hybrid provisions
Whilst the vote of the AHP was clearly intended to support the recent OECD and European Commission propositions related to the so-called mismatches of hybrid finance instruments, the French unilateral approach based on a denial of the interest deduction now appears to create serious risks of double taxation.
Indeed, aforementioned multilateral propositions instead aim at denying the benefit of a participation-exemption regime for dividends at the level of the lender (or, rather, financing provider) (PE-Based Approach) where the dividends so received have given rise to a deduction at the level of the borrower, since the relevant payments could be regarded as interest payments.
As a result, the confrontation of the AHP with a legislation following the PE-Based Approach (e.g., the German anti-avoidance rule targeting hybrid debt instruments) could give rise, for the same payment, to (i) a denial of the deduction at the level of the French borrower, and (ii) a denial of the participation-exemption regime at the level of the lender.
As the AHP does not provide for any safe-harbor or tie-breaker in the case where the other jurisdiction involved in the 25% Test comparison has adopted a PE-Based Approach, one may wonder to what extent the guidelines to be published by the French tax authorities will at all address such double taxation risk.
OTHER OFFICIAL PUBLICATIONS
- Update of the French financial transactions tax (FFTT) guidelines
The French tax authorities have issued on 15 January 2014 an updated version of their guidelines in respect of the FFTT (Updated Guidelines).
Amendments to the scope of the FFTT. The Updated Guidelines now provide that:
- preemptive subscription rights (droits préférentiels de souscription) do not constitute equity securities falling within the ambit of the FFTT;
- the acquisition of either (i) the usufruct or (ii) the bare ownership of an equity security falling within the ambit of the FFTT may be subject to the FFTT (i.e., in case of a stripping of the ownership of an equity security); and
- the exercise of a pledge does not constitute an acquisition for FFTT purposes (the Updated Guidelines thereby apply the same rationale as in the case where equity securities falling within the ambit of the FFTT are posted as collateral and definitively appropriated as a result of a counterparty default).
Specifics on the computation of the net position. The principles governing the net positions computation are not actually modified. However the Updated Guidelines now specify that the net position is computed (i) on the (actual or deemed) settlement date (with the consequence that a broker which has not elected for the deemed settlement date option would not be able to obtain the netting of transactions having different settlement dates), and (ii) individually at the level of each broker (with the consequence that a given investor using multiple brokers would not be able to obtain the netting of its overall position).
Other specific amendments. With respect to foreign exchange, the Updated Guidelines provide that the conversion rate should be the closing rate of the day preceding the settlement date (although an option for the closing rate of the day preceding the trade rate is available, provided such option is made for all transactions realized within the same month).
With respect to the UCITS industry, the Updated Guidelines also provide certain precisions with respect to (i) UCITS reorganizations which may benefit from the intragroup reorganizations exemption, and (ii) certain UCITS internal reorganizations.
- Administrative supreme court aligns accounting and tax treatment of provisions
In a long-awaited Sté Foncière du Rond-Point decision dated 23 December 2013 (Decision), the French Administrative supreme court (Conseil d’Etat) has ruled that, unless tax rules provide otherwise, a provision which has been deducted under French GAAP rules must be deducted for French corporation tax purposes.
Several courts and authors have in the past disagreed as to whether companies may enjoy a certain margin of appreciation with respect to the tax treatment of provisions which are deductible for accounting purposes.
Although it leaves some room for uncertainty as to its practical consequences with respect to past and current provisions, the Decision makes it clear that the tax treatment must follow the accounting treatment, and that the symmetrical correction theory may, in the context of the recapture of a provision, apply only under certain conditions.
- New double tax treaty between China and France
On 26 November 2013, China and France entered into a new double tax treaty (Treaty). The Treaty, which is the result of five years of negotiation, incorporates most of the OECD standard provisions:
- Article 4 provides detailed rules, including six illustrative sets of facts (which are similar to those provided for in the double tax treaty entered into between the UK and France), to address qualification and residence issues involving flow-through partnerships (but excluding investment funds);
- Article 10 provides for a reduced 5% withholding tax rate in favor of dividends distributed in respect of 25% or more shareholdings;
- Articles 10, 11, and 12 provide for specific anti-avoidance provisions with respect to dividends, interest, and royalties pursuant to which the Treaty benefits should not be extended in cases where the main purpose or one of the main purposes is to take advantage of the Treaty; and
- Article 24 furthermore provides for a general anti-treaty shopping provision, pursuant to which the Treaty benefits should not be available where (i) certain transactions or arrangements would be mainly aimed to secure a more favorable tax position, and (ii) obtaining such more favorable tax treatment would be contrary to the object and purpose of the relevant Treaty Articles.
The Treaty will come into force as from January 1 of the year following its enactment by both China and France. Existing structures may consequently have to be reviewed in order to account for the new provisions of the Treaty, and in particular its anti-abuse backbone.
- Forms to be used by trustees subject to disclosure obligations
Where a trust arrangement (within the French tax law meaning) (Trust) either (i) has a settlor or one of its beneficiaries who is a French resident for tax purposes, or (ii) comprises an asset which is located in France, the trustee of such Trust is subject to two disclosure obligations:
- it must disclose the constitution, modification, or termination of such Trust (including, in each case, the terms of the relevant deed), and
- it must yearly disclose the market value of the assets comprised within such Trust which fall within the ambit of French taxes.
The French tax authorities have now published the mandatory forms to be used by the trustees which are subject to the above-mentioned disclosure obligations, it being noted that, for 2014, the yearly disclosure must in principle be filed by 15 June 2014 (the corresponding noncompliance penalty amounts to the higher of €10,000 or 5% of the market value of the assets comprised within the Trust).
- Non-cooperative jurisdictions list update
In a letter dated 20 December 2013 and addressed to the Finance Commissions of the French Parliament, the French Ministry of Economy and Finance had announced that it would propose that the Bermuda Islands and the Bailiwick of Jersey be removed from the list of non-cooperative jurisdictions (NCJ List). Such removal has been officially published by an administrative decree dated 17 January 2014, with a retroactive effect as at 1 January 2014. As a result, the Bermuda Islands and the Bailiwick of Jersey have never effectively been part of the NCJ List (which effect is to trigger the application of a particularly penalizing set of French tax rules).
However, the NCJ List will most likely be once again updated during 2014 within the frame of its yearly update process. Jurisdictions which would then be added (if any) to the NCJ List would be effectively added thereto only as from 1 January 2015, whilst jurisdictions which would be removed from the NCJ List would be retroactively removed therefrom with effect as at 1 January 2014.