By Ambroise Bricet, Mathieu Gautier and Marie Pierre Hôo
This material has been prepared by professionals in Taj, French tax and legal firm, member of Deloitte Touche Tohmatsu

The French tax authorities issued guidance on 4 April 2008 that allows an EU parent corporation to obtain a refund of a portion of French capital gains tax paid in connection with the disposal of shares in a French subsidiary. This new measure should mitigate the risk of French law being incompatible with EC law.

Before 2005, a 19% capital gains tax was imposed on the disposal of a participation in a subsidiary under the standard long-term capital gains regime. The applicable capital gains tax rate was thereafter reduced to 15% in 2005 and to 8% in 2006. After 2007, however, capital gains derived from participation shares may benefit from a 95% exemption, with the remaining 5% of the gain subject to corporate income tax at the standard rate of 33 1/3%, and giving rise to an effective tax rate of 1.67%.

The 95% exemption is available only with respect to gains derived by French residents; it is not available to such capital gains derived by nonresidents. Before the 4 April guidance was issued, nonresident parent companies that owned substantial participations in French entities were subject to an 18% capital gains tax (16% before 2008). The tax was due where an applicable tax treaty granted France the right to tax substantial participations (for example, treaties with Spain and Italy). Many practitioners considered this difference in tax treatment, based entirely on the residence of the parent company, as incompatible with the freedom of establishment principle in the EC Treaty.

The French tax authorities have now decided that parent companies located in another EU Member State, or an EEA Member State that has signed a treaty that includes an administrative assistance clause, may obtain a refund of a portion of the French capital gains tax paid at the 18% or 16% rate that exceeds the corporate tax that the parent would have paid had it been a French resident company.

An EU parent (or EEA eligible parent) that wishes to obtain a refund must satisfy the following conditions:

• Have previously paid capital gains tax in France;
• Is subject to corporate income tax in its state of residence, without being exempt;
• Sold the participation in a fiscal year beginning as from 1 January 2006; and
• Owned the shares directly and continuously for at least two years before the sale.
  

Based on the existing tax treaties between France and other EU/EEA states, the above rule will apply only to parent companies that are resident in Spain, Italy, Austria, Sweden or Bulgaria as their respective tax treaties grants France the right to tax substantial participations. Parent companies located in other EU Member Sates were already protected against the French capital gains tax since their treaties did not provide for a substantial shareholding clause.

As a result of the refund mechanism, capital gains will give rise to an effective tax rate of 1.67%, regardless of whether the parent company is located in an EU/EEA Member State or in France (the effective rate for French residents, however, is actually 1.72% due to surtaxes). By eliminating the discrimination between French taxpayers and EU/EEA parent companies with respect to French capital gain taxation and providing for specific procedures, the French rules should no longer be incompatible with EC law. The new guidance also will ease shareholding restructuring when a French subsidiary is held by an Italian, Spanish or Swedish parent company, for instance.

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