France Tax Alert - 14 December 2012
FTA comments on anti-abuse provisions relating to acquisition of participating shares
By Patrick Fumenier and Marie-Pierre Hoo
The French tax authorities (FTA) recently made official comments on the anti-abuse rule in the French Tax Code (article 209-IX) that limits the deduction of financial expenses linked to the acquisition of participating shares.
Article 209-IX, which was introduced in the 2012 Finance Act and applies for financial years beginning on or after 1 January 2012, is designed to ensure that expenses related to the acquisition of a participation in a French company are deductible for tax purposes only if the relevant shareholding is managed from France. If not, a portion of the interest expense linked to the acquisition is disallowed each year in an amount corresponding to the ratio between the acquisition price and the average of the company’s overall indebtedness for the financial year concerned. This limitation will apply until the end of the eighth financial year following the year of acquisition.
Apart from some legal exceptions (i.e. when the value of the participation owned is below EUR 1 million, the French company demonstrates that its indebtedness ratio is below that of the group or the purpose of the loan was to finance the acquisition of assets other than shares), the company that acquires the shares will have to demonstrate that the shareholding is effectively managed from France in order for the financial costs to be tax deductible.
FTA comments and clarifications
Requirement that shares be effectively managed in France
This requirement that the shares are effectively managed in France will be deemed to be met when the company that holds the shares constitutes an “autonomous decision-making center.” In other words, the company must be able to show that it has decision-making powers over its shares and that it effectively contributes to the decision-making process, in particular, through the shareholders’ meeting.
The FTA indicates that the qualification of a company as an “autonomous decision-making” center” is to be determined based on the facts and circumstances of the case and can be evidenced by any means (notably by a set of indicia). The following are examples of indicia that could be particularly relevant:
- The autonomous nature of the decision to acquire the shares; and
- The ability to freely dispose of the shares, to conclude contracts related to the shares (such as pledges, loans or rentals) provided the company still is able to participate in the decision-making process of the company whose shares have been lent or rented.
If the rights associated with the ownership status are “excessively” limited, i.e. if the company is subject to an agreement that prohibits the disposal of the shares, the company will not be considered an autonomous decision-making center. However, the FTA specifically states that a company’s internal governance rules (provided they are formalized and general) will be taken into account in determining whether a company has autonomous decision-making powers. “Lock-up” clauses (which prohibit the transfer of shares) will not be taken into account if they result from constraints imposed by a bank at the time the loan was granted for the acquisition of the participating shares.
With respect to the requirement that the company make an effective contribution to the decision-making process, the FTA states that it is not necessary that the shareholding actually be managed by the company that holds the shares. The management can be undertaken by any company that controls or is controlled by the company holding the shares, provided that company is established in France.
To enable the acquiring company to demonstrate that it meets the requirement that it make an effective contribution to the decision-making process of the company whose shares are held, the following documentation should be retained:
- Documents relating to the functional, organizational and structural relationships between the parties, such as charts demonstrating the decision-making process applicable to the company; and
- Documents evidencing contributions made at the shareholders’ meetings, effective representation on the governing bodies of the company whose shares are held, the ability to appoint the legal representatives or certain representatives of the governing bodies of that company, and/or the ability to decide on dividend distributions.
The authorities specifically addressed the following:
Permanent establishments (PE): Despite its lack of legal personality, a PE can constitute an autonomous decision-making center. When the PE keeps its own separate accounts and has entered the shares covered by the anti-abuse rule in its balance sheet, the PE can use the above indicia to demonstrate that it has fully autonomous decision-making powers over the shares.
Passive holding companies: According to the FTA, a “passive” holding company, as opposed to an “active” holding company, in principle, cannot constitute an autonomous decision-making center. By definition, a passive holding company does not participate in the management of the companies in which it holds shares, but only performs some typical rights of a shareholder. Thus, an acquisition made by a passive holding company likely will be subject to the restrictions on the deduction of interest expense.
Timing of determination of effective management of shares: There are two sets of rules: one set for shares that are acquired after the date on which the new law entered into force and one set for shares that were acquired before that date.
In general, whether the acquiring company constitutes an autonomous decision-making center should be determined over the 12-month period from the date the shares were acquired. In practice, the relevant evidence can be provided in the year of acquisition or in the following year (e.g. with respect to shares acquired in 2012, a company whose fiscal year corresponds to the calendar year can demonstrate that it is an autonomous decision-making center on 31 December 2012 or on 31 December 2013). (The company must present the evidence at the time the corporate tax return; the evidence will be based on the indicia existing during the period ending on 31 December 2012 or 31 December 2013, at the company’s election. This is a taxpayer favorable option since the company can elect for which of these two periods it will present the evidence.) Once the evidence is presented, the decision-making requirement does not have to be met throughout the add-back period (i.e. the period during which disallowed interest expenses potentially would be added back to taxable income). However, if the company does not provide the evidence in due time, it will be subject to the tax add back until the end of the eighth year following the year of acquisition, even if the decision-making requirements are subsequently met.
As regards shares acquired before the law entered into force, evidence must be provided in respect of the first financial year beginning on or after 2 January 2012. Therefore, a company whose financial year coincides with the calendar year must present the evidence for the year ended 31 December 2013. It is important to note that a company will only have to demonstrate that it has decision-making powers over the shares in respect of that year (i.e. not in respect of the year in which the shares were acquired).