According to the French tax authorities (FTA), in the context of a global economy, international tax audits are an essential part of the fight against fraud.
As part of the 2021 Finance Bill, the French government has released a report on tax audit policy. The report contains information on the practices of the FTA, particularly regarding tax audits in the field of international transactions, and figures to monitor tax audit activity.
This public report shows that transfer pricing adjustments remain an important component of tax audit activity. This is the consequence of new practices by the FTA that make greater use than before of some instruments (automatic exchanges, transfer pricing documentation, etc.).
Results of French Tax Audits in International Transactions
The share of audits with tax adjustments related to international transactions is equal to 15% of total audits, whatever the legal basis.
In most cases, these tax adjustments are related to transfer pricing adjustments and territoriality rules or derive from the application of anti-abuse rules.
Tax Audits and Transfer Pricing
What are the results of the tax audits?
The French tax law contains an old provision, dating from 1933, (Article 57 of the French tax code) which allows the FTA to make transfer pricing adjustments. According to this provision, profits transferred through intra-group transactions by way of an artificial increase or decrease in the purchase or sale price or by any other means must be taken into account in the taxable basis.
Transfer pricing adjustments concern on average more than 400 tax cases per year (2017: 442, 2018: 452, 2019: 355). In 2019, the total amount of adjustments to the taxable basis was 3.9 billion euros ($4.67 billion).
What kind of tax cases are involved?
The French tax law relating to transfer pricing adjustments is very flexible and allows the FTA to make tax adjustments in many kinds of cases, including increased purchase price, sale prices minus or business restructuring resulting in the transfer of functions without compensation.
In addition, according to the FTA, in several cases tax adjustments which are made concern transactions with territories granting a low tax regime: Bermuda, Cayman Islands, United Arab Emirates, Hong Kong, Ireland, Liechtenstein, Singapore and Switzerland.
Tax Audits and Territoriality Rules of Corporate Income Tax
Based on territoriality rules, French corporate income tax (CIT) only applies to companies operating in France, as well as (subject to tax treaties) the profits of foreign companies that have a permanent establishment or a registered office in France.
What are the results?
Tax audits results are clearly down: only 191 tax cases in 2019 (down 22% compared to 2018) and an amount of 191 million euros of tax adjustments (down 80% compared to 2018).
What kind of tax cases are involved?
- Undeclared activities in France
Tax adjustments related to territoriality rules mainly concern cases in which the FTA consider that an activity is carried out in France without being declared.
To discover such undeclared activities, following authorization by a judge, the FTA may carry out a search of the premises of companies and seize documents (contracts, legal documents, e-mails, etc.). The FTA may then consider that a foreign company is carrying out an irregular activity in France because it has an undeclared permanent establishment in France, or is entirely managed from France, i.e., it has its effective management headquarters there.
It must be emphasized that, according to the French high administrative court, based on the Organization for Economic Co-operation and Development (OECD) commentaries on the Model Tax Convention, a foreign company is deemed to have a permanent establishment in France where another company of the same group, even if it does not formally enter into contracts in the name of the foreign company, decides on transactions which the foreign company merely endorses and which, when so endorsed, commit them (CE 11/12/2020 no. 420174, Conversant International Ltd). Even if this decision is related to a rather old double treaty convention (France–Ireland) dated from 1968, and according to which the literal application of the provisions should have not allowed such an interpretation, this decision complies with the new definition of “permanent establishment” provided by the multilateral instrument (MLI) to implement tax treaty measures to prevent base erosion and profit shifting (BEPS).
This wide interpretation from the French high administrative court of the concept of “dependent agent” could actually lead to a unilateral application by the FTA of the MLI: this could, for example, be the case where the foreign company has its headquarters in a state, like Ireland, that has not agreed the MLI’s definition of “permanent establishment.”
Protective Case Law
According to the case law (CE, December 7, 2015, no. 368227, Sté Frutas y Hortalizas Murcia SL), qualification as a hidden activity is excluded where a foreign company proves that it has made a mistake. This proof can be provided by demonstrating that:
- the foreign company has complied with its tax reporting obligations in its state;
- the foreign company is liable in its state to a level of taxation which is comparable to that which exists in France;
- there are means of exchanging information between France and the state of the foreign company.
This case law is quite protective for taxpayers, because it prohibits the FTA (i) from applying penalties of 80% for irregular activities, and (ii) from making tax adjustments over a period of 10 years (only the statute of limitation of three years should apply).
The FTA have acknowledged that this case law has led to a decrease in the number of tax adjustments in respect of the territoriality of CIT.
French tax law includes several anti-abuse mechanisms that allow the FTA to combat schemes to locate income or profits abroad. These anti-abuse rules concern both individuals and companies.
What are the results?
In 2019, tax adjustments made based on anti-abuse rules amounted to 845 million euros, up 68% on 2018.
What kind of tax cases are involved?
- Relocation of capital to countries with low-tax regimes
There is an anti-abuse rule (Article 209 B of the French tax code) which allows the FTA to tax in France profits made in companies established abroad but controlled by French companies. Within the EU this anti-abuse provision only applies in the case of an artificial arrangement. Outside the EU, this provision does not apply where the activities carried out by the foreign entity are not primarily aimed at locating profits in a low-tax country.
In 2019, the total figure for adjustments to the taxable basis, based on this anti-abuse rule, amounted to more than 500 million euros.
- Interest deductions and financial payments
The FTA’s tax audit services often look at financial intra-group loans and make tax adjustments based on an anti-abuse provision. There is an anti-abuse mechanism (Article 212 of the French tax code) which aims to limit the possibility of deducting financial charges related to intra-group loans in the following situations:
- if the interest rate charged is excessive (i.e. above the market price);
- if the financial expenses paid have not been taxed in the state of the beneficiary.
This anti-abuse provision has been subject to rewriting as from 2019 and 2020, with the implementation of the anti-abuse mechanism provided for by the Anti Tax Avoidance Directive (ATAD) which implements OECD BEPS conclusions at the EU level.
However, regarding the proof of the market interest rate, the French administrative high court has recently ruled (CE 9e ch., 10 December 2020, no. 428522, Sté WB Ambassador) that the borrowing company, which has the burden of proving the market rate, is entitled to provide such proof by any means, and that as such, in order to assess that rate, it may, where appropriate, take into account the yield on bond loans issued by companies in comparable economic conditions, where such loans constitute in the hypothesis a realistic alternative to an intra-group loan. In practice this case law, which confirms a previous case, is likely to create room for discussion with the FTA to find the “good” market rate.
What are the Methods Mainly Used by the FTA?
In the field of international transactions, the FTA’s audit services mainly use two types of tools:
- the transfer pricing documentation in the standard BEPS format;
- exchanges of information.
How is the transfer pricing documentation used by the FTA?
The new transfer pricing documentation standard, compliant with the BEPS standard, has applied in France since January 1, 2018 and has been designed to ease the work of the tax audit services. This documentation (a master file and a local file) must be made by large companies and shown to the FTA only in case of a tax audit.
The FTA have released guidelines to establish a minimum content standard with the possibility of presenting the information by using data charts which are linked to the tax returns (country-by-country reporting (CbCR) return, transfer pricing policy return).
However, in 2019 the FTA found that in one third of tax audits the structure of the transfer pricing documentation did not comply with the standard. It is therefore clearly stated in the public report related to French tax audit activity that the compliance of transfer pricing documentation will be monitored in future tax audits.
In addition to the arm’s-length nature of intra-group transactions, the FTA’s audit services mainly look at the accounting implementation of the pricing policy, even if, in practice, the FTA allow considerable flexibility in the presentation of that type of information.
It must be emphasized that the information related to accounting should only concern information from the company that produces the local file, and under no circumstances should it include information from the accounting records of other group companies.
How are exchanges of information used by the FTA?
- Exchanges of information on request
The FTA no longer hesitate to send requests to collect information abroad (tax returns, amounts of taxes paid, details of intra-group transactions, communication of the local file from the transfer pricing documentation, etc.). More than 5,700 requests were sent by the FTA to foreign authorities in 2019. This information may then be used to prompt tax reassessments, and it is therefore necessary to pay attention that the FTA comply with all the rules specific to these exchanges in order to be able to use this information.
- Country-by-country data
The FTA have indicated that the CbCR data received from other countries is forwarded to a tax audit service in order to improve knowledge of the groups concerned and to develop new risk analysis models. These risk analysis models can then, according to the FTA, be applied at national level to smaller companies.
In accordance with the provisions of the CbCR Multilateral Competent Authority Agreement (MCAA), CbCR returns shall not be used as a basis for tax adjustments but may be used to carry out analysis of transfer pricing risks and any risk of erosion of the tax basis. However, insofar as this information is sent to a tax audit service, it could be used as a basis for targeting companies for tax audits.
- Automatic exchange of advance cross-border rulings and advance pricing agreements
The implementation at the EU level of OECD BEPS Action 5 related to cross-border rulings and advance pricing agreements provides the possibility of access to appropriate information on a European register.
Therefore, tax audit services do not need to process the CbCR data, and have direct access to the register and can know in advance of a tax audit whether a cross-border ruling has been granted.
This register is fully operational and contains more than 18,000 rulings, of which more than 75% have been granted by Luxembourg and the Netherlands.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Thierry Viu is an Associate with CMS Francis Lefebvre Avocats.
The author may be contacted at: email@example.com