The French Finance Act for 2019 aspires to reconcile tax competitiveness with the fight against tax avoidance. Yet this twofold ambition is clearly not a walk in the park …
”Nexus-friendly” Patent Box Regime
Under previous legislation, French corporations enjoyed a preferential tax regime which was labeled as a harmful practice by the Organization for Economic Co-operation and Development (OECD) as it did not comply with the so-called nexus approach.
Under the new patent box regime, income derived from patent rights as well as capital gains realized on the sale of patents held for a minimum of two years—except where the sale occurred between affiliated companies—are taxed at a 10 percent rate. Patentable inventions may also be included within the scope of the regime.
The reduced rate is to be applied to a “post nexus” taxable net income defined according to a research and development expenses-based ratio.
ATAD Compliant Financial Expenses Deduction Limitation Rules
The Anti-Tax Avoidance Directive (ATAD) general limitation now applies: net financial expenses may be deductible up to the higher of two thresholds—either 3 million euros ($3.38 million)—or 30 percent of adjusted EBITDA (earnings before interest, tax, depreciation and amortization). Seventy-five percent of the disregarded net financial expenses may still be tax deducted under certain circumstances.
Where a company is thinly capitalized, the deduction of net financial expenses incurred by related-party debt is capped at the higher of 1 million euros or 10 percent of adjusted EBITDA.
Financial expenses that are not deductible in any given year may be carried forward indefinitely, whereas unused deduction capacity may be carried forward for the next five years.
Complying with ECJ Rulings
Changes to the French tax group regime (intégration fiscale) aim at bringing French domestic law into conformity with European case law.
Some intra-group transactions can no longer be neutralized for the sake of calculating the tax group’s overall taxable income—waivers of debt, subsidies and sales of substantial shareholdings eligible to participation-exemption.
With regard to dividend distributions, neutralization may be replaced by a 99 percent tax exemption. Under the participation-exemption regime, dividend distributions from the EU/European Economic Area to France may be 99 percent tax exempt as well.
Finally, to best deal with the aftermath of Brexit on tax consolidated groups, U.K. resident companies will remain eligible for the French tax group regime until the end of the financial year. Along the same lines, under certain conditions, the merger of the parent company into another company of the group will no longer cause the termination of the group.
Anti-abuse Provisions as a Weapon of Mass Reassessment
ATAD’s anti-abuse provision now generally applies to corporate income tax: the tax authorities may disregard an arrangement or series of arrangements which has not been set up for sound commercial reasons implying economic reality and the main purpose of which is to obtain a tax advantage.
There are no specific penalties and no procedural safeguards attached to this anti-abuse provision and questions remain as to how it aligns with existing anti-abuse rules.
A second new anti-abuse rule is the main tax purpose test applicable to situations involving all other taxes than corporate income tax. Under prior legislation, only fictitious or solely tax-driven operations were to be disregarded by the French tax authorities; so-called abuse of law.
As of January 1, 2020, operations driven by the main purpose of avoiding or reducing the final tax burden will also be disregarded. The blurring around the definition of the “main purpose” and the lack of specific penalty attached to it—contrary to the “sole tax purpose abuse of law” which is subject to a 40 percent or 80 percent penalty—seems detrimental to legal certainty.
The possibility for taxpayers to seek an opinion of the “abuse of law” committee certainly constitutes a procedural safeguard, but it does not appear sufficient for the new provision to be exempt from criticism.
Enhanced Regime for Newcomers
France has had for some time a preferential tax regime applicable to both individuals moving to France under an employment contract, and some managers. Basically, the tax advantage amounts to the exemption, under certain conditions, of any extra salary paid in respect of their move inbound. A flat 30 percent tax exemption is now available, whether the employees/managers are directly hired by a French company or on secondment to France.
The taxation of foreign carried interest received by new incoming managers has also been made more attractive. Where it used to be taxed as salary under the progressive income tax schedule, which could lead to a 60–65 percent taxation rate, it may now benefit from a 30 percent flat taxation rate.
Digital Services Tax
Separate from the Finance Act, and because of the lack of consensus on the matter at European level, a domestic digital services tax is currently pending in Parliament. It would be introduced as a 3 percent tax assessed on French-sourced turnover where a company’s global and French turnover exceeds 750 million euros and 25 million euros, respectively.
The question remains as to the constitutional consistency and conformity with international law of such a unilateral action. To be continued…
As the new patent box regime will be complex to implement, companies should anticipate extra formalities and costs.
As some pre-existing rules remain regarding financial expenses deduction limitation, groups should review if their intra-group transactions fit the whole system.
If companies acknowledge that they might fall within the scope of the new general anti-abuse rule, they should rely on the specific tax ruling introduced to review their situation regarding corporate tax (six-month implied consent).
With regard to any doubts that a company may have regarding its tax liability in France, the recently introduced “mutual-trust based relationship” between companies and the French tax authorities should both promote and simplify discussion, which should ultimately lead to less litigation.
And, last but not least, if not already covered, companies should prepare for a “hard Brexit” and all its tax consequences.