VAT Groups: a French Revolution

For 40 years, the French government refused to implement the value-added tax (VAT) group mechanism, considering it too expensive for public finances and a source of fraud. However, recent developments from the Court of Justice of the European Union (CJEU) forced France to consider the implementation of this regime.

Article 162 of the Finance Act for 2021 (Article 162 of the Finance Act 2020-1721 of December 29, 2020, which creates a new Article 256 C of the French Tax Code) contains provisions regarding the new French VAT group regime which are yet to be further clarified.

Context of the Reform

Since the entry into force of Directive 77/388/EEC of May 17, 1977 (the “Sixth Directive”), in 1978, the European Economic Community, and later on, the European Union, offered member states the possibility to treat groups of entities as one unique taxpayer.

Article 4, paragraph 2, point 4 of the Sixth Directive—Article 11 of Directive 2006/112/EC of November 28, 2006 (the “VAT Directive”)—provides that “each Member State may treat as a single taxable person persons established in the territory of the country who, while legally independent, are closely bound to one another by financial, economic and organizational links.” (English version of the Directive).

This mechanism has several advantages:

• securing the VAT treatment of intra-group transactions;
• improving the group’s cash flow;
• reducing the administrative burden.

Although this regime seemed beneficial for both member states and taxpayers, France has always refused to implement it into its domestic law. On the other hand, French businesses were not pushing for the implementation of this regime, either. The reason was simple: France had transposed another VAT regime that served the interests of business groups.

Article 261 B of the French Tax Code (FTC), transposing Article 132, paragraph 1, f) of the VAT Directive, provides for a mandatory VAT exemption mechanism applicable to transactions carried out in the context of an “autonomous group of persons exercising an exempt activity or for which they are not taxable persons.”

This regime allowed businesses performing VAT-exempt activities, such as the financial, banking and insurance sectors, to “pool” certain expenses in complete exemption of French VAT.

In France, this mechanism was notably made available to the banking and insurance sectors, as well as the social housing real estate sector, whose activity is almost fully VAT exempt. On the other hand, other member states had a very restrictive understanding of this group mechanism: in Germany, for example, the exemption was limited to the medical sector.

In 2017, the question of the extent of the scope of the exemption was raised before the CJEU.

According to the judges, both Germany’s restrictive interpretation (Commission v Germany (C-616/15)), and the extensive interpretation (DNB Banka (C-326/15) and Aviva (C-605/15)) , were sanctioned: by these decisions, the CJEU held that the VAT exemption applicable to groups was reserved solely to autonomous groups of entities the members of which carried out an activity of public interest mentioned in Article 132 of the VAT Directive, excluding by law the financial and insurance sectors.

Due to these CJEU decisions, the business sectors using the provisions of Article 261 B of the FTC, and especially the financial sectors, are facing billions of euros in VAT costs. In this context, the challenge of France’s position as regards the scope of this exemption prompted the French government to implement an alternative to Article 261 B of the FTC. That is how the VAT group regime went back onto the table.

Implementation of the VAT Group Mechanism into French Law

The French government has conceded the implementation of the VAT group.

Conditions of Implementation

The future Article 256 C of the FTC should provide that, as regards potential beneficiaries, the French regime will be available to French-based companies as long as they can be treated as independent taxpayers acting as such. This first condition of establishment restricts the application of the scope from the previous exemption mechanism which allowed cross-border schemes.

In order for these independent entities to be able to form a VAT group, they must be closely linked to each other financially, economically and organizationally. Though it is not clearly stated in the text, one can assume that the entities shall cumulatively fulfill those three requirements.

First, from a financial perspective, taxable entities which are controlled in law, directly or indirectly, by the same entity, are considered to be financially linked to each other, including the latter. This condition is met when a taxable entity or a non-taxable legal person holds more than 50% of the shares of another taxable person, directly or indirectly through other taxable persons or non-taxable legal persons, or more than 50% of the voting rights of another taxable person or non-taxable legal person under the same conditions.

The scope of this first element is quite wide, wider than the group mechanism implemented for corporate income tax purposes which requires a 95% holding of shares. To broaden the scope even more, Article 256 C provides for cases in which the financial link is presumed. These cases envisage the situation of group entities the financial structure of which is legally organized and which does not rely on capital holding, such as:

• cooperative banks;
• pension funds;
• certain insurance companies;
• companies in charge of ensuring the governance of a joint social protection group.

During the debates, the parliament added a fifth case, that of low-income housing organizations. This would be the only addition to the project submitted by the government.

According to this first set of conditions, it is notable that the financial aspect is envisaged quite widely. The question is then whether a group of French-based entities that are not directly linked to one another, but indirectly via a company, that do not fulfill the conditions, may still benefit from this regime.

Can we expect the application of this regime to the subsidiaries held by a non-established holding or even subsidiaries belonging to a radial structure where the parent would have no taxable activities whatsoever? Other countries such as Belgium have made this possibility available. The French tax authorities would be wise to provide comments in this regard in order to secure these types of situations.

The second condition is that the entities must be linked from an economic standpoint. Article 256 C provides for three situations in which entities may be considered as economically linked to each other:

• the main activity carried out by each member of the group is of the same nature;
• the activities of the members are interdependent, complementary or pursue a common economic objective (services; partial supplies of goods that can be included in the VAT group); or
• a member of the group carries out an activity that benefits in whole or in part the other members of the group.

This last hypothesis deals directly with cost centralization vehicles that benefited from the exemption provided for by Article 261 B of the FTC. Future groups will therefore be able to integrate these entities, but as long as they are based in France and do not belong to another VAT group. One may underline that this last condition is not provided for by the VAT Directive.

Finally, the entities must be linked from an organizational point of view: the member entities of the VAT group shall in law or in fact, directly or indirectly, be placed under “common management.” This notion of common management refers, for instance, to:

• formal or informal governance structures; or
• members who organize their activities partly or totally in consultation.

An Optional Mechanism

France has decided that the VAT group regime will be optional, to maintain a rather flexible approach. In certain member states, the mere fact that a group meets the three conditions described above triggers the application of the VAT group regime and all its consequences. This is not the path the French government has taken. However, once the decision to enter into a VAT group is made, the regime appears to be more rigid than the former exemption mechanism.

The option must be exercised under certain conditions in order to effectively set up a VAT group. Particular attention must be paid to the date on which the option must be exercised: Article 256 C of the FTC provides that the option can be exercised at the latest on October 31 for implementation of the group regime on January 1 of the next year. Beyond that point in time, the implementation of the regime will have to be postponed for another year.

The option is made by a representative of the VAT group to which it belongs. By opting for the implementation of a group, entities commit themselves to staying in the group for a three-year period. Other entities can only enter or exit the group in case of restructuring operations, for instance. A member that no longer meets the conditions of Article 256 C of the FTC may exit the VAT group.

Once the three-year period is over, entities may come in and out of the group as long as the representative agrees. The option to extend or reduce the extent of the group must be made before October 31 for implementation on January 1 of the next year.

Compared to the previous state of the VAT law, the new group mechanism has both stricter and more flexible conditions than the exemption provided for by Article 261 B of the FTC. As regards the effect of such regime, the new VAT group not only exempts intra-group supplies but goes beyond that in various ways.

Necessity to Apprehend all the Effects of the Group

The effect of the regime consists in considering a group of entities as one unique taxable entity. Conversely, each member of the group is, de lege, not considered as a taxable entity any more but for VAT purposes only. There are two main consequences to this:

• Supplies of goods and services that take place within the group are considered as falling outside the scope of VAT. In order for a supply to be subject to VAT, it has to be made between two independent entities. In the case of one unique taxable entity, this condition is no longer met.
• Reporting obligations of each member of the group are transferred to the representative of the group.

Internal Supplies Outside the Scope of French VAT

In accordance with the provisions of the new regime, goods and services (the VAT exemption provided for by Article 261 B of the FTC solely concerns services) supplied by one member of a VAT group to another (internal transactions) fall outside the scope of VAT. Only the supplies acquired from or made to a non-member of the group (external transactions) remain within the scope of VAT.

There are various positive impacts to this. The first, the one that was envisaged in the implementation of the regime, is for group members to be able to perform internal transactions without attracting French VAT.

Another positive impact that derives from this mechanism is that all internal transactions are de facto secured by the simple fact that they are disregarded. Indeed, Article 162 of the Finance Act for 2021 draws the conclusion of the existence of a unique taxable entity from a procedural perspective and creates a new Article L. 16 F of the French Tax Procedure Code. This Article provides that “the members of a single taxable person may be audited […] as if they were not members of the single taxable person, except for supplies to another member of this single taxable person.”

The benefits that groups of entities can draw from this mechanism are real. That being said, the mere fact that intra-group supplies are now out of the scope of French VAT is not without consequences.

On the one hand, it will impact the recovery right of the group as a whole. Article 162 of the Finance Act merely states that each member becomes a “distinct sector of activity.” Apart from this specification, the text does not provide for any other guiding principles, thus forcing one to rely on the general principles of deduction. The tax administration is expected to provide clarification on that important ground.

There are also still many questions to resolve. For example, a question arises as to what will happen to the sectors already formed within the group entities? Will it be possible to maintain them as sub-sectors? If not, what will happen to the capital assets affected to a particular sector? In the current state of law, such movement shall give rise to regularization of the input VAT.

Another question is whether an expense incurred by one member of the group can be allocated to the activities of another member of the group or one of its sub-sectors.

A decree is expected in 2021 and should provide more details on the future rules of calculation of deduction rights.

Another significant consequence of the fact that internal transactions are no longer subject to VAT is their potential impact on other taxes, notably the French payroll tax.

The French payroll tax is a tax based on salaries paid by an employer. The problem is that the rule governing this tax provides that the quantum of tax is calculated based on a taxation ratio, which itself is calculated by dividing the total amount of income that a company receives and that is not subject to VAT, by the total income of the company (either taxable or not). That is why, if a majority of the income received by an entity suddenly falls outside the scope of French VAT, it will have negative consequences from a payroll tax perspective.

Those consequences will be residual for companies that already have a VAT-exempt activity, whether totally or partially. However, the financial stakes could be much larger for operational entities that always used to have taxable input and output flows and which hire most of the workforce within a group.

Early feedback was reassuring on this point. The government stated that the VAT group mechanism only applied for VAT purposes, and that the calculation of other taxes should not be affected by the implementation of a group in any way whatsoever. Early stages of preparation of the implementation of the group expressly mentioned the case of the French payroll tax.

The definitive wording of Article 256 C of the FTC is somewhat disturbing in this regard. Point 7 of Section III will provide that “[t]he existence of the single taxable person for the purposes of applying the rules of value added tax shall not affect other taxes, duties and levies of any kind payable by its members” without further mentioning the specific case of the payroll tax. (Finance Bill no. 3360 registered at the Presidency of the National Assembly on September 28, 2020).

The explanatory note provided by the government solely states that “this new system, […] will have no impact on the calculation of taxes assessed and collected similarly to VAT”. It is generally agreed that this wording does not cover the payroll tax.)

This issue could cause significant financial consequences from a payroll tax perspective, thus nearly closing the door of the VAT group to any operational entity. Although possibly far-fetched, this interpretation is supported by one main idea: that this mechanism was implemented notably to give the financial sector a fall-back plan. This allows the government to give the mechanism scope narrowed down, de facto, to a particular sector, without having to expressly discriminate between taxpayers.

Finally, not only will the group “erase” certain flows, it will also “create” new ones. According to the CJEU’s case law Skandia (C-7/13) followed the French supreme administrative court, the State Council (SC, November 4, 2020, nr 435295, BNP Paribas Securities Services), the European judges holding that supplies rendered to a foreign branch belonging to a VAT group from its headquarters must be treated as an external transaction falling within the scope of VAT.

More recently, the CJEU also held in the Danske Bank A/S case (C-812/19) that, conversely, the same supplies would fall within the scope of VAT should the headquarters belong to a VAT group. In a nutshell, services rendered between headquarters and their foreign branches which were in the past totally exempt from VAT due to a lack of reciprocal independence must now be considered as giving rise to the collection of VAT.

For groups of entities the deduction rights of which are very low, this could trigger substantial costs from a VAT perspective. This is particularly true considering the fact that for regulatory reasons entities of the banking sector may have no choice but to open up branches.

There are other consequences of the implementation of a group, more challenging from a practical point of view.

Reporting Obligations Transferred to the Representative

Article 256 C of the FTC provides that a representative is appointed from among the members of the group. The representative undertakes to fulfill the reporting obligations as well as any formality in terms of VAT for which the group is liable. Also, in the case of taxable transactions, the representative is required to pay the tax on behalf of the group and to obtain the reimbursement of the VAT credit.

This means that the representative will need to have all the required data to be able to file VAT returns for the whole group. This will require a transfer of information sufficiently detailed, consistent and provided in a timely manner. From experience, such transfer can be quite a difficult task for some groups.

From an administrative point of view, certain obligations will need to be clarified when it comes to their application to a VAT group. The first is the necessity to establish a reliable audit trail. As of January 2013, each entity is required to draft documentation establishing a reliable audit trail to prove the authenticity, integrity and legibility of the input invoices it receives and the output invoices it issues.

How will this obligation be translated into the new mechanism; will the representative be held accountable for the documentation of the whole group or would each company have to support the external transactions it performs, whether inbound or outbound?

The second obligation would be to receive and issue electronic invoices for domestic transactions (e-invoicing) as well as to send details about other transactions (e-reporting). In the same Finance Act, France has decided to plan the progressive entry into force of the obligation to receive and issue invoices in an electronic format. The question arises whether internal transactions would be subject to either the e-invoicing or e-reporting obligations.

Planning Points

The implementation of the VAT group is arguably a revolution in the French VAT landscape, considering its impact and the necessity to adapt many of the existing mechanisms to this new paradigm. We have only been able to provide a glimpse of the many questions it raises and which will need to be answered before 2023.

One thing we are certain of is that business groups must study all the implications and consequences of this new regime to fully take advantage of its benefits without suffering from possible harsh and unexpected consequences.

Practically speaking, a specific method of study/analysis must be put in place by entities willing to implement the new French VAT group: for instance, they have to anticipate whether they can/want to put in place the VAT group, and when. If so, they have to anticipate which entity of the group should be members of the new French VAT group.

Of course, those preliminary and necessary steps have also to be taken keeping in mind that such reform implies an important investment regarding booking and data systems of each member and of the group.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Filiz Alparslan is VAT Partner and Zaccharie Pérais is VAT Associate with Fidal.

The authors may be contacted at: filiz.alparslan@fidal.com; zaccharie.perais@fidal.com