INSIGHT: French Tax Audits on Nonresident Taxpayers

Tax audits were suspended in France due to the Covid-19 crisis. However, as from September 2020 the French tax authorities (FTA) are resuming their tax audit activity.

French tax audit activity concerns not only French resident taxpayers but also nonresidents (individual and companies) that may be subject to various tax liabilities, such as wealth tax, income tax, value-added tax (VAT) in France.

The FTA have understood for a considerable time that there may be important financial issues regarding tax liabilities of nonresident taxpayers. A suitable administrative body has therefore been designed to monitor this, and there is now a wide range of legal tools to facilitate tax audits on nonresidents.

Monitoring Nonresident Taxpayers

Two kinds of services monitor the tax affairs of nonresidents:

• the specific tax department dedicated to nonresidents (Direction des Impôts des Non Residents—DINR); and
• the various tax audit services.

Tax Department for Nonresidents

Nonresident taxpayers (companies and individuals), who must file tax returns and pay taxes (income tax, wealth tax, corporate tax, VAT) due to their activity carried out in France, their assets located there, or their income from French sources, must fulfill their tax liabilities with the tax department for nonresidents.

This department may also in theory perform tax audits. However, in practice, as there is no tax audit unit in the department, such tax audits when they occur are very basic.

Tax Audit Services

All French tax audit services—local, regional and national tax audit units—have been enabled to carry out tax audits on nonresident taxpayers since 2017. Depending on a nonresident taxpayer’s income or assets value in France the tax audit is carried out by the local, regional or national tax audit unit. In practice, large companies or individuals with significant assets held directly or indirectly in France are audited by national tax audit services, which are experienced in auditing international tax affairs.

Tax Audit Programming

A data mining department has been put in place within the central tax administration to improve the quality of tax audit programming, and thousands of pieces of information may now be processed with algorithms.

Like many other countries, France is also involved in the automatic exchange systems related to the Foreign Account Tax Compliance Act (FATCA), exchanges based on the common reporting standard, country-by-country reporting (CBCR), cross-border rulings and cross-border tax-planning arrangements. All these data are received by the data mining department to process and establish lists of taxpayers considered as “at risk” regarding tax evasion or tax fraud. For example, the FTA have stated that the use of CBCR data is processed with a national tax audit service in order to improve knowledge of the groups concerned and to develop new tax risk analysis models.

Relationship Between Tax Department for Nonresidents and Tax Audit Services

There is full communication between the tax department for nonresidents and the tax audit services. For example, all tax returns related to trusts are received by the tax department for nonresidents. These tax returns are then recorded in an electronic register to which tax audit services have direct access. Tax audit services may therefore easily audit the assets held through a trust by individuals, for example in order to check whether tax liabilities regarding wealth tax or inheritance tax have been fulfilled.

French Tax Audit Procedures

There are two kinds of tax audit in France:

• “external” tax audits, which consist in an examination of a company’s accountancy or a deep investigation of the situation of an individual; and
• “desk” tax audits, which are carried out exclusively from the FTA’s premises on the basis of documents held by the FTA (for example, tax returns, answers from the taxpayer to the FTA’s requests).

“External” Tax Audits

With regard to external tax audits, the FTA may use three kinds of procedure:

• accounting audit procedure: this is a tax audit that only concerns companies and must take place at the company’s premises. The FTA audit the company’s entire accounting files and compare them with facts they are aware of in order to check whether the tax returns comply with tax legislation. The accounting audit procedure may relate to all taxes (corporate taxes, VAT, local taxes, etc.) or only some of them. The accounting audit is the most in-depth tax examination that may be conducted by the FTA on companies.

Regarding foreign companies, accounting audit procedures are mainly used where there are complex issues (multiple financial flows, transfer pricing analysis, for example).

In 2019, around 35,000 accounting audit procedures were carried out by the FTA (for both French and foreign companies).

• accounting examination procedure: this procedure only concerns companies and enables the FTA to carry out a tax audit from their office, on the basis of the electronic accounting files which must be provided by the company on the FTA’s request. In practice, the accounting examination procedure is not an in-depth tax examination like the accounting audit, and has been created in order to speed up the process for very simple cases and small and medium-sized companies. That is why, when an accounting examination procedure is initiated, the FTA has only six months following receipt of the accounting files to make a tax adjustment.

However, even in simple tax cases, if the accounting examination cannot be carried out due to the failure of the company to provide the FTA with the accounting files, the FTA may initiate an accounting audit procedure.

In 2019, around 7,000 accounting examination procedures were carried out by the FTA (for French and foreign companies) which is quite a low number when compared to the number of accounting audit procedures.

• examination of an individual’s tax situation: this procedure is used for individuals in complex cases where there is a need to audit the financial accounts. With respect to nonresidents this procedure is mainly used by the FTA when they assume that the tax residency of an individual should be in France.

In 2019, around 2,600 examinations of individual tax situations were carried out by the FTA (for residents and nonresidents).

“Desk” Tax Audits

Desk tax audit procedures consist of all the work done by tax officers using the information and documents contained in the various files they hold. In a desk tax audit procedure, the FTA are not allowed to look at the accountancy files and the FTA’s officers are not compelled to go to the company’s premises. However, the FTA may send requests for information to taxpayers and, as for other tax audit procedures, make requests for information to foreign tax authorities.

In practice, desk tax audit procedures related to companies are simple tax audits where the goal is limited to checking the corporate income tax (CIT) returns or VAT refund requests. Desk tax audit procedures are thus mainly used for individual taxpayers who are liable to income and wealth tax.

In 2019, around 270,000 desk audits were carried out in France on companies, whereas more than 838,000 were carried out on individuals.

European Tax Audit Tools

Within the EU, the tax authorities may use several tools to collect information, based on the Council Directive on exchange of information (2011/16/EU) and the Council Regulation (904/2010) on administrative cooperation and combating fraud in the field of VAT:

• exchange of information on request: in the course of tax audit procedures, the FTA do not hesitate to send requests for information to other states, including EU members. In 2019, more than 5,700 tax requests for information were sent by the FTA to other tax authorities;
• presence in administrative offices and participation in administrative inquiries: the procedures for presence in the administrative offices of other EU member states and participation in administrative inquiries are designed to enable a state to obtain information rapidly on one or more taxpayers whose domicile or head office is located in another EU member state. Tax officers may go to another member state to collect information and participate in a local tax inquiry. In 2019, the FTA used these procedures only once.

Tax Audit Procedures Used by FTA for Nonresident Taxpayers

Tax Audits Related to Nonresident Companies

• Permanent establishments in France

Under tax treaties and French tax law, a permanent establishment in France of a nonresident company is subject to CIT in France like a French company. Therefore, that permanent establishment is audited by the FTA in the same manner as for other French resident companies: accounting audit, accounting examination or desk tax audit.

Of course, whatever the tax procedure is, the tax audit is only focused on the tax results of the French permanent establishment, that is to say the activity connected to France, which excludes the possibility for the FTA to require the accounting records of the foreign company for its worldwide activity.

In the course of an inquiry, the FTA may also assume that a nonresident company has an undeclared permanent establishment for its business in France. Given the difficulty for the FTA, who bear the burden of proof, to prove the existence of a permanent establishment, it is often necessary for them to conduct a tax search with police officers. The tax search, which must be authorized by a judge, allows the FTA to seize documents (letters, emails, contracts, etc.) on the spot—that is to say, in the place where the FTA assume that the permanent establishment is located. Such documents can then be analyzed to reveal the existence of an undeclared permanent establishment in France or even the effective head office of a nonresident company in France.

In such a case, if the FTA assume, based on the information collected, that there is an undeclared permanent establishment or a head office in France, they will always initiate an accounting audit procedure.

• Immovable property in France

Income received by nonresident companies and derived from immovable property located in France is subject to CIT. A CIT return must be filed and sent to the tax department for nonresidents.

The accounting audit procedure may raise legal difficulties as, in such a case, there is no possibility for the FTA’s officers to go to the company’s head office. In addition, if the company’s head office is located in another EU member state the appointment of a tax representative in France is not mandatory (even for a tax audit). One of the substantial and legal conditions to carry out an accounting audit procedure may therefore not be fulfilled.

On the other hand, if the foreign company has appointed a tax representative in France, which it may always choose to do, or may be requested to do if the head office is in a non-EU member country, the accounting audit may be carried out with no legal difficulty for the FTA.

Therefore, in order to avoid any litigation, the FTA use the accounting examination or the desk tax audit procedure. However, despite the legal uncertainty, the FTA are likely to use the accounting audit procedure in complex cases where, for example, there are several tax aspects which must be analyzed such as financial expenses, depreciation, or several entities located abroad in the holding chain.

Tax Audits Related to Individuals

Most of the time, the FTA use desk audit procedures by sending requests for information to the taxpayer. However, where the FTA have already collected clues suggesting that the tax residency should be in France and not abroad, an in-depth investigation is systematically initiated with an examination of the tax situation.

Thierry Viu is an Associate with CMS Francis Lefebvre Avocats.

The author may be contacted at: thierry.viu@cms-fl.com

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