The French government has responded to anti-avoidance sentiment by proactively redefining its strategies for preventing what it considers to be aggressive tax planning. Among other recommendations, authorities would be granted access to cost accounting, and calculations related to costs, in order to determine transfer pricing. The need to show substance will be a major driver of reforms.
French tax auditors are increasingly intolerant of practices deemed to aid tax avoidance, such as restructurings that transfer a manufacturing activity outside France, breach distributor agreements, change distributor, agent or other functions, or close down sites. Such actions raise the issue of the indemnification of the French company or of a possible transfer of goodwill. A whopping 40 percent penalty may be imposed on companies for business restructuring reassessments undertaken on the grounds that the French company was unable to ignore that the restructuring was not made in its interest.
Finally, authorities have introduced requirements to provide cost accounting and consolidated accounts in the scope of a tax audit.
While the public and the media support reform, tax professionals are less enthusiastic, expressing concern that the changes are politically driven, poorly defined and responsible for introducing uncertainty into the regime. Indeed, some measures that gained parliamentary approval were later struck down by the constitutional court.
As part of this trend, French companies are dealing with more stringent compliance regulations. More and more, taxpayers are being saddled with the burden of proof of compliance and obliged to spend time and energy demonstrating their compliance in complex areas such as transfer pricing and international transactions.
France has implemented several measures to address BEPS issues — sometimes before the publication of BEPS final reports. These measures deal with hybrid instruments, CFCs, interest deductibility, thin capitalization rules, treaty abuse, PEs and transfer pricing documentation, among others.
Hybrid instruments: A new limitation on the deductibility of interest on intra-group financing was introduced for financial years (FY) ending on or after 25 September2013. The deduction of interest is allowed only if thelender is subject to ‘sufficient taxation’ equal to at least25 percent of French CIT during the same FY (i.e. 8.33,8.6 or 9.5 percent, depending on the CIT surcharges).This restriction applies between related entities when the payer is established in France, regardless of where the payee is located.
If the lender is a foreign tax resident, the level of sufficient taxation is determined by comparing the effective tax rateapplied to the interest received by the foreign lender, andthe reference French CIT rate that would have applied if the lender were a French tax resident.
In addition, profit distributions received by a parent company that were deductible from the subsidiary’s taxable income are excluded from the benefit of the participation exemption regime.
Controlled foreign company rules: Profits made byCFCs that are established in low-tax countries (where thecorporate tax charge is more than 50 percent lower thanthe French corporate tax) and whose parent companyis subject to French CIT are subject to CIT at the Frenchparent company’s level. This rule applies to foreignsubsidiaries when the French parent company ownsdirectly or indirectly more than 50 percent of its share capital (this threshold is reduced tp 5 percent if more than 50 percent of the CFC is held by companies located in France or by companies that control or are controlled bycompanies located in France). The corporate tax paid bythe CFC in its jurisdiction can be offset against the Frenchcorporate tax due by the parent company (if the corporate tax is similar to the French corporate tax).
Interest deductibility: In addition to the new anti-hybrid rule mentioned above, thin capitalization rules already exist under French tax law, as well as a general limitation of the tax deductibility of net financing expenses and other specific rules limiting the deduction of interest (i.e. the Carrez and Charasse amendments).
Tax treaties: All new tax treaties entered into by Franceinclude substance and anti-treaty shopping provisions.
Permanent establishment: The new tax treaty betweenFrance and Colombia includes a new definition of PE that aggregates the period of presence of related companiesto determine whether the PE threshold is reached. Thistreaty also introduces the notion of PE for services. Similarmodifications are expected to be made to existing taxtreaties.
Transfer pricing: Since 2010, the preparation of transferpricing documentation (master file and local file) has beenmandatory for all companies with revenues or balance sheet assets exceeding EUR400 million or that belong to a group in which one of the companies exceeds thesethresholds. In the event of a tax audit, this documentation must be made available to a tax inspector within 30 days of a request to provide it.
Since 2013, abridged transfer pricing documentation hasbeen required to be filed each year with the tax authoritieswithin 6 months of the filing of the annual CIT return.
The CbyC reporting requirement has been introduced under French tax law as of 1 January 2016 for companies whose consolidated turnover exceeds EUR750 million. The French authorities are considering reducing this threshold, which would considerably spread the scope of this obligation. There is also consideration about makingCbyC reports public.
France signed the multilateral instrument for the exchange of information regarding CbyC reporting on 27 January 2016.
In keeping with the spirit of the BEPS project, the French Finance Bill for 2016 implemented a new anti-avoidance rule (transposing the GAAR included in EU Directive no. 2015/121 of 27 January 2015) taking effect 1 January 2016. Under this rule, the parent-subsidiary regime is not applicable to a ‘non-genuine’ scheme that was set up only or mainly for tax purposes and produces advantages contrary to the regime’s purpose.
The French tax authorities may use pre-existing abuse-of-law procedures under French tax law to counteract sham transactions and situations where a transaction is solely tax-motivated and the parties have obtained the tax benefit through a literal application of the rules while disregarding their spirit. This procedure may be used to tackle hybrid mismatch arrangements.
To supplement ongoing BEPS discussions at the OECD, French tax officials are also looking to other jurisdictions for ideas on how best to deal with the issue. Investigators from the General Inspectorate of Finances comparedtax regimes in Canada, Germany, the United States, the Netherlands and the United Kingdom to those of France and found that France was the only country in the group not to have included the arm’s length principle in its substantive law. Moreover, its enforcement tools were considered less adequate than those of its counterparts.
The authors of the report proposed adjustments to the tax code that would require entities of the same group to engage in business relations equivalent to those that independent enterprises would have engaged in. This would allow the tax administration to take better advantage of its enhanced right of access to information, to establish internal rules and guidelines for the application of transfer pricing methods, and to constantly evaluate its own practices and guidelines.
Constraint will characterize the overall impact of thesemeasures in the short term. Companies will be forced tospend more time and resources to meet reporting obligations.The task of ensuring consistency among all parts of onecompany in all its countries of operation will be monumental.
While tax managers are aware that change is coming, they can only do so much to prepare. They recognize that substance will be a key point in any reform. Room to use hybrid or stratified structures has shrunk as authorities demand that transactions demonstrate a link to theunderlying business. Companies are taking a more cautious approach as they seek to realize greater tax efficiencies.
Companies are also concerned about confidentiality, as CbyC reporting requiring broader sharing of information was introduced in France as of 1 January 2016. The requirements raise the risk of competitors gaining accessto vital information and compromising a company’s ability to operate.