On April 1 the French Ministry of Finance presented four measures aiming at “improving relationships between tax administration and taxpayers”. The first measure in particular, dedicated to the improvement of tax predictability, consisted in the publication of tax schemes designated as abusive. The objective of greater transparency thus seems paved with good intentions.
The first list of abusive tax schemes was published in a section of the FTA’s website dedicated to tax audits and fight against tax fraud - an interesting label for relationships improvement. Initially composed of 17 schemes, this list now counts 18 structures and should be completed over the time. Each case is generic, includes a short description of the facts observed and the elements reassessed, mentions the amounts of the penalties incurred according to the applicable laws and, last but not least, concludes with an invitation to contact the FTA to initiate regularization.
The 18 structures published cover a wide range of topics yet the present article focuses on the main schemes relating to corporate tax.
Management packages, which do not fall in the scope of existing tax regimes such as stock-options or free shares, are offered by funds and groups to top management in the context of Leveraged Buy-Outs. FTA describes packages such as acquisition or sale of stocks at preferential terms, and considers, based on existing case law, that such benefits should be taxed as salaries (as opposed to capital gains) when the beneficiary does not bear a stockholder risk or has invested not a significant amount. Furthermore, when the beneficiary uses an intermediary structure to avoid any taxing, FTA stresses that abuse of law (with a 80% penalty) may be applicable.
Profit shifting further to a business restructuring
Focus is made on a business restructuring which results in shifting functions and risks from a French company A to an affiliated company B resident in a foreign country. Prior to the restructuring, the role of the French entity included manufacturing and distribution of its production as well as assuming the related risks. After the restructuring, its role is limited to a toll manufacturer. FTA noticed that profits of company A significantly decreased while profits of Company B increased, enjoying a favorable tax regime, while the only difference was a change in the invoicing flows.
In the course of a tax audit, FTA would perform a functional analysis of Company A before and after the restructuring, and would scrutinize the activity of Company B, including means in personnel and assets. FTA may then perform a transfer pricing reassessment and/or consider that Company A should have been compensated with respect to the restructuring.
Commissions paid to a company located on a tax heaven
In case where French companies pay commissions paid a company located in tax heaven, they must be able to justify that services have been actually rendered, at an arm’s length price, and benefit the payer (article 238 A of the French Tax Code). FTA takes the example of payments made to a foreign company which has no business premises and no personnel, and enjoy a full tax exemption under an “offshore” status. If the French payor cannot demonstrate that services have not been rendered, payment will not be deductible and considered as a deemed distribution subject to a withholding tax, and a 40% “bad faith” penalty would apply. Furthermore, if the payment has not been reported on the payor’s tax return, a penalty of 50% of the payment would apply. Finally, FTA will try to identify the beneficiary of payments through the international exchange of information procedure and tax the corresponding income, if territorial rules allow.
In France, royalties paid to a non-resident company are subject to a 33.33% withholding tax (unless provided otherwise by a tax treaty) or to a 75% withholding tax if paid to a company based in a Non Cooperative States or Territories (“NCST”).
FTA addresses conduit structures where a royalty is paid to a company resident in a Treaty Country, hence avoiding any withholding tax, which then pays itself a royalty to a company resident in a country which has not signed a Tax Treaty with France. In the case where the intermediary company has no substance, FTA would apply the abuse of law doctrine, assess the applicable withholding tax and apply a 80% penalty.
A similar approach is presented for Treaty Shopping on dividends, where a structure would use the exemption provided on dividend payments within the EU: a non-EU parent company would contribute shares in a French company to an EU affiliate. French law actually provides for a Specific Anti-Abuse Rule in this respect, denying the exemption when the sole purpose of the structure is to avoid dividend withholding tax. In such is the case, FTA would reassess the applicable withholding tax and apply penalty up to 80% (applicable to fraudulent transaction).
Double dipping on interest
Under this structure, a French company would borrow from a bank to fund in equity a foreign subsidiary. The foreign subsidiary would lend the cash to a French affiliate of its French parent. Foreign finance subsidiary would enjoy a low effective tax rate on interest income thanks to a notional interest regime. Dividends paid out by such finance company would be 95% exempt in the hands on the French parent.
FTA assumes that the only purpose of the structure is tax avoidance. The dividend exemption would be challenged on the grounds of abuse of law, with a 80% penalty.
Publishing structures viewed as abusive in the context of an effort to “improve relationships with taxpayers” can appear as quite ironic. But the FTA seems to genuinely believe that taxpayers are not aware that tax inspectors are actively challenging the structures which are described: business restructurings have been set officially on the radar screen since the publication of Chapter 9 of the OECD’s Transfer Pricing Guidelines in 2010; treaty shopping on royalties has been addressed by the French Administrative Supreme Court in 1999.
Furthermore, a real concern is raised by the description of so-called “abusive” structures: management packages are widely implemented and their first goal is to incentivize top management in order to increase the performance of the company; it is quite questionable for FTA to consider that the only purpose of such packages may be tax avoidance. Also, the example on interest double dipping is also quite enlightening: in order to describe the approach of a tax auditor, the FTA assumes that the transaction is abusive... The consequences are then obvious.
This concern was expressed to the head of the tax audit department at the French Ministry of Finance during an April 14 conference held by CMS Bureau Francis Lefebvre. He ensured that his services will be reminded that the mere publication of a structure must not prevent them for conducting a thorough analysis of each individual case, specifically for the application of penalties. Indeed, the publication of the abusive structures is only a press release, and does not change the state of applicable law.
One can only hope for the best!