Legal news

Elimination of double taxation on international flow, which is the main purpose of bilateral tax treaties, is not perfectly achieved in several situations. The recent changes of case-law highlight again the fact that that the solutions found over time concerning elimination of double taxation deserve to be harmonized, under the leadership of the judge, or even, of the legislator.

1 – Most of bilateral tax treaties signed by France provide for beneficiaries of foreign source passive income (dividends, interests, royalties) the allocation of a tax credit on the French tax, corresponding to the tax collected in the source State, within the limit of the conventional rate.

In a recent decision Faurecia1, the Conseil d’Etat stated that the tax credits linked to foreign source income that are not set off by a company subjected to corporate tax on French tax are not refundable.

This decision permits us to examine the several issues at stake concerning elimination of double taxation on foreign source passive income:

– Does a withholding tax collected abroad on a passive income always give the right to a credit tax that can be set off against the French tax?

– What are the mechanisms that limit the amount of credit tax that can actually be set off against the French tax?

– When the creditor settled in France isn’t able to use all or part of the relevant credit tax, can he benefit from a reimbursement or from a deferral of the credit tax not set off?

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– Alternatively, can he note an expense deductible from the taxable base up to the withholding tax amount not offset by the set off of a credit tax?

– What about the situations in which the withholding tax is levied in the other State in violation of the conventional provisions?

The answers to those questions mostly result from case law which made a fragmented, partially incomplete and sometimes unsatisfactory precedent, regarding the desired purpose of the bilateral tax treaties, i.e. the elimination of double taxation.

1. Withholding taxes on foreign source income levied according to tax treaties.

A. The amount of foreign credit tax is limited, according to the “stopper rule” (“règle du butoir”).

2 – Most of tax treaties signed by France provide for beneficiaries of foreign source passive income the set off, against the French tax due to this income, of a tax credit corresponding to the tax actually levied in the source State, within the limit of the conventional rate. More seldom, the tax treaty provide a tax credit at a rate globally set and that can exceed the amount of the withholding tax (“fictitious” tax credit).

According to the “stopper rule”, the tax credit is limited to the portion of the French tax (at the common law rate or at the reduced rate, plus the additional contributions) corresponding to the income leading to a set off. The stake is therefore to determine the income, net of the expenses that have to be deducted according to French lax, for the calculation of the “corresponding French tax”.

As a matter of principle, the method to use is the one of the direct allocation of the expenses to the income leading to a tax credit. Concerning the investment income (“revenus de capitaux mobiliers”), the scope of the expenses that have to be set off against the foreign income could still be discussed. The tax administration wants to deduct from this income, the totality of the expenses linked to the acquisition, the maintaining and the selling of the asset that is the income generator, according to article 39 of the French tax code (CGI). However, the Conseil d’Etat, in a notice given by the Finance

Section2, only takes the custody fees (“frais de garde”) and the collecting costs (“frais d’encaissement”) ; he rejects the global approach wanted by the tax Administration and therefore refuses the set off of the loan interests relating to the acquisition of the assets that are income generator. More recently, the Conseil d’Etat, in a case of purchase-resale of shares around the ex-date (“autour de la date de détachement du coupon”), dismissed the restrictive analysis of the expenses to be decuted proposed by the Finance Section and considered that the provisions of article 39 of the CGI had to be applied3

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However, the practical scope of those divergences has to be relativized. First, a specific anti-abuse system is likely to be applied since 2011, when the companies make purchase-resale of shares around the ex-dates (article 220, 1, a of the CGI). In this

3 situation the financial expenses incurred for the acquisition of the shares, and the capital loss on sale and/or the retrocession given to the seller of the shares according to the contract between the assignor and the buyer, have to be deducted for the calculation of the capping set off of the tax credit – except cases where the safeguard clause (“clause de sauvegarde”) applies. Besides, the “stopper mechanism” only applies, concerning dividends, only to products that do not benefit from the “parent-subsidiary” regime (“regime mère-fille”). Indeed, for dividend under the regime of mother companies, the tax credits cannot be reused if this is a tax-free dividend. Nor cannot they offset on the tax relative to the share for fees and expenses (“quote-part de frais et charges”), not considered as a partial taxation of the dividend, but as a global method of exclusion of expenses linked to the acquisition of the exempted income4

Concerning interests on debts, the amount of expenses to be deducted from the interests levied should be limited to expenditure on management and collecting, except for situations of back-to-back financing.

Finally, concerning the foreign source royalties, the principle is the direct allowance of the expenses made for the levy of those revenues. This method can and has to be favoured by the beneficiary of the income, as soon as the tools of supervising and management permit it.However, in order to avoid the difficulties that can arise an exact ventilation of the exploitation fees between the foreign source royalties and the other categories of operating revenues, the tax administration accepted that the affectation should be achieved by allocating the operating net income to the extent of the gross amount of royalties coming from a State compared to the total revenues of the company5

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B. The tax credit could not be offset against the French tax, in the base in which the corresponding revenues have been included.

3 – Case law strictly considers, that it follows from Article 220 of the CGI that a tax credit can only be offset against the portion of the corporate tax, at the common law rate or at the reduced rate, which applies to the considered income. In other words, a tax credit attached to income subjected to the corporate tax common law rate cannot be set off against the amount of corporate tax at reduced rate possibly owed by the company6, and vice versa7. This approach seems questionable as Article 220 of the CGI aims at calculate the cap of tax credit but does not provide the terms of use of the capped tax credit. In any event, according to the actual case law, in the case of an absence or of a lack of tax owed by the company, the residual tax credit would be written off (“tomberait en non valeur”). The withholding incurred abroad would therefore be, in proportion to the tax credit not usable, deductible from the taxable bases only when the applicable conventional provisions do not prohibit such a thing.

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C. A tax credit concerning a debt remaining uncashed at the end of the fiscal year can be directly offset on the tax considered for this fiscal year.

4 – Finally, a last restriction to the use of tax credit has to be considered, linked to the delay between the income accounting giving right to the tax credit (that leads to the due of corporate tax at the end of the fiscal year) and the payment of the considered income (which is the operative event of the withholding tax and entitle to the tax credit). Regarding those principles, the entitlement to a tax credit may not yet be born at the date of the end of the fiscal year of taxation of a debt of a foreign source income. In this case, the tax should, in principle, be calculated without the offset of a tax credit, and then given back later on on the basis of a claim by the taxpayer after payment of the foreign withholding tax that is the compensation of the tax credit.

However, by way of simplification, the Administration admits, as a practical guideline, a method consisting in pairing, by advance and under subsequent control of the Administration, the income that benefited from a tax credit calculated according to the provisions of the tax treaty between France and the source State8

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D. A loss-making company, that cannot use foreign tax credit, won’t be able to obtain the reimbursement…

5 – This is what is said in the Faurecia decision of the Conseil d’Etat, in which the judges decided that tax credits relating to withholding tax collected abroad, not offset on the French tax notably because of the deficit situation of the taxpayer, cannot be refunded.

The company asserted, in support of its reimbursement application, the fact that the mechanism of tax credit offset in only a method of reimbursement of the debt owed by the French Public Treasure (“Trésor Public”) and therefore, there is nothing to argue against their repayment in cash. However, the Conseil d’Etat assessed that it does not result “from the provisions [of the tax treaties], nor from any provision or any principle of national law that the tax credit that could not have been set off has to be returned by France to the resident beneficiary of those revenues”.

The submissions of the public prosecutor (“rapporteur public”), Edouard Crépey, highlight two arguments in favour of the rejection of the return of foreign tax credits. First, it is recalled that “the subsidiary possibility of a reimbursement in cash is not attached to the tax credit mechanism”, but that it should be relied on the text that deals with the tax credit to know the treatment that needs to be done. Indeed, in national law, several tax credits, of which the rules of use have been planned by the legislator, on a case-by-case basis: thus, some tax credits are refundable, others are deferrable, and others ones are lost because of a lack of set off. Furthermore, it is highlighted the existence of a principle of literal interpretation of the tax treaties that the Conseil d’Etat applies in the case in point: thus, if this is true that one of the purposes of bilateral tax treaties is to eliminate double taxation, this purpose can only be achieved if the relevant tax treaty actually provides for this absence of double taxation.

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E. … nor deduce from its taxable bases in France the amount of the foreign withholding tax, if the applicable tax treaty precludes such a possibility.

6 – The question of the deductibility of foreign withholding taxes, in the case of the non-use of the relevant tax credit, has led to several disputes almost concomitant, to numerous comments and has been widely been discussed.

It results now from the Conseil d’Etat case-law that the foreign withholding tax is not deductible, when the clear provisions of the applicable tax treaty precludes such a possibility9

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This is the case, in the case Céline, of the tax treaties signed by France with Italy and Japan. By analogy, this is the case, more widely, with numerous tax treaties signes by France. It does not result explicitly from this decision that the deduction would be granted, conversely, in the case in which the tax treaty would not include an explicit prohibition on this point. However, the Versailles Administrative Court of Appeal (“Cour administrative d’Appel de Versailles”) decided in this way, concerning a French company earning royalties of Greek.

. As the Administration did not file an appeal in to the Court of Cassation (“Cour de Cassation”), we can legitimately consider that this solution has been endorsed. On this basis, it results from the main tax treaties signed by France that only withholdings tax levied on royalties in a limited number of countries can lead to a deduction in France, when the conventional tax credit cannot be used:

2. Withholding taxes levied in breach of conventional provisions.

7 – This situation can include several realities to which are faced companies in the context of their international trade relations:

– A withholding tax is levied by a State pursuant to its national law, in breach of the tax treaty convention –for instance, on a class of income for which the bilateral treaty give an exclusive taxation right to the residence State) ;

– A withholding tax is levied by a State because of an extensive interpretation of the definition of an income submitted to a withholding tax given by the treaty. Indeed, we know that the definitions of the concepts of royalty and dividend can lead to a disagreement of interpretation. Some States, for example, call it a royalty a payment given for an operation that is not a skills transfer, but is limited to technical assistance service or the provision of qualified staff ;

– A withholding tax is levied according to the allocation terms of taxing power provided by the tax treaty, but at a higher rate than the maximum rate provided ;

– Some States have created withdrawals for which the company is neither the liable, nor the debtor, even though it bears the charge on an economic plan. The main examples we can note are the following ones:

– The withholding tax at a rate of 24% levied in Algeria on service deliveries made by an agent located in France for a client located in Algeria (withholding tax on income tax (“impôt sur les bénéfices”), tax on professional activity (“taxe sur l’activité professionnelle”) and VAT) ;

– The withholding tax at a rate of 10% levied in some cases in China on the corporate gain made by the transfer of shares of a foreign intermediary company owning a participation in a Chinese company ; this text is applied by Chinese authorities in breach of the tax treaty between France and China, of which the substantial participation clause should only apply for a direct transfer of shares of a Chinese company by an shareholder located in France.

– The dividend distribution tax of a rate of 20,358% levied in India on the dividend distributions realized by resident companies for their shareholders, whether they are resident or not.

We can note that France could also be blamed on this point. Especially, the contribution of 3% on the revenues allocated provided by Article 235 ter ZA of the CGI, could be considered as not compliant to the conventional provisions, as it can be analysed as a dividend taxation contrary to some tax treaties concluded by France.

8 – The French company that bears a foreign withholding tax levied in breach of the relevant tax treaty does not benefit from a tax credit in France. In the alternative, we therefore look at the deductibility of the foreign withholding tax, the question is to know how a tax treaty which expressly provides the prohibition of deducing the withholding tax in the residence State, can apply to the French taxpayer, while this tax treaty is not respected by the source State.

Following the Céline decision, the Administration considered that the deduction is forbidden, when the tax treaty expressly provides so, even when this treaty is not respected by the source State.

7 The administrative court of Montreuil finally ruled on this question, considering that the deduction of the foreign tax of the taxable results of a French company would be in any events granted, when the foreign tax has been levied in breach of the tax treaty11. Indeed, the provisions of the clause relating to the elimination of double taxations which, in some treaties, prohibit this deduction would only apply to revenues considered as taxable or not taxable “in accordance with the provision of this Treaty”, according to the terms laid down in most of the treaties.

According to our information, the tax administration would have changed its position in the context of tax controls, following this decision.

Conclusion

9 – The tax treatment of withholding taxes and conventional tax credits on foreign passive income has been forged over time by case law. This Praetorian construction is based on the appreciation made by the judge concerning the articulation of the rules of French national law and of the conventional provisions.

The last decision of the Conseil d’Etat (the Faurecia decision above-mentioned), saying that the tax credit that cannot be set off, cannot be refunded to the French taxpayer, illustrates again the limits of the tax payers to ensure the neutrality of international flows. Another issue, not yet decided by the judged but evoked by the public prosecutor in this case seems important though: the possibility to delay the use of foreign tax credits in the time. And, on this aspect, it is interesting to note that the legislator considered, some years ago, to include in the French General Tax Code a delay mechanism of conventional tax credits over a two-year period, coupled by an acknowledgement of the tax credit to be lost at the end of the delay period12

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Nicolas BRAHIN

Avocat au Barreau de Nice

nicolas.brahin@brahin-avocats.com

fichier à telecharger:
Looking for elimination of double taxation on international flows_papier en tête

Have you foreseen to take over a company which is chargeable to corporate tax? Have you thought about another transaction more interesting than a simple corporate buyout: to create a takeover holding? Which benefits?

1. LBO : a common transaction

1. The buy-out by the holding company

Today, the usual way to buy-out a company, more precisely a SMEs (“PME” or “Petites et Moyennes Entreprises”) is to adopt a plan that involves a holding, especially when the purchaser partly finances this acquisition.

In this plan, the purchaser doesn’t buy directly the target company (“société cible”) but the buy-out is made by the intermediary of a holding, specially created for the acquisition.

2. The functioning

In order to buyout a company, a holding takes a bank loan.

The dividends shared out by the target company, allow the holding to be able to honor the loan due date.

This operation is known as LBO, “leverage buy out” which refers to the funding of the operation by the acquired company itself.

3. LBO into practice

It is common that the buyer bring into the acquired company business an asset of 25% to 30%.

Thus, thanks to this particular operation, a contribution of 250 000 to 300 000 euros will be enough to acquire a company whose value corresponds to 1M euros.

The remaining amount will be borrowed by the holding.

This kind of operation gives some obvious financing facilities but also significant tax breaks.

2. The tax benefits derived from the LBO

1. Interests exempted from tax levy

The classic buyout operation refers to the situation that the buyer as a natural person gains directly company issued equity.

The interests derived from the acquired company are taxed relatively heavily.

A progressive tax schedule based on 60% of the revenues distributed is applied.

Also, these dividends are subject to 15, 5% of social contributions.

By creating a holding for the buyout, the dividends shared out aren’t subject to social contributions.

The dividends can be almost totally exempted from taxation (equivalent to 95%).

This tax benefit will not be applied if the holding keeps for two years the dividends and a parent subsidiary tax system is chosen.

Be aware that this option can be exercised in the cases where the holding (parent company or “société mère”) holds at least 5% of the share capital of the acquired company and those two companies are subject to corporation tax.

2. Another tax optimization

At the moment of the holding incorporation, it’s important to provide for the option concerning the tax consolidation for the target company and the holding.

Indeed, about this tax consolidation, the taxation is made at the standard of algebraic sum of the tax results of the integrated group of companies.

The incorporation of a holding made in order to buyout the target company generates usually a deficit because of the annual carrying charges which will reduce the target company’s tax result.

A corporate tax economy is reached but consequently it will increase the existing financial resources of the incorporated group.

3. Advices

The success of this transaction depends of the acquired company’s power to share out adequately the dividends in order to guarantee the refund of the loan taken out by the holding.

Incorporated a takeover holding will fund the acquisition by the company that you want to buyout. By combining this transaction, the parent subsidiary tax system and the tax consolidation, you will be exempt 95% of the dividends collected by the holding. You will reduce the tax corporation of the acquired company.

Nicolas BRAHIN, Avocat

Master’s Degree in Banking and Financial Law

Université Panthéon-Sorbonne

Email : nicolas.brahin@brahin-avocats.com

fichier à telecharger:
160607 LBO Structure

It results from the combination of articles L1231-1¹ and L1237-11² of the French Employment Code (“Code du Travail français”) that the contractual termination of the employment agreement can only intervene as required by the legal rules which regulate this way of termination.

Those rules are intended to guarantee the freedom of consent of the parties.

This is what the French Highest Court or “Cour de Cassation” sums up in its ruling of 15th October 2014³.

Does this ruling mark the end of the amicable termination of the agreement?

From a legal point of view, do the parties still have recourse to terminate the relationship by mutual agreement based on article 1134 al.2⁴ of the French Civil Code (“Code civil français”) and the previous jurisprudence?

This issue is not new and both legal doctrine and magistrate are concerned about it.

Since the entry into force of the contractual termination’s measure⁵, the doctrine soon understood that both employer and employee can no longer have recourse to the amicable termination.

The French jurisdictions and the French High Court keep up with the pace⁶.

The contractual termination “ordinary law” of the negotiated termination of the employment agreement

The Cour de Cassation made it clear in a legal ground principle which will be explained in the following words.

An employment agreement can be terminate by mutual agreement or on the initiative of the employer or employee.

If the contract is terminated by mutual agreement, an agreement between the parties concerning this kind of termination will be required.

Thus, the contractual termination’s validity can be checked.

That means that the consent of the two parties can be considered.

This is the result of the combination of articles L1231-1⁷ and L1237-11⁸ of the French Employment Code (“Code du Travail français”).

If the contractual termination is accepted as a negotiated way to terminate the agreement, the provisions of article L1231-4⁹ of French Employment Code (“should not be ignored.

This article provides that the parties cannot foresee to renounce in advance to invoke the rules about termination of permanent employment agreement contained in the French Employment Code.

Those rules are made for both employee and employer in order to protect them.

Those arguments mean that any termination, amicable or negotiated, which doesn’t come within the scope of specific provisions of contractual termination and legal exceptions, constitutes de facto a redundancy without actual and serious basis.

Nicolas BRAHIN, Avocat

Master’s Degree in Banking and Financial Law

Université Panthéon-Sorbonne

Email : nicolas.brahin@brahin-avocats.com

fichier à telecharger:
160607 The contractual termination of the employment agreement

A fiscal mechanism foresees an exemption for the VAT to which the transfer of an immovable affected by a rental activity is subjected to.

I.CASES WHERE THE EXEMPTION IS POSSIBLE:

Article 257 bis of the French tax code (“Code general des impôts”) provides a specific mechanism of VAT exemption for an operation undertaken between taxable persons (“redevables de la taxe”) leading to a transmission of the total or partial sum of assets (“universalité totale ou partielle de biens”) (in return for payment or freely, or by assets to a company).

In certain cases, either the transfer benefits from an exemption of taxation, or the transferor (“cédant”) is exempted to proceed to the regularization of the VAT previously deducted.

If the conditions of application of the exemption are fulfilled, the tax authority fully applies this mechanism.

The tax authority has allowed this mechanism to apply under conditions to the sale (isolated) of an immovable affected by a rental activity subjected to VAT.

This implies that the property is sold to a purchaser that intends to pursue the transferor’s rental activity (with leases subjected to VAT, ipso jure or by option).

This mechanism does not apply in the event of an isolated sale of an immovable if it is (only) partially affected to a rental activity.

II. THE APPLICATION OF THE EXEMPTION TO A VACANCY:

An immovable temporarily vacant during the transfer can benefit from this mechanism.

A vacancy can indeed be justified by the market situation of the immovable, a change of tenancy, by works or after any damage without the intention of renting the immovable subjected to VAT being questioned.

Consequently, the duration of the vacancy is not taken into account for “article 257 bis”, it is only the demonstration of an intention to rent during the vacancy that needs to be proved.

The circumstances that have motivated the departure of the (last) tenant of the immovable are not alone capable of questioning the application of the mechanism.

III. THE CONDITIONS FOR THIS EXEMPTION IN THE EVENT OF A VACANCY:

It must be kept in mind that the mechanism of “article 257 bis” will only be applicable if the transferor can prove he is actively searching for a tenant.

In practice, the proof can easily be given if the transferor has handed a research mandate for a tenant (or a management mandate).

However, the rent must be adjusted to the market.

In the event of a resale of immovable activity, if a person liable to VAT proceeds to the isolated sale of an immovable in inventory (current assets), the tax authority considers that the exemption is not applicable even if while waiting for the resale, the immovable is affected by a lease subjected to VAT.

fichier à telecharger:
160506 VAT for the transfer of a rented immovable (TVA cession immeuble)

For construction or major works, the concerned professionals must have an insurance that covers their decennial liability.

All construction professionals, whose decennial liability could be sought according to articles 1792 and following of the French civil code (“Code civil”) for major works, after their receipt, must have a mandatory specific insurance that covers their civil decennial liability.

A building and construction contractor must justify of a decennial liability insurance that he encloses with his estimates and invoices.

The Macron law of August 6, 2015 provides for examples of insurances certificates.

In the decree published on January 13, 2016, there is a certificate example for a contract subscribed to personally with specific mentions if it concerns a construction site.

A specific example is set for large construction sites necessitating a collective agreement for decennial liability (“Contrat collectif de responsabilité décennale CCRD”).

In all cases, an insurer will not be able to insert a mention in the certificate that could limit or set aside the meaning of the minimal mentions.

If he wants to refer to contractual clauses, he will have to reproduce them in the certificate.

Aside from this, the certificate can contain mentions referring to other guarantees or extensions of his contract.

This new legislation will be applicable to the certificates drafted after the July 1, 2016 and concerning construction operations, which date of opening of the construction site is after July 1, 2016.

The opening date is understood in light of the meaning given by the French insurance code (“Code des assurances”).

All concerned professionals will be advised in due time of when they need to claim this from their insurer and then, when they will have to provide the proper certificates.

Operators, owners (“maître d’ouvrage”), co-owner’s property manager (“syndic de copropriété”) must ensure they have a certificate in conformity with the necessary works.

Notaries must enlist these certificates to acts of sale.

fichier à telecharger:
160315 Decennial certification_0

After the French Court of cassation (“Cour de cassation”) case of the 11^th of March 2014, the legislator’s decision, in his legislation of the 31^st of July 2014, is to limit the powers of the super-expert (“tiers-expert”) and to return its substance to agreements concluded between the parties (statutory or not).

Although this legislation gives back to the super-expert his role and forces him to apply the agreements concluded between the parties, more precisely, the application of the formula defined in statutes or any other agreement, it also raises new questions concerning the meaning to give to the application of incomplete formulas or those that have become null and void with time.

In the event of the absence of formula in the statutes and/or in the agreement, it could be natural for the super-expert to research the most adapted approaches according to him.

It must be reminded that in that case the multi-criteria approach is recommended such as the intrinsic approaches (Business Leaders of France “DCF dirigeants commerciaux de France”, reevaluated net assets) and analog approaches (price reference on the basis of listed companies and/or recent comparable transactions).

The situation has become delicate in cases where the strict result of the application of the formula leads to a negative or undetermined result.  Should the formula be preserved?

In the presence of the result of a negative price, case-law has accepted the conversion of a negative price to the price of one euro as long as the price is serious (French Court of cassation case of the 7^th of June 2011, n°10-17584).

In the presence of an undetermined price due to a vague formula based on absent or out of date aggregate, different interpretations can appear:

• The literal interpretation: the expert declares himself incompetent to correctly fulfill his mission and refers it to the President of the Court.
• The practical interpretation: in order to maintain the formula, the super-expert could interpret the formula and modify it by researching to preserve the spirit of the formula originally contracted.

Another interpretation would be to consider that a wrong formula is equivalent to the absence of a formula, thus, the expert would regain his freedom. However, in this situation, it could be questioned if the expert is exceeding his powers in regards to the new legislation. Only future case-law will settle this issue.

It is worth noting that the spirit of the new text is to preserve a maximum of price clauses contained in statutes or any other agreement.

In order to avoid these situations, it is recommended in the drafting of agreements to use the formulas that foresee the application of the closest principles to those agreed by the parties.

It is also important to foresee in the drafting of price formulas, a combination between a determined price and a price determinable in the circumstances of a forced sale. It is equally important to maintain aggregates concerning the activity and context of the company.

It is recommended to avoid using aggregates that would be too low in the income operating statement (“compte de résultat”) (net profit, current profits before tax), that could significantly be impacted by accounting restatements (depreciation, non-recurring items…) and that could lead to interpretation.

Finally, in the case of reference to net debt, it is worth taking into account the existing bank debt (especially for companies under LBO) with the risk of obtaining a systematic negative price during a certain period.

Overall, the changes brought to article 1843-4 of the French civil code (“Code civil”) strengthens the agreements concluded during parties’ disagreements and also questions the limits of the expert’s role in the application of the agreement’s formula.

fichier à telecharger:
160315 The super-expert_0