Business is usually carried out in France through a company, although it is also possible to undertake a business activity as an individual. A commercial or industrial activity could be undertaken through the setting-up of a corporate entity or, if relevant, through the setting-up of a partnership. The choice of the appropriate legal form is generally dictated by various objectives and constraints; ie, by much wider considerations than mere tax consequences.
From a tax standpoint, corporate entities such as the société anonyme (SA), the société par actions simplifiée (SAS), the société à responsabilité limitée (SARL), which ensure the limited liability of their shareholders, are in principle subject to corporate income tax at their own level under standard conditions. Because of its very flexible legal regime allowing for a broad contractual freedom, the SAS is widely used for both operating and holding activities.
The société en commandite par actions (SCA) is a joint-stock company that is also subject to corporate income tax but provides for two kinds of partners: limited partners with a limited liability and general partners who are subject to a joint and several liability. The SCA is a rather outdated legal form by now but it can be useful in some cases for the setting-up of an investment structure with strong governance rules as this legal form makes it possible for the general partners to keep the control of the company with a quite reduced investment.
The société en nom collectif (SNC) is a partnership allowing commercial activities to be undertaken under the so-called French semi-transparent tax regime. Broadly speaking, this specific regime provides for a calculation of the taxable income at the level of the entity but with an effective taxation of such income at the level of its partners depending on their pro rata rights to the profits. As the profits are subject to tax directly at the level of the partners, the partnership structure avoids a double taxation but it is worth noting that the partners in an SNC are subject to a joint and several liability.
The old-fashioned société en commandite simple (SCS) is a “hybrid” vehicle from a tax perspective, as it is semi-transparent for the part of the income attributable to general partners (joint and several liability) and subject to corporate income tax as regards the income attributable to the limited partners (limited liability).
If certain conditions are fulfilled, entities normally subject to corporate income tax may opt to become semi-transparent from a tax perspective, and vice versa.
Truly transparent entities are quite rare under French tax law. There is a specific real estate co-ownership company (société immobilière de copropriété) that aims at building or holding real estate assets and allowing for an actual tax transparency.
Other transparent entities are usually used as investment funds that may take the form of (i) fonds commun de placement (FCP) without a legal personality and thus out of the scope of corporate income tax or (ii) société d'investissement à capital variable (SICAV) with a legal personality but benefiting from a full exemption of corporate income tax. Investment funds may also use the form of société de libre partenariat (SLP), which, provided that specific investment ratios are respected, offers a full transparency from a French tax perspective.
French partnerships are not per se transparent entities but benefit from a so-called semi-transparent tax regime. As described above, French partnerships are not subject to corporate income tax at their own level. Instead, the taxable profits (or taxable losses) are assessed at the level of the entity but subject to tax at the level of the partners, whether or not distributed. The actual repatriation of profits or offset of losses is therefore irrelevant for the purposes of the taxation of the partners.
The French partnership could be useful in certain situations. For instance, if it is expected that the activity to be carried out by the partnership will be loss-making, the partnership tax regime would allow the losses generated at the level of the partnership to be offset against profits realised at the level of the partner.
For non-operating activities, the partnership could take the form of a société civile (SC), widely used for passive activities such as the holding of assets, typically shares or real estate.
Under French domestic tax law, a corporate entity or a partnership is a tax resident in France if it has its legal seat or its effective place of management in France.
However, the corporate income tax rules are based on the territoriality principle under which a nexus must be found between the income and the French territory. Therefore, the place of the actual activity or source of income is the key driver for determining the scope of liability to corporate income tax.
Hence, French tax-resident companies are only subject to corporate income tax in France on earnings derived from a business conducted in France (or earnings allocated to France by a double tax treaty). Foreign-source income generated by a French tax-resident company through a foreign branch is not subject to corporate income tax in France.
French partnerships subject to the semi-transparent tax regime are also considered as French tax-resident entities. Subject to the provisions of the relevant double tax treaty, this situation may have an impact on the taxation of foreign-source profits generated by a partnership or on the taxation of the partnership’s profits at the level of its foreign partners.
The standard corporate income tax rate (CIT) is 31% for financial years opened in 2019. As an exemption for 2019 only, large companies with a turnover equal to or above EUR250 million are subject to a 33.3% rate. However, profits are subject to a 28% rate up to EUR500,000 both for standard and large companies.
The standard corporate income tax rate is expected to progressively decrease to 28% (31% for large companies) for tax years opened in 2020, 26.5% for tax years opened in 2021 and 25% for tax years opened in 2022.
An additional social surcharge on CIT applies at the rate of 3.3% on the part of the CIT burden of the companies exceeding EUR763,000.
A special 15% rate for small and medium companies (SMEs) applies on profits up to EUR38,120.
French partnerships are in principle subject to tax at the level of their partners. Therefore, business profits allocated to a partner subject to CIT will be subject to the above rates whereas business profits allocated to an individual French tax resident will be subject to personal income tax under the progressive income tax scale.
Income generated on business activities carried out either directly by a French resident individual or through a French partnership (taking the legal form of an SNC) is subject to personal income tax under the progressive income tax scale: 0% up to EUR10,064, then 14% up to EUR27,794, then 30% up to EUR74,517, then 41% up to EUR157,806 and finally 45% on income exceeding EUR157,806 (progressive rates applicable on 2019 income).
Individual taxpayers are also liable to an income tax surcharge of 3% or 4% on income exceeding, respectively, EUR250,000 or EUR500,000 for a single taxpayer. The thresholds are doubled for couple taxpayers.
The taxable profits subject to corporate income tax under the territoriality rules are in principle assessed on accounting profits, subject to some positive or negative adjustments to the accounting results, as the case may be.
There are many applicable tax adjustments. The main tax adjustments to the accounting results could be, for instance, non-deductibility of certain taxes, such as the CIT burden itself, restriction to the deductibility of interest, specific tax treatment of long-term capital gains, limitation of the deductibility of capital losses, immediate taxation of latent gains on some investments, exemption of dividends benefiting from the parent-subsidiary regime (95% exemption or, under certain conditions, 99% exemption of dividends received from shares representing at least 5% of the capital of the distributing company, if held for two years), restricted deductibility of provisions, possibility to benefit from a favourable tax regime (tax provisions, accelerated depreciation, tax deferrals, etc), specific rules applicable to tax losses available for carry-forward, specific rules applicable to companies pertaining to a tax group.
In accordance with accounting principles, all CIT payers are required to keep regular accounts based on an accrual basis.
R&D expenses related to the value of an asset must in principle be activated/capitalised. However, R&D expenses that do not lead to the creation of a new asset or increase the value of a fixed asset can be deducted immediately from the taxable income of the financial year during which they are incurred.
In addition, taxpayers can benefit from an R&D tax credit amounting to 30% of their R&D expenses (meeting certain requirements and after application of certain rebates) up to a total amount of expenses of EUR100 million and to 5% of their R&D expenses in excess of EUR100 million.
Further, income deriving from the licensing, sub-licensing or sale of industrial property (patent, plant rights, manufacturing processes, software) can be taxed at a favourable reduced rate of 10% for the part of such income determined by application of a “nexus ratio”.
There are also specific incentives for certain kinds of investments through the granting of over amortisation rights.
Companies created before 31 December 2020 in view of taking over industrial business experiencing critical difficulties may benefit from a CIT exemption during an initial 24-month period under certain conditions.
French tax-resident shipping companies may opt for a specific tonnage tax regime instead of CIT for a minimum period of ten years to the extent that at least 75% of their turnover is derived from shipping activities and their management and operating activities are performed from France.
A full CIT exemption for a 12-month period followed by a 50% CIT exemption for the next 12 months is available for innovative new companies that are SMEs having less than eight years of existence, not created as part of a restructuring or concentration and performing R&D activities representing at least 15% of their costs.
Operating losses are deductible, for tax purposes, in the financial year during which they are incurred.
As a general rule, tax losses may be carried forward (TLCF) indefinitely until the enterprise is deemed to cease (eg, until a substantial change in the activity, a change in tax regime, a liquidation or an absorption). TLCF can be freely offset against the taxable income of the following tax years, provided that such taxable income does not exceed EUR1 million and only up to 50% of the part of the taxable profit exceeding EUR1 million.
A carry-back of tax losses is also possible up to the lower of the taxable profit of the preceding financial year and EUR1 million, resulting in a tax credit (equal to the normal CIT rate applicable to the profit on which the losses were carried back multiplied by the amount of such losses) that can be (i) used to pay the CIT burden of the next five financial years or (ii) refunded afterwards.
Income losses may usually be offset against capital gains, whereas the reverse is not true.
Interest paid to third parties is generally deductible in the financial year of accrual to the extent that the debt is incurred in the own corporate interest of the company and is duly registered for accounting purposes.
Interest paid to shareholders is deductible to the extent that (i) the share capital is fully paid up and (ii) the rate does not exceed a maximum rate determined by the French tax authorities (average rate on bank loans granted to enterprises on a longer than two years period; ie, 1.47% in 2018).
Interest paid on related parties’ debt is also subject to this maximum rate, unless the company is able to demonstrate that the higher rate corresponds to the one that it could have obtained from independent financial institutions under similar circumstances.
Deductibility of interest paid on related parties’ debt is subject to a minimum taxation test under which the recipient must be subject to a taxation of at least 25% of the CIT burden that would have been applicable if the recipient had been subject to CIT in France on the interest income.
Further, interest deduction is generally limited to EUR3 million or 30% of the adjusted tax EBITDA of the borrowing company. Where the company is thinly capitalised (debt towards related parties exceeding 150% of the equity), the thresholds are reduced respectively down to EUR1 million or 10% of the adjusted tax EBITDA. A company subject to such limitations may, however, obtain an additional deduction of up to 75% of the interest incurred if it can be demonstrated that the consolidated group (for accounting purposes) to which this company belongs is more indebted than the company itself. Interest not deducted by virtue of this set of rules can be carried forward indefinitely for possible further deduction from the taxable basis of the following years.
French tax law allows for vertical or horizontal tax groups. A vertical tax consolidation group can be set up between French companies subject to CIT where at least 95% of the share capital and the voting rights of the subsidiary is held directly or indirectly by the French parent company of the group that is not itself held by another French company subject to CIT. A horizontal tax group between French resident sister companies at least 95% owned by an European company is also available.
The members must opt for the application of the consolidated tax regime and must have the same financial year.
The tax group regime allows the tax group to be treated as a fiscal unity for CIT purposes. The parent company is liable for the CIT assessed on the consolidated profits and losses generated by all the companies in the tax group. The regime also allows alleviated taxation on dividends or alleviated definition of subsidies, to neutralise certain intra-group operations (capital gains or losses on intra-group sales of assets, depreciation of intra-group receivables or assets), and to apply at the level of the group some specific tax regimes (nexus rules on IP, deductibility of interest).
Capital gains are in principle subject to the standard CIT rate. However, capital gains eligible to the long-term regime may benefit from a reduced or zero rate of taxation.
The long-term regime applies in principle to capital gains derived from the disposal of fixed assets held for more than two years.
However, the long-term regime is available to companies subject to CIT only on specific capital gains. For instance, capital gains derived from the sale of shares in non-listed real estate companies or in predominantly financial companies are subject to CIT at the standard rate.
The ordinary reduced CIT rate for long-term capital gains is 15%. However, capital gains derived from the sale of (i) certain industrial property eligible to the patent box are subject to a 10% rate and (ii) shares in listed real estate companies are subject to a 19% rate.
Long-term capital gains on qualifying participation shares (various conditions have to be met by the participation in order to qualify; in particular, a 5% shareholding is generally required) are exempt of CIT subject to the taxation of a lump sum of 12% of the capital gain (leading to an effective tax rate of 3.84% including CIT at 31% and social surcharge).
Companies are liable to registration duties on the acquisition of business or real estate assets as well as to stamp duties (or financial transaction tax) on the acquisition of shares, depending on the situation.
Operating companies are subject to local taxes (contribution économique territoriale, or CET) consisting of a property contribution (cotisation foncière des entreprises, or CFE) and an added value contribution (contribution sur la valeur ajoutée des entreprises, or CVAE).
The CFE is calculated on the notional rental value of immovable assets whereas the CVAE is calculated on the added value generated by the company (a progressive tax rate ranging from 0% for a turnover under EUR500,000 up to 1.5% for a turnover exceeding EUR50 million).
The majority of the closely held local businesses operate without a corporate form as individual enterprises, micro-entrepreneurs or individual enterprises with limited liability. This way of organisation is straightforward and avoids a double level of taxation (at the level of an entity and at the level of the individual).
The standard CIT rate was 31% in 2019, whereas the maximum rate of the progressive income tax scale was 45% (plus the additional tax of 3% or 4%, as the case may be).
There are no specific rules preventing individual professionals from using a corporate structure taking into consideration that when the business profits are distributed to the individual shareholder as dividends, such dividends will be taxed (at a 30% flat rate), making the corporate route “all together” less interesting from a tax perspective.
There is no concept of a closely held company under French tax law preventing a closely held corporation from accumulating earnings for investment purposes subject to the general abuse of law principles and controlled foreign company (CFC) rules.
As an exception, the French domestic CFC rules provide for a taxation in France of profits generated outside France in foreign permanent establishments or foreign controlled subsidiaries established in a low-tax jurisdiction.
The French taxpayer is subject to corporate income tax in France on a pro rata of the passive income generated by such entity in accordance with the financial rights held directly or indirectly by the French taxpayer in such entity.
Under French case law, the deemed distributed income derived from a low-tax foreign entity is considered as “other income” for the purposes of the application of the double tax treaties signed by France, which means that French case law considers that the double tax treaties do not prevent France from applying these domestic CFC provisions.
The CFC rules are not applicable within the European Union and outside the EU where the taxpayer is able to demonstrate that the main purpose and effect of the foreign entity is not to shift profits to a low-tax jurisdiction.
There is no specific regime of a closely held corporation for individual tax purposes except under the general anti-abuse provisions and the specific anti-avoidance rule for individuals.
Under the specific anti-avoidance rule, where a French tax individual holds at least 10% of the rights (either in capital, rights to the profits or political rights) in a foreign entity having a passive investment activity and that is subject to a low-tax regime in its jurisdiction, the profits realised by such entity are deemed distributed to the French resident individual and are subject to tax irrespective of the effective distribution.
French tax-resident individuals are in principle subject to a flat tax of 30% (individual income tax and social contributions included) on dividends received from or on the capital gain derived from the sale of shares in a corporation subject to CIT.
French tax-resident individuals are in principle subject to a flat tax of 30% (individual income tax and social contributions included) on dividends received from or on the capital gain derived from the sale of a publicly traded corporation subject to CIT.
Under French domestic tax law, French-source dividends distributed to foreign-resident corporations are in principle subject to a withholding tax at the rate of 30% that will be reduced in accordance with the standard CIT rate as from 2020 (28% in 2020, 26.5% in 2021, and 25% in 2022).
An exemption is available in accordance with the EU parent-subsidiary regime under certain conditions. The exemption is extended to certain Economic European Area and Swiss parent companies.
An exemption is also available to French-source dividends paid to EU-resident Undertakings for the Collective Investment in Transferable Securities (UCITS) and certain other foreign UCITS residents in a jurisdiction having a tax information exchange agreement or provision.
Dividends paid to a non-cooperative state or territory (NCST) are subject to a 75% withholding tax.
Generally speaking, no withholding tax applies on French-source interest paid to a non-resident company unless the payment occurs in an NCST, in which case a 75% withholding tax applies.
French-source royalties are in principle subject to a withholding tax at a rate equal to the standard CIT rate (31% in 2019). The withholding tax is increased to 75% in the event of a payment to an NCST. Under the Interest and Royalties Directive, a full exemption is available for royalties paid to EU companies under certain conditions.
The primary tax treaty country used by foreign investors to make investments in France is Luxembourg, which benefits from the EU legislation as well as a double tax treaty with France. Belgium is often used too, for the same reasons.
The so-called treaty shopping consisting of using a jurisdiction in view of benefiting from the favourable provisions of the double tax treaty signed between this jurisdiction and France can be challenged by the French tax authorities through the concept of the abuse of tax law, which has been recognised by French courts as applicable to double tax treaties even in the absence of an anti-abuse provision in the relevant double tax treaty.
The French tax authorities may challenge the increased purchase price paid by a French subsidiary to its foreign parent company or the reduced selling price received by a French subsidiary from its foreign parent company.
The pricing of IP assets also often gives rise to a reassessment where excessive royalties are paid by a French subsidiary to its foreign parent company for the use of patents, trade marks, technical assistance and know-how.
Financing activities are a very sensitive area too in situations of intra-group interest-free loans or intra-group loans bearing excessively high or low interest rates.
French tax authorities do challenge related parties’ limited risk distribution arrangements through the transfer pricing analysis (abnormal transaction), as well as on the ground of abuse of law considerations, in particular when the related parties change the allocation of risks and rewards between them, shifting from a distributing activity of buy and resale remunerated by a commercial margin to a commissioner activity remunerated on a cost-plus basis: the French tax authorities could disregard the new contractual relationships.
French transfer pricing rules implemented are in line with the OECD principles under which all transactions carried out with related companies should be arm’s length.
French tax authorities recognise the right of compensating adjustments. When the compensating adjustment has to be realised by France, the taxpayer is normally put back in the situation that would have been applicable if the transfer pricing had been originally applied under the arm’s-length principles.
The compensating adjustments are applicable to the financial years upon which the taxable results of the foreign entity have been reassessed by the foreign tax authorities notwithstanding any French statute of limitations.
French tax authorities may, however, refuse to operate a mutual agreement procedure (MAP) under certain circumstances (lack of evidence of double taxation, application of heavy penalties, self-corrections made by the taxpayer, etc).
As a general rule, non-resident companies carrying out business activities through a branch are subject to corporate income tax under the same assessment and computation rules as resident companies.
French-source investment income that is not received by a French branch of the non-resident company is not subject to tax at the level of the French branch but can be subject to withholding tax while paid to the foreign company.
However, French branches of non-resident companies are in principle subject to a branch remittance tax on their after-tax income that is deemed distributed to the foreign head office. The branch remittance tax was applied at the rate of 30% in 2019, which shall be progressively reduced to 25% by 2022. The rate is increased to 75% where the head office is located in a non-cooperative state or jurisdiction.
However, such a branch remittance tax does not apply to French branches of EU head companies. Further, most of the double tax treaties concluded with France prevent France from applying the branch remittance tax.
Capital gains realised by non-resident companies derived from the disposal of shares in a French company are not subject to tax in France, except in the two following situations.
Most double tax treaties concluded by France do not impede the application of such domestic tax provisions.
French domestic tax law does not provide for specific change of control provisions under which, for instance, the French underlying company would lose its tax losses carry-forward or triggering the taxation of the capital gain, or being subject to registration duties.
However, as indicated above, a foreign-resident company could be considered as a French real estate-rich company subject to capital gain taxation and registration duties.
As a general rule, transfer pricing between related parties must be arm’s length in accordance with Article 9 of the OECD Model Tax Convention.
The determination of the arm’s length is primarily based on a comparability analysis under which the conditions of transactions between independent parties placed in the same situation should be applicable to the related parties’ transactions in view of eliminating any special conditions deriving from the related-party situation (the so-called comparable uncontrolled price).
In the case of lack or inadequacy of an appropriate comparable, a functional analysis must be performed, following which the most relevant method should be applicable to the situation at hand: typically, resale minus method for distribution activities, cost-plus method for the provision of services, or profit split method and transaction net margin method under specific circumstances.
In principle, the deduction for payments of management and administrative services is subject to the justification:
In order to provide the required justification, the nature and amount of the costs incurred by the non-resident service provider should be evidenced in a detailed way in order to be re-invoiced to the French paying company.
For instance, the French tax authorities may challenge the management fees paid by the French company in consideration of the following:
No specific limitations apply to foreign-owned French companies. However, the general limitation for the deduction of net financial expenses up to EUR3 million or 30% of the tax EBITDA as implemented in France as of 1 January 2019 applies, in accordance with ATAD. Moreover, a thin-capitalisation mechanism applies in relation to related-party debts following which if the related-party debts exceed 1.5 times the equity of the French borrower, the thresholds are reduced to EUR1 million and 10% of the tax EBITDA on the pro rata basis of the net financial expenses related to the related-party debts.
In addition, deduction of interest expenses is subject to a minimum taxation test at the level of the related-party recipient of the interest income: the deduction is only allowed to the extent that the recipient is at least subject to 25% of the effective tax rate that would apply to the interest in France (ie, 8% in 2019).
Moreover, interest paid to a lender or in a bank account situated in a non-cooperative jurisdiction is in principle non-deductible.
French-resident companies are subject to corporate income tax on profits derived by enterprises carried out in France only: their worldwide profits deriving from permanent establishments located outside France are not taxed in France in accordance with the French territoriality principle. The territorial scope of French corporate income tax could, however, be extended by the provisions of the relevant double tax treaties.
Foreign-source passive income such as dividends, interest, royalties and capital gains allocated to the French-resident company (and not to the foreign permanent establishment) are subject to tax in France unless the provisions of the relevant double tax treaty prevent France from taxing such income.
In most of the situations, the double tax treaties allow France to tax foreign-source income as well as the source jurisdiction, in which case France must grant a tax credit in relation to such income in view of eliminating the double taxation.
Under the territoriality principle, profits deriving from a foreign permanent establishment are out of the scope of French corporate income tax. Accordingly, expenses allocated to such a foreign permanent establishment are not tax deductible from the French taxable basis.
If the taxable result of the foreign permanent establishment is a loss, such loss is not offsettable against any profit falling within the French taxable basis, except under certain circumstances.
Foreign-source dividends may benefit from the French participation-exemption regime under standard conditions, in which case the dividends are tax-exempt except for a lump sum of 5% of the gross dividends, which is subject to corporate income tax at standard rate. The lump sum can be reduced to 1% for European distributing companies, if certain conditions are fulfilled.
The main conditions of application of the French participation-exemption regime are a shareholding of at least 5% of the share capital of the foreign distributing company, held for at least two years, and true economic substance of the foreign distributing company.
Intangibles developed by French companies can be used by non-resident subsidiaries without incurring French corporate income tax. However, the IP-owning French company must receive an arm’s-length remuneration for the licensing or the sale of the IP rights.
Otherwise, the French company could be reassessed on the lack of remuneration.
As an exception, under French CFC rules, French-resident companies could be subject to tax in France on the profits realised by a subsidiary or a permanent establishment located in a low-tax jurisdiction.
The CFC rules would also apply to the branches of a French company located in low-tax jurisdictions.
The French tax authorities may disregard the tax residency of foreign-related companies of a French company in the situation where a lack of substance can be evidenced characterising a fictitious arrangement under the concept of abuse of tax law.
Foreign companies must have appropriate technical and human resources to carry out their activity. Substance is particularly scrutinised for companies having a holding activity. If it can be considered that the foreign company’s sole purpose is to benefit from a domestic or tax treaty favourable provision and that substance is missing, the French tax authorities can deny the benefit from such a favourable provision.
Under French domestic law, French-resident companies are subject to corporate income tax on the capital gains upon disposal of shares in non-resident related companies.
The French company may benefit from the long-term regime assuming that the conditions are met (in particular, the shares should be qualified as participation shares for tax purposes and held for at least two years). In this case, the capital gain is tax-exempt except for a lump sum of 12% subject to corporate income tax at standard rate, leading to an effective tax rate of 3.84% in 2019.
However, this long-term regime is not available for participations in real estate or cash-rich companies and companies situated in a non-cooperative jurisdiction subject to a safeguard provision.
Double tax treaties signed by France could prevent France from the taxation of certain foreign-source capital gains or allow taxation subject to the allocation of a tax credit for eliminating the double taxation.
A general anti-avoidance rule has been implemented in French domestic tax law as of 1 January 2019. Under this rule, an arrangement or a series of arrangements that are not genuine having regard to all facts and circumstances must be ignored for corporate income tax purposes to the extent that it has been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that goes against the object or purpose of the applicable tax law.
A specific anti-abuse provision is also applicable for the purposes of benefiting from the favourable regime of restructuring.
The concept of abuse of tax law may apply either to operations exclusively tax-driven or to operations principally tax-driven (a new concept that became applicable as of 1 January 2020).
French tax authorities may audit the taxable returns of a company on a random basis or making use of various information collected. Large enterprises (ie, companies whose gross turnover of gross assets exceeds EUR400 million on a consolidated basis) are usually audited regularly.
The statute of limitation (income tax) usually expires at the end of the third calendar year following that for which the tax is due, with some notable exceptions.
As regards Action 1, “Address the tax challenges of the digital economy”, the French Parliament adopted on 25 July 2019 a law introducing a digital services tax. Further, the principles of the International VAT/GST Guidelines for the collection of VAT on cross-border B2C supplies of services and intangibles are applicable.
As regards Action 2, “Neutralise the effects of hybrid mismatch arrangements”, France has implemented two recommendations, as follows:
As regards Action 3, “Strengthen CFC Rules”, France has CFC rules and applies a rather wide definition of a CFC and a legal and economic control test for defining a CFC.
As regards Action 4, “Limit base erosion via interest deductions and other financial payments”, France has transposed the interest limitation rule of the EU's Anti-Tax Avoidance Directive into its domestic legislation.
As regards Action 5, “Counter harmful tax practices more effectively, taking into account transparency and substance”, the revised French IP regime is now compliant with the nexus approach.
As regards Action 6, “Prevent treaty abuse”, France has its own Model Convention and announced its intent to incorporate the recommendations in its treaty policy.
As regards Action 7, “Preventing the artificial avoidance of PE [permanent establishment] status”, France has indicated the intent to include the new definition of PE in future bilateral negotiations of tax treaties and has amended the definition of PE to reflect the recommendations set out in this Action 7.
As regards Action 13, “Re-examine transfer pricing documentation”, France has implemented legislation that provides for delivery of (i) a master file, (ii) a local file, (iii) a country-by-country report and (iv) the automatic exchange of country-by-country reports.
As regards Action 15, “Develop a multilateral instrument”, France has participated in the development of the Multilateral Instrument and has signed the Multilateral Instrument.
The present French government is quite active as regards the implementation of the BEPS Action Plan and is seeking to achieve a full international tax co-operation and the implementation of effective measures tackling tax evasion and tax planning, adapting taxation rules to the new economy.
For instance, France has implemented a digital services tax before any agreement at the EU or OECD level in this respect.
International tax policies have a high public profile in France and France is very active in the implementation of a co-ordinated international action against tax competitiveness, tax evasion and aggressive tax planning.
The French government has implemented a progressive reduction of the standard corporate income tax rate to align with the average taxation rate in the EU/OECD jurisdictions but has no competitive tax policy objective.
Generally speaking, the French tax system does not include harmful tax practices any longer: the French IP box regime has been amended to include a nexus approach as recommended by the OECD; no other French tax regime was highlighted by the OECD's work.
France has already implemented various measures to tackle the use of hybrid mismatch arrangements.
As regards inbound dividends, dividends distributed that are tax deductible from the taxable basis of the distributing company are not eligible to the French parent-subsidiary regime that aims at exonerating dividends deriving from profits that have already been taxed. As such, this measure prevents the use of hybrid instruments that would be considered as equity instruments in France (being per se eligible to the French parent-subsidiary regime) while being considered as debt instruments at the level of the distributing company.
Likewise, as regards outbound interest payments, interest paid by a French-resident borrower that is not subject to a minimum taxation at the level of the recipient is not deductible in France. This measure aims at circumventing the use of hybrid instruments that would be considered as debt instruments in France while being considered as equity instruments at the level of the lender.
Further, France has already implemented the general anti-abuse provision in its domestic legislation and will implement the hybrid mismatch rules provided for by ATAD 2 as of 1 January 2020 (and as of 1 January 2022 with respect to reverse hybrid provisions) by virtue of the 2020 Finance Act.
France will also implement the other recommendations of Action 2 of the BEPS report, which will probably reduce again the situation of hybrid mismatch in cross-border transactions.
French corporate income tax rules are based on a territorial principle. Accordingly, interest expenses incurred at the level of a foreign branch are not offsettable against French taxable profits nor taken into account for the purposes of the calculation of the various interest limitation rules.
CFC rules are in principle designed as an anti-avoidance mechanism that aims at avoiding the shifting of profits to low-rate jurisdictions that should normally fall within the taxable basis of an entity located in a standard/high-rate jurisdiction.
Moreover, CFC rules are usually viewed as a backstop mechanism of the transfer pricing adjustments in order to make ineffective the shifting of profits outside of the relevant tax jurisdiction where the evidence of an actual transfer pricing manipulation is too burdensome.
Accordingly, CFC rules should only cover highly mobile (eg, digital or financial services) and/or passive income (eg, dividends, interest, royalties) and to the extent of the benefit of safeguard provisions rather than all income, including any income generated from value-creating activities in low-tax jurisdictions.
Indeed, CFC rules should keep their anti-avoidance purpose and not create a general presumption of profit shifting for all activities realised in a jurisdiction that has lawfully decided to keep a competitive and attractive tax environment.
The French CFC rules cover all income attributed to a related affiliate located in a low-tax jurisdiction but include two safeguard provisions: (i) a territorial safeguard provision for affiliates located in the EU to the extent that it does not constitute an artificial scheme and (ii) a safeguard for taxpayers that can demonstrate that the main purpose or effect of the affiliate’s activities is not to shift profits to a low-tax jurisdiction but that such affiliate has true and effective operating activities.
These safeguards are key points as the definition of a low-tax regime under the French CFC rules is based on a threshold corresponding to 50% of the actual taxation that would have been borne by the affiliate if it had been a French taxpayer: this variable definition could lead to the inclusion or the exclusion of affiliates depending on the increase or decrease of the domestic standard corporate income tax rate respectively while the actual corporate income tax rate of the foreign affiliates did not vary.
Sweeper CFC rules could thus prove to be harmful.
Given the current legislative environment and the implementation of anti-avoidance rules/limitation of benefit provisions in the existing double tax treaties concluded by France, the impact of the proposed double tax convention (DTC) limitation of benefit or anti-avoidance rules is likely to be very limited. Treaty shopping and artificial interposing of entities for the sole purpose of benefiting from the more favourable provisions of a relevant double tax treaty is already scrutinised and French domestic tax legislation contains numerous provisions to tackle tax evasion and profit shifting.
The French transfer pricing regulation is based on the general arm’s-length principle.
Accordingly, the changes proposed by the OECD in its Transfer Pricing Guidelines to incorporate BEPS Action Items 8 to 10, “Assure that transfer pricing outcomes are in line with value creation”, should not per se change the legal framework of transfer pricing in France. However, this guidance is used when preparing the transfer pricing documentation of multinational enterprises (MNEs) and in the case of tax audit/reassessment by the French tax authorities.
For instance, the new clarification that legal ownership of IP rights alone does not necessarily generate a right to all (or indeed any) of the royalties is likely to affect the current transfer pricing methods for the determination of profit allocation as regards profits stemming from IP rights.
The new French IP box regime is quite competitive, with the so-called long-term regime leading to a 10% reduced rate of taxation of certain IP-related income and gains, whilst applying the new nexus approach, which aims at denying the benefit of such a reduced tax rate to the recipient of IP income that did not effectively incur the R&D expenses related to the creation, acquisition or development of the relevant eligible IP.
France has implemented a country-by-country reporting (CBCR) obligation since 2016, before the issuance of the OECD multilateral agreement dated 27 January 2016 and EU Directive 2016/881/UE dated 25 May 2016 (DAC 4) in this respect.
Although these new rules create an additional reporting/compliance burden for MNEs, they may secure their intra-group relationships and avoid double taxation situations by granting the same level of information to the relevant tax authorities.
However, most French groups are much more reluctant as regards to the public CBCR proposed by the draft EU Directive COM/2016/198/2, as strategic information could become public, jeopardising true competitivity.
The French government decided not to wait until a consensus is reached at OECD level to implement a domestic digital services tax that entered into force retrospectively as of 1 January 2019.
France indicated that the domestic digital services tax would be replaced by the OECD standard once an agreement is reached.
The digital services tax applies to resident and non-resident companies with a worldwide turnover exceeding EUR750 million and a French turnover exceeding EUR25 million. The taxable base is in principle the French-source turnover derived from online advertising, from the sale of personal data for advertising purposes and from the provision of peer-to-peer online platforms. The French-source turnover will be calculated using a digital presence coefficient based on the proportion of French users. The digital services tax rate is 3%.
The OECD has recently released on 9 October 2019 a proposal for discussions in view of addressing tax challenges arising from the digitalisation of the economy.
The draft proposal aims at re-allocating some profits and corresponding taxing rights to countries and jurisdictions where MNEs have their markets. It would ensure that MNEs conducting significant business in places where they do not have a physical presence be taxed in such jurisdictions, through the creation of nexus rules and profit allocation rules (the so-called Pillar One). The OECD proposal also focuses on the development of a new global anti-base erosion (GloBE) mechanism granting jurisdictions the right to “tax back” (secondary taxation rights) when primary taxation rights have not been exercised, or have been insufficiently exercised (low effective taxation) by other jurisdictions (the so-called Pillar Two). France is actively supporting the OECD works to reach a consensus solution on one or both (combined) pillars, with a final report by the end of 2020 presenting the multilateral agreement reached in this respect, even if the proposed workflow timeline seems very ambitious.
French domestic tax law provides for a withholding tax on outbound payments of royalties related to the use of offshore IP rights when the IP owner does not have a fixed place of business in France. The withholding tax is levied at a rate corresponding to the standard corporate income tax rate (ie, 31% in 2019). However, the withholding tax is increased up to 75% when the recipient is located in a non-cooperative jurisdiction unless it can be evidenced that the payments are related to actual transactions whose main purpose and effect are not to divert the royalties in a tax-haven jurisdiction.
There are no other general comments about the BEPS process.
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France is known for having one of the highest compulsory levies-to-GDP ratios in the world, at approximately 50%, a complex tax system and a tough tax administration. The reality is probably more complex and the picture is not so bleak. It can be underlined, for instance, that half of the compulsory levies are not actually taxes but social security contributions paid to unemployment insurance, health insurance and pension funds that are calculated on the basis of wages paid to employees or on the net income of self-employed persons. Who knows that the French corporation tax rate will be 25% in 2022, while it will be around 30% in Germany? Who knows that French wealth tax is now only applicable to real estate property? Who knows that French inheritance tax only applies to approximately 5% of successions? These key strengths and trends are unfortunately hidden by weaknesses coming from uncertainty on the interpretation of the laws, complexity of the system and difficult relationships with the tax authorities.
In this context, it is fair to say that the French tax system is driven by two opposing trends: (i) a pro-business trend supported by recent changes that enhance or supplement existing attractive tax measures and (ii) a pro-administration trend driven by EU directives that is materialised by new tools made available to the tax authorities to collect information and combat not only tax fraud and tax evasion but also tax optimisation.
The authors of this article have tried to draw an accurate picture of the evolution of the French tax system observed in their practice, based on recent developments, and to show how they interact with some emblematic tax provisions of the French tax system.
Pro-business Trend: Recent Changes Enhancing or Supplementing Existing Attractive Tax Measures
The government has significantly reduced the taxes on dividends, interests, capital gains and companies' net income, and narrowed the scope of some of the most criticised tax provisions that were viewed as obstacles to growth and investment. These changes supplement existing attractive regimes, notably in favour of innovation and investment.
Changes applicable to individuals
The introduction of a flat tax on dividends and capital gains, the replacement of the French wealth tax by a tax on real estate properties, the enhancement of the limitation of the exit tax as well as the enhancement of the “impatriation” regime are emblematic of the pro-business trend initiated by President Macron.
Reduction of taxes on dividends, interest and capital gains (“flat tax”)
The 2018 finance law introduced a new regime for passive income taxation (dividends, interests, capital gains on transfer of shares). While these classes of income were subject to income tax at rates ranging from 0% to 45%, plus social taxes, they are now subject to a flat tax at a 30% rate, including income tax at 12.8% and social taxes at 17.2%. Nevertheless, taxpayers have the option to subject such income to the progressive rate of income tax if this is more favourable.
Gains made by managers of qualified investment funds on the disposition of shares of “carried interest” may be taxed as capital gains (and not as salary income) provided that their acquisition has met a number of conditions. This favourable tax treatment is also applicable to gains on the sale of shares of carried interest made by employees or directors of foreign investment funds who moved their tax residence to France between 11 July 2018 and 31 December 2022, provided that they have not been resident of France in the three preceding years and were non-residents when they acquired the shares.
Narrowing the scope of the French wealth tax
Since 1 January 2018, the French wealth tax named Impôt sur la Fortune (ISF) has been repealed and replaced by the Impôt sur la Fortune Immobilière (IFI). IFI is levied at the same progressive rates as ISF, but its basis consists exclusively of real property held directly or indirectly by the taxpayer and his family whose net value exceeds EUR1.3 million. Note that the 30% abatement to the value of the main residence has been maintained under the new regime. The French Tax Code (FTC) limits the deductibility of debts incurred to finance the acquisition of the property when the loan is repayable in full at maturity or does not provide a fixed maturity date, or when it has been granted by relatives or companies controlled by relatives.
Real property used for the business activity of an enterprise is excluded from the taxable basis, except when the business activity merely consists of leasing real property.
Attractive “impatriate” regime
The “impatriate” regime applies to employees assigned to France by their foreign employer or who are directly recruited abroad by a French company, who are temporarily exempt from income tax for an eight-year period (previously five years) on a portion of their salary income, provided that they establish their tax residence in France and have not been resident of France for tax purposes in the preceding five civil years.
The tax-exempt salary income has two components: (i) amount of the “impatriation” premium or, for employees recruited from abroad, 30% of the total remuneration if more favourable, provided that the taxable balance is at least equal to the remuneration received by a person performing similar activities in France plus (ii) part of the remuneration corresponding to work carried out outside France, according to specific calculations.
During the “impatriation” period, only 50% of the amount of securities income and capital gains on the sales of securities kept outside France is subject to French tax.
Impatriates are exempt from IFI on foreign real property until December 31st of the fifth year following the date on which they have established their tax residence in France.
Limitation of the scope of the exit tax
Individuals transferring their tax residence out of France and who have been resident of France during at least six of the last ten years are subject to an exit tax assessed on unrealised gains of shares representing at least 50% of the financial rights of a company or of a portfolio of securities whose value exceeds EUR800,000.
Payment of the tax is automatically deferred when the taxpayer moves his residence either to a member state of the European Union or, since 1 January 2019, to a non-EU country that has signed with France an assistance agreement intended to combat tax fraud and tax evasion, as well as an assistance agreement on tax collection. Prior to 1 January 2019, the tax deferral in the second case was conditioned by the appointment of a tax representative resident in France and the provision of a security interest to the tax authorities.
Before the vote of the 2019 finance law, the suspended tax was discharged after 15 years (or on the date the taxpayer returned to France). From now on, the suspended tax is discharged after two years, increased to five years when the value of the portfolio exceeds EUR2.57 million on the date of the transfer of residence.
Changes applicable to companies
The progressive decrease of the corporation tax and withholding tax rates recently engaged consolidate the attractiveness of some specific incentives provided for by the FTC.
Decrease of the corporation tax rate
The 2018 finance law has provided that the standard rate of French corporation tax, which has been set at 33.33% for almost 20 years, will be progressively reduced to 25% for business years starting on 1 January 2022 (28% in 2020; 26.5% in 2021).
Profits earned by small companies (ie, whose turnover does not exceed EUR7.63 million and whose capital is at least 75% controlled by individuals) will continue to be taxed at 15% up to EUR38,120, the 25% rate being applicable over that amount as from 1 January 2022.
Decrease of the withholding tax rate on dividends
The rate of withholding tax levied on dividends paid by a French company to non-resident individuals has been decreased from 30% to 12.8%. Such rate may be further decreased by applicable tax treaties.
Dividends paid to non-resident companies or legal entities are currently subject to withholding tax at the rate of 30%, subject to the provisions of applicable tax treaties. This rate will be aligned with the corporation tax rate and so will be reduced to 25% as from 1 January 2022.
Attractive tax environment for R&D and innovation
For a long time, France has been praised for the tax incentives granted to R&D and innovation. The main incentives are the R&D tax credit (CIR), the innovation tax credit (ITC), the young innovating enterprises status (Jeune Entreprise Innovante, or JEI) and the patent regime that has been amended by the last 2019 finance law.
The CIR benefits companies subject to corporation tax in France that are engaged in R&D activities. The CIR rate amounts to 30% of eligible expenses until EUR100 million and 5% for expenses above this limit. Only R&D activities defined as fundamental research, applied research and development research are included in the scope of the CIR. The CIR is creditable against the corporation tax liability. The excess portion of the CIR over corporation tax may be carried forward for three years and be refunded after this period. An immediate refund is possible for tax-exempt new firms, innovative start-ups and corporations that qualify as SMEs.
The ITC is built on the same model as the CIR. It applies to companies that meet the EU definition of SMEs. Its rate amounts to 20% of eligible expenses up to EUR400,000 (hence a maximum ITC of EUR80,000). ITC is creditable against corporation tax due or refunded to SMEs.
Subject to certain conditions, a JEI carrying out R&D activities may benefit from a favourable tax and social security regime consisting of an exemption of corporation tax on 100% of the profits earned in the first profitable fiscal year, and 50% of the profits earned during the next profitable fiscal year as well as some social security contributions exemptions.
The patent box regime has been deeply amended by the 2019 finance law. The new regime is applicable to tax years beginning on or after 1 January 2019. The purpose of the reform was merely to align the French patent box regime with the OECD recommendations (BEPS Action 5) by covering new types of income and introducing the “nexus” approach. In addition, the preferable tax rate is decreased.
The rationale of the French patent box regime, as amended, is to allow net licensing income (or sub-licensing, etc) and gains arising from specific IP assets benefiting from a favourable 10% rate (formerly 15%) for entities subject to corporation tax. Eligible IP assets are still patents, certificates of public convenience, non-patented patentable inventions, proprietary obtention certificates and manufacturing processes, but also copyrighted software.
Without expanding on its complex calculation, the nexus approach leads to a limitation of the benefit of the 10% rate to the extent of direct costs related to creation and development of the eligible assets, so excluding indirect costs and purchase price.
A complex but relatively “friendly” frame for financial costs deduction
The FTC contains a long list of provisions that can potentially prevent the total or partial deduction of financial costs. However, despite this complex set of rules, ultimately, taxpayers are generally able to achieve a high ratio of actual deduction.
The main provision of this list, introduced in the FTC as from 2019 in order to implement ATAD, consists of a limitation of the tax deductibility of net financial charges to 30% of the company’s tax EBITDA, or EUR3 million if higher.
Provided that the company is not thinly capitalised, it can deduct an additional amount equal to 75% of the net financial expenses not initially deducted in the case where its equity-to-assets ratio is equal to or higher than the same ratio of the consolidated group to which it belongs.
In the case where the company is thinly capitalised, the net financial expenses would be deductible only up to 30% of the tax EBITDA (or EUR3 million if higher) to the extent of the debt from unrelated parties up to the higher of 10% of the tax EBITDA (or EUR1 million if higher) to the extent of the debt from related parties. A company is considered to be thinly capitalised where the average amount of debt from related parties exceeds 1.5 times the amount of equity.
This thin capitalisation provision is not applicable provided that the company is able to demonstrate that its own debt-to-equity ratio is less than the debt-to-equity ratio of the consolidated group to which it belongs.
Fortunately, the French government has decided to apply the option offered by ATAD allowing French companies to carry forward indefinitely the non-deducted financial expenses as well as the unused deduction capacities.
However, two unsatisfactory provisions have been maintained in the new set of rules.
Pro-administration Trend: New Tools to Combat and Sanction Fraud, Evasion and Optimisation
Introduction in the French Tax Code of two additional measures aimed at combating abuse of law
Until the vote of the 2019 finance law, the tax authorities were allowed by Article L 64 of the Code of Tax Procedures (LPF) to ignore acts characterised as an abuse of law, either because such acts are fictitious, or because, seeking the benefit of a literal application of legal provisions against the objectives pursued by their authors, their exclusive purpose is to reduce or eliminate the tax burden that the taxpayer would have normally borne in view of his actual situation or activities, had he not concluded the disputed transaction. When the existence of an abuse of law is successfully sustained by the tax authorities, the assessment is automatically increased by a penalty amounting to 40% or 80% of the avoided tax (depending on where the taxpayer had the main initiative of the transaction or was its main beneficiary). The parties to the disputed transaction are jointly liable for the payment of the penalty.
The 2019 finance law has introduced two additional set of rules based on the abuse of law theory.
The multiplication of anti-abuse rules and definition in the French Tax Code is creating a serious source of legal uncertainty (respective scope of each set of rules; cumulative of exclusive application, etc). These rules must also be analysed by reference to anti-abuse provisions contained in double tax treaties, such as the OECD Multilateral Convention and the recent decisions of the European Court of Justice raising the question of whether a treaty benefit may be denied on the basis that it results from an arrangement qualifying as an abuse of law or from the fact that the recipient is not the beneficial owner of the disputed income (ECJ, February 26, 2019, C-115/16, C118/16, C119/16 and C299/16).
Reinforcement of criminal proceedings and investigation instruments
With a view to strengthen action against tax fraud, the Parliament passed a law on 23 October 2018 whose purpose is to improve detection, apprehension and punishment of fraud. Aside from the creation of a tax police force of approximately 50 people based in the premises of the Ministry of Finance, the law increases criminal sanctions and fines and gives more powers to criminal investigating judges.
In particular, the law has put an end to the Ministry of Finance’s monopoly to decide on the opportunity of prosecuting tax fraud before criminal courts. From now on, the tax authorities have the obligation to forward to the public prosecutor’s office reassessments exceeding EUR100,000 when they are completed either by the 80% penalty applicable in the event of abuse of law or fraudulent manoeuvres, or by the 40% penalty applicable in the event of bad faith or abuse of law, provided in this case that the taxpayer has been subject to a reassessment completed by a 40% or 80% penalty in any of the preceding six years.
DAC 6 directive in the trend of expanding automatic transfer of information
The law of 23 October 2018 also authorised the government to pass an Ordonnance approving the transposition into French law of EU Directive 2018/822 of 25 May 2018 on administrative co-operation in the field of taxation (DAC 6), also known as the EU Directive implementing mandatory disclosures rules for intermediaries (MDR). The Ordonnance was published on 22 October 2019.
Its implementation will most likely provide a valuable source of additional information to the French tax authorities completing that collected through CBCR (OECD Country-by-Country Reporting in the area of transfer pricing), CRS (OECD Common Reporting Standard) and FATCA (US Foreign Account Tax Compliance Act).
DAC 6 definitely falls in the framework of CRS, CBCR and FATCA, which aims at increasing tax transparency as a reaction to the 2008-09 financial crisis as well as to some scandals regarding politicians' assets hidden in tax havens and aggressive optimisation by multinational groups. Even if it is necessary to endow the tax authorities with modern and efficient tools to collect information, a major concern is the critical lack of frame designed for the use of such new information by the tax authorities.
As a conclusion, it appears that, for the time being, France’s attractiveness does not seem to have been affected by the intensification of repressive control measures, as confirmed by recent surveys conducted by AT Kearney and EY according to which France has entered the top five of the most attractive places in the world for investors (see “The 2019 AT Kearney Foreign Direct Investment Confidence index”) and become the second most attractive European member state for foreign investments, just behind the UK (see EY, “France’s Attractiveness Survey 2019”).
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