Corporate Tax 2021

Last Updated March 15, 2021

France

Law and Practice

Authors



Hogan Lovells (Paris) LLP has a Paris tax team that advises on the structuring and implementation of complex transactions, including mergers and acquisitions (both public and private), finance, private equity, real estate (representing investment funds or sponsors in France or involving French operations and interests) and capital markets transactions. The firm assists clients with tax audits and represents them on the tax aspects of litigation proceedings before French administrative and civil courts. It also advises clients on issues of private wealth tax management in relation to their business development. The firm's lawyers combine their legal skills with market and sector-specific knowledge in order to provide innovative tax-efficient solutions to clients across all industry sectors. In addition, to provide clients with the most comprehensive advice possible, the tax group works closely with lawyers from other practice areas in the Paris office and offices around the world.

Corporate Structures in France

Businesses set up in France usually adopt a corporate form, although it is possible to carry out a business activity in France as a sole trader. Two main categories of corporate structure (or companies) can be distinguished:

  • limited liability companies (sociétés anonymes, sociétés par actions simplifiées, sociétés à responsabilité limitée), in which the shareholders’ responsibility is limited to the amount of their contributions; and
  • partnerships (sociétés civiles, sociétés en nom collectif), in which the partners’ responsibility is generally joint and unlimited.

Certain forms of companies (namely the sociétés en commandite par actions, or SCA, and the sociétés en commandite simple, or SCS) have two types of partners: the general partner(s) (associé commandité), whose liability is joint and unlimited, and the limited partners, whose responsibility is limited to the amount of their contributions (SCAs and SCSs must have at least one general partner and one limited partner).

In practice, the société par actions simplifiée is by far the most commonly used.

In addition to these corporate forms that have a separate legal personality, there is a specific form of company, the société en participation, which is a purely contractual arrangement with no separate legal personality. The courts may also construct the existence of a company from facts (société créée de fait – no separate legal personality).

Tax Treatment

From a French tax law perspective, corporate entities may be treated as either of the following.

  • Opaque – the entity’s tax liability is assessed at its own level and the tax due is paid by the entity on its own (this regime generally applies to limited liability companies). All companies that are opaque for tax purposes are subject to French corporate income tax (CIT).
  • Semi-transparent (which is a concept not entirely similar to the “tax transparency” regime applied in certain other jurisdictions) – the entity’s tax liability is still assessed at its own level but the tax due is paid by the entity’s partners in accordance with their own tax regime (ie, French CIT or French personal income tax) and irrespective of whether the profits have been distributed. Losses realised by the entity can be set off against the profits realised by the partners in the course of their own activity(ies).

The French semi-transparent tax regime generally applies to entities that are not limited liability companies, irrespective of whether they have a separate legal personality, and, in particular, to French partnerships.

As indicated in 1.1 Corporate Structures and Tax Treatment, French tax law does not provide for a full tax “transparency” regime in a way that other states do (with some limited exceptions that are extremely rare in practice).

The main reason for using a semi-transparent entity in France is to take advantage of the losses realised, as the case may be, by that entity in order to set off profits realised by the entity’s partners in the course of their own activity(ies).

Investment structures exist, however, under French law that can be considered as being “transparent” from a French tax perspective. Two categories of entities can be distinguished here:

  • investment vehicles deprived of legal personality and thus placed outside the scope of French CIT; and
  • investment vehicles that are set up as corporate entities but are entitled to a partial or full exemption from French CIT, provided certain conditions are met in terms of investments and distributions.

The main types of financial investment structures existing under French law are:

  • the fonds communs de placement (FCP), which are joint ownership investment structures with no separate legal personality outside the scope of French CIT;
  • the société d’investissement à capital variable (SICAV), which are created as limited liability companies (either as sociétés anonymes or sociétés par actions simplifiées) and benefit from a French CIT exemption; and
  • the sociétés de libre partenariat (SLP), a more flexible investment vehicle inspired by the English law partnership that takes the form of an SCS and is exempt from tax.

In practice, the most commonly encountered vehicles for private equity transactions are SLP and FCP/SICAV structured as Fonds Professionnels de Capital Investissement (FPCI), which are funds opened only to so-called professional investors.

A company or a partnership is considered to be resident in France for French domestic tax law purposes if it has its legal seat or its effective place of management (siège de direction effective) in France. A company’s effective place of management can be defined as the place where the most important corporate decisions are made and corresponds ordinarily to the place where the highest-ranking corporate bodies of that company (eg, the board of directors) hold their meetings and take their decisions.

However, because French CIT is not computed on a worldwide basis, a company that is resident in France for domestic tax law purposes should only be subject to CIT in France on its:

  • net income derived from business activities carried out in France;
  • passive income from foreign sources; and
  • other profits for which France has been granted a right to tax under a double tax treaty.

The criteria that are used under French domestic tax law to determine whether a company carries out a business activity in France are similar to those used in the OECD Model Tax Convention to determine whether a company has a permanent establishment in a state (ie, either a fixed place of business or a dependent agent) with the addition of a third criterion: a company has a French business when it has carried out a “complete commercial cycle of operations” in France (generally, where a double tax treaty applies, this last criterion has no impact).

French partnerships that are semi-transparent for tax purposes also qualify as French tax residents under French domestic law.

Tax Opaque Entities

For companies subject to CIT, the standard French CIT rate has been brought down to 26.5% (to be further reduced to 25% in 2022) for fiscal years opened as from 1 January 2021. However, for companies and for tax consolidated groups that have a turnover equal to or higher than EUR250 million, the applicable CIT rate for fiscal year 2021 equals 27.5%.

A reduced 15% CIT rate applies to companies that, inter alia, have a turnover of less than EUR10 million for a given fiscal year, for the fraction of their profits up to EUR38,120 (the ordinary CIT rate of 26.5% applies for the surplus).

An additional 3.3% surtax also applies on the amount of CIT liability after deduction of an amount of EUR763,000, unless (i) the taxable entity has a turnover of less than EUR7,630,000 and (ii) at least 75% of its paid-up share capital is held by individuals or by companies that satisfy the same conditions (up to one level of intermediation).

Tax Semi-transparent Entities

Profits realised by French semi-transparent partnerships are subject to tax in the hands of their partners and according to such partners’ own tax regime (ie, either CIT or French personal income tax).

Business profits accruing to individuals, directly or through a semi-transparent entity, are subject to French personal income tax (impôt sur le revenu, or PIT) at a progressive rate (up to 45% over EUR158,123 – an additional 3% or 4% surtax may apply depending on the overall taxable income of the taxpayer and its family, as the case may be).

Taxable profits for incorporated businesses subject to French CIT are calculated based on the accounting profits determined in accordance with French generally accepted accounting principles (GAAP), realised in respect of each fiscal year, after making the required tax adjustments (either as deduction or add-backs).

The most substantial add-backs for tax purposes concern:

  • certain provisions, the deduction of which is denied for tax purposes (eg, provisions for taxes or provisions for impairment of a going concern);
  • certain payments for taxes (including the amount of French CIT paid itself); and
  • non-deductible financial expenses pursuant to specific intra-group payment limitations and/or to the general cap (see 2.5 Imposed Limits on Deduction of Interest).

The most substantial deductions for tax purposes concern:

  • the recapture of provisions, the deduction of which was previously denied for tax purposes; and
  • certain kinds of profits that benefit from a full or partial exemption for tax purposes (eg, dividends eligible to the French parent-subsidiary tax regime or capital gains on participating shares qualifying for the French participation-exemption tax regime).

Profits accruing to incorporated businesses subject to French CIT are always taxed on an accruals basis.

Patent Box

France has a patent box regime providing for the application of a reduced 10% tax rate to the net income accruing from the sale, lease or sub-lease of certain IP fixed assets (eg, patents, software, industrial know-how). The French patent box has been revised recently to take into account the so-called nexus approach recommended by the OECD and the EU, making its application conditional on the existence of R&D expenses incurred directly by the taxpayer or by unrelated entities.

R&D Tax Credit

Certain qualifying R&D expenses may also give rise to a specific tax credit equal to 30% of the fraction of the total amount of qualifying R&D expenses (reduced to 5% for the portion of eligible expenses exceeding EUR100 million). The tax credit available for a given year can be used to set off the amount of French CIT due in respect of the same year and the three following fiscal years, any excess remaining afterwards is paid directly to the taxpayer (certain companies can claim an immediate refund of the tax credit without having to wait three years).

French domestic tax law allows for a great number of favourable tax regimes applicable to incorporated businesses.

Such regimes generally depend on:

  • the nature of the business carried out by the taxpayer (eg, if it is innovative);
  • the size of that business (especially for small or medium enterprises); or
  • its location (to favour the creation of businesses in certain areas).

The incentives granted may, for example, correspond to temporary exemptions from CIT, the possibility to benefit from an immediate repayment of certain tax credits or the application of an accelerated amortisation schedule.

Deduction Cap

Ordinary tax losses incurred in respect of a given fiscal year may be carried forward for French CIT purposes indefinitely and without reduction of their amount. The amount of French carry-forward tax losses that can be offset against the taxable profit of any given fiscal year is capped at EUR1 million plus 50% of the taxable profit of the considered fiscal year that exceeds that amount.

Ordinary tax losses may also, under certain conditions, be offset against taxable profits of the preceding fiscal year, up to an amount of EUR1 million.

Forfeiture of Tax Losses

Ordinary tax losses do not forfeit when the company’s shares are sold or when there is a change of control. However, ordinary tax losses will forfeit in the case of change of corporate object or substantial change of activity of the company. A substantial change of activity is assessed based on the variations of turnover, balance sheet and staff.

Interest expenses are generally deductible like any other expenses: the corresponding debt needs to be (i) correctly accounted for, (ii) incurred in the entity’s own interest and (iii) meet the arm’s-length requirements.

General Cap

If the yearly net financial expenses of a company (or tax consolidated group) exceeds the higher of EUR3 million or 30% of its tax-adjusted EBITDA, a general deductibility cap applies, disallowing deduction of expenses that are over that threshold. The cap also includes a thin capitalisation test that, if met (at the level of the company or of the tax consolidated group), reduces the cap to the higher of EUR1 million or 10% of the tax-adjusted EBITDA (for a fraction of the financial expenses). There are possibilities for “additional” deductions and safe harbour clauses exist. Financial expenses disallowed under this rule may be carried forward under certain conditions.

Interest Rate Limitations

In addition, French domestic law restricts the deduction of interest paid to shareholders and/or related companies: interest paid to individual shareholders or to corporate shareholders that do not qualify as related companies are only deductible (i) if the share capital of the paying company has been fully paid up and (ii) up to the rate published by the French tax authorities each quarter (1.17% for the last quarter of 2020). Interest paid to related companies can be deducted at a higher rate if the payor demonstrates the arm’s-length nature of such interest; the standard of proof is high and it is generally recommended to prepare a transfer pricing study as evidence. Interest disallowed under this rule cannot be carried forward and may be recharacterised as deemed distributed income (and subject to withholding tax, as the case may be).

Anti-hybrid Rule

France has introduced the new anti-hybrid rule resulting from the implementation of EU Directives ATAD 1 (2016/116) and ATAD 2 (2017/952) in replacement of its older anti-hybrid rule. The new rules are generally applicable from 1 January 2020, while the specific provisions with respect to so-called reverse hybrid mismatches will apply from 1 January 2022.

The new rule generally aims at tackling situations where there is a mismatch in the treatment of a cross-border payment (eg, deduction in the source state without inclusion in the payee’s tax basis in another state, double deduction or no inclusion in either country). Such hybrid mismatches may result from differences in the tax treatment applied to financial instruments, entities or payment attribution rules between two countries. This rule generally applies only to transactions between related entities (although there are exceptions).

Depending on the nature of the hybrid arrangement, a corresponding neutralisation method is provided for under the new law, either by denying deduction or including a payment in taxable income.

Additional Limitations

A specific anti-debt-push-down rule known as "Amendement Charasse" limits the interest deductibility on debt incurred to acquire related-party shares following the inclusion of both entities into the same French tax consolidated group.

Interest disallowed under this rule cannot be carried forward but should not be subject to tax as deemed distributed income.

Finally, interest paid to a company located in a non-cooperative state or jurisdiction (NCST) within the meaning of the French tax code is generally not deductible.

CIT Tax Consolidated Group

Perimeter

Tax consolidation is allowed under French law for CIT purposes: a company may become solely responsible for the payment of the French CIT due by itself and by other French companies that it controls, directly or indirectly, at 95% or more (in terms of share capital and voting rights). The parent company of the group must not be held, at any time, 95% or more (in terms of share capital and voting rights) by another company subject to French CIT.

It is also possible to create a tax consolidated group if companies based in the EU or in a state party to the European Economic Area agreement (EEA) are interposed in the ownership chain (provided certain conditions are met), or where the parent company of the group is located in another EU/EEA state (in which case the tax consolidated group may include the French companies that the parent company controls, directly or indirectly, at 95% or more and one of the French subsidiaries will become the “parent” company of the tax consolidated group – so-called horizontal tax group).

Computation of the tax consolidated group’s profits

The taxable profit of a tax consolidated group is calculated by taking the sum of each of the group members’ own individual taxable profit and making certain adjustments to the result, especially to neutralise (either definitely or temporarily) certain transactions that took place within the consolidated group’s perimeter (eg, sale of assets). Dividend distributions within the group also benefit from a 99% exemption from CIT (compared to the ordinary 95% exemption provided under the French parent-subsidiary tax regime).

The parent company is responsible for paying the CIT due, if any, to the French tax authorities.

Tax losses incurred by the tax consolidated group can be carried forward or back and offset against the group’s taxable profits, like ordinary tax losses of a standalone company (the limitations mentioned in 2.4 Basic Rules on Loss Relief apply at the group’s level). However, tax losses incurred by a member before joining the tax consolidated group may only be offset against that members’ individual taxable profit (after adjustments, as the case may be).

VAT tax group

Tax groups also exist for French VAT purposes, but at a much less complete level. A new system of VAT consolidated group has been introduced in French law since 2021 (to implement EU rules already adopted by other member states) but its application will only become effective as of 2023.

Standard Rule

Capital gains realised by companies are generally subject to tax at the ordinary French CIT rate.

Sale of Shares

The French participation-exemption regime provides that capital gains realised on the sale of participating shares that have been held for at least two years benefit from an 88% exemption from CIT (provided certain conditions are met) and are thus only taxed effectively at 3.41% in 2021 (assuming the 27.5% CIT rate applies and factoring the additional surtax) and 3.10% as from 2022.

Capital gains realised on the sale of shares that do not qualify as participating shares (eg, shares in non-listed real estate companies or predominantly financial companies) or participating shares that have not been held for two years are subject to CIT at the standard rate.

Specific Rates for Certain Assets

Certain capital gains, although not exempt from CIT pursuant to the participation-exemption regime, may benefit from favourable tax rates. In particular:

  • a 19% tax rate applies to the capital gain realised on the sale of shares in a listed real estate company;
  • a 10% tax rate may apply to the capital gain realised on the sale of certain IP fixed assets pursuant to the French patent box (see 2.2 Special Incentives for Technology Investments); and
  • a 15% tax rate applies to the portion of capital gain realised on the sale of other stock into certain kinds of investment entities (eg, an FCPR or an FPCI/SLP) that has been held for at least five years, and that does not otherwise benefit from a full exemption from tax.

Companies that enter into a transaction for the acquisition of assets may be liable to pay French registration duties, generally computed on the basis of the higher of (i) the purchase price or (ii) the fair market value of the asset.

The applicable rate varies depending on the purchased asset’s nature; for example:

  • 0.1%, 3% or 5% in respect of shares (depending on the nature of the company whose shares are purchased; intra-group sales and sales of shares that are subject to the financial transaction tax are exempt);
  • up to 5% in respect of going concerns (and assimilated transactions); and
  • circa 6% in respect of immovable property (although a reduced 0.715% rate may apply in certain cases).

Registration duties are generally due from the buyer, but the parties may agree that the registration duties will be paid by the seller (or by both parties) as they see fit.

The sale of shares in certain French listed companies that had a market capitalisation of more than EUR1 billion on December 1st of the previous year is subject to the financial transaction tax at a 0.3% rate (instead of registration duties).        

Territorial Business Contribution

French companies are also subject to local taxes, notably the contribution économique territoriale (CET), which consists of two levies:

  • the contribution foncière des entreprises (CFE), which is an annual tax assessed on the notional rental value of certain French real estate assets – either owned or rented – used by the taxpayer for the purposes of its activity (rates are determined by the local authorities depending on the features and location of the taxable assets); and
  • the cotisation sur la valeur ajoutée des entreprises (CVAE), which is due by persons carrying out an activity subject to the CFE and that have a yearly turnover of more than EUR500,000. CVAE is computed on the “added value” generated by the business during the year of taxation at a progressive rate between 0.25% and 0.75% since 1 January 2021 (if the taxpayer is part of a group, the effective tax rate is determined on the basis of the group’s consolidated turnover).

Property Tax

Companies may also be liable to pay property tax (taxe foncière) in respect of the real estate assets (built or unbuilt) that they own as at January 1st of each year. Tax rates are determined by the local authorities, according to the features and location of the assets and applied to the rental value (even if the property is not rented out by the owner) as determined by the local authorities.

Other Taxes

Other specific taxes may apply, depending on the activity performed by that business (eg, tax on numerical services, tax on electricity producers).

Closely held businesses or corporations do not form a category that is distinct from other types of businesses or corporations under French tax law.

In practice, small local businesses can be set up either as sole traders (it is possible to choose between several legal frameworks and in certain cases to benefit from a limited liability regime) or take the form of a tax semi-transparent entity if there is more than one individual involved in the business. Tax opaque entities are also used; in particular, to limit the responsibility of the shareholders.

The advantage for individuals to have their business set up as sole traders or using a tax semi-transparent entity lies in the fact that profits accruing from such businesses are only subject to tax once (ie, in the hands of the trader or partners – see 1.1 Corporate Structures and Tax Treatment), while profits realised by tax opaque entities are subject to tax twice (ie, at the level of the company and, after their distribution, in the hands of the shareholders – see 3.4 Sales of Shares by Individuals in Closely Held Corporations).

In 2021, business profits realised by individuals or accruing to tax semi-transparent entities whose partners are individuals are subject to French PIT at a progressive rate:

  • taxable income fraction up to EUR10,084 – 0%;
  • taxable income fraction between EUR10,085 and EUR25,710 – 11%;
  • taxable income fraction between EUR25,711 and EUR73,516 – 30%;
  • taxable income fraction between EUR73,517 and EUR158,122 – 41%; and
  • taxable income fraction over EUR158,123 – 45%.

An additional 3% or 4% surtax may also apply, depending on the overall taxable income of the taxpayer and its family, as the case may be.

By comparison, profits accruing to companies subject to CIT are ordinarily taxed at a 26.5% rate (since 1 January 2021 – see 1.4 Tax Rates) and the profits distributed to individual shareholders will be subject to a 30% “flat tax” in the hands of the shareholders (see 3.4 Sales of Shares by Individuals in Closely Held Corporations).

As a result, although there are no French domestic tax rules that prevent individuals from setting up a business under a corporate form, the profits earned by such business and ultimately distributed to the individuals should be, in practice, subject to tax at a higher effective rate than the applicable CIT rate due to the effects of the economic double taxation.

Basically, the amount of earnings that can be accumulated by French companies is not subject to any limitation, provided no artificial/abusive scheme can be characterised (French individuals may be subject to a controlled foreign corporation (CFC) rule similar to the one discussed in 6.5 Taxation of Income of Non-local Subsidiaries Under CFC-Type Rules).

As a rule, dividends and capital gains realised on the sale of shares in corporations subject to CIT realised by French tax-resident individuals are subject to a 30% “flat tax” (12.8% for the French PIT plus 17.2% for the French social security contributions). An additional 3% or 4% surtax may also apply, depending on the overall taxable income of the taxpayer and its family, as the case may be.

The same rules apply for the dividends from, and sale of shares in, publicly traded corporations as for the dividends from, and sale of shares in, closely held corporations.

The domestic withholding tax rate applicable in the absence of a double tax treaty is as follows.

  • Dividends – dividends paid by French companies to non-resident entities are subject to a withholding tax rate equal to the standard CIT rate (ie, 26.5% for 2021). Dividends may be exempt from withholding tax under certain conditions, when the beneficial owner of the dividends is a company located in the EU, in certain EEA countries or in Switzerland.
  • Dividends paid by French companies to undertakings for collective investment in transferable securities (UCITS) located in the EU or in a state that exchanges information with France under a tax treaty or a tax information exchange agreement may also benefit from a withholding tax exemption, under certain conditions.
  • Interest – no withholding tax is levied on interest paid by French companies to non-resident entities (provided they are not paid in a bank account opened, or a person established, in an NCST).
  • Royalties – royalties paid by French companies to non-resident entities are subject to a withholding tax rate equal to the standard CIT rate (ie, 26.5% for 2021). Royalties may be exempt from withholding tax under certain conditions when the beneficial owner of the royalties is a company located in the EU.

If the payment of a dividend, interest or royalties is made to a person who is resident in an NCST or to a bank account located in an NCST, the withholding tax rate is generally increased to 75%.

The primary tax treaty country foreign investors use to make investments in French corporate stock or debt is Luxembourg.

The use of treaty country entities by non-treaty country residents may be challenged by the French tax authorities on the basis of the “abuse of law” doctrine that is applicable to the use of international tax treaty provisions (see 7.1 Overarching Anti-avoidance Provisions).

As a rule, transactions (ie, transfer of goods/assets, provision of services, royalties) between companies of the same group must be concluded under normal conditions, identical to those of the market (arm's-length principle).

If the transaction is not carried out under such conditions, the French tax authorities may refuse (i) partially or totally the deduction of the expenses by the beneficiary and consequently increase its taxable profits and/or (ii) question (partially or totally) the deductibility of the VAT paid by the beneficiaries in respect of this acquisition of goods/assets or provision of services. Transfer pricing reassessments may also give rise to deemed distributed income issues.

If the French tax authorities consider that the price is lower than the arm's-length price, they could consider that the selling company or service provider grants a subsidy to the beneficiary company and increase its taxable profit accordingly.

The French tax authorities may challenge the use of related-party limited risk distribution arrangements on the basis of the “abnormal act of management” or “abuse of law” doctrines.

For instance, in the context of an international group of companies, limited risk distribution may be used to transfer functions from a company to another one. Thus, French tax authorities may consider that the transformation of a French subsidiary from exclusive distributor to commercial independent agent may result in a transfer of customers to the foreign company and reintegrate the remuneration that the company should have received in such transfer in its taxable income. After the setting up of the arrangement, there is a risk of permanent establishment in France of the principal if the arrangement has not been set up properly and notably with sufficient substance in the jurisdiction where the principal is located.

French transfer pricing rules do not vary from OECD standards.

International transfer pricing disputes are not often resolved through mutual agreement procedures (MAPs) (statistics published in 2019 by the OECD recorded fewer than 350 cases since 2016 in France).

The right to compensating adjustments may be allowed by the French tax authorities. It is not provided for in all double tax treaties concluded by France, though. Moreover, some double tax treaties provide that the compensating adjustments will be allowed only if this adjustment is justified, or in the context of a MAP provided for in Article 25 of the OECD Model Tax Convention.

Compensating adjustments must be treated in such a way as to put the company back in the position it would have been in if the transfer prices had been determined in accordance with the arm's-length principle. They will be made for the fiscal years during which the taxable income of the company has been reassessed.

However, the French tax authorities may refuse to enter into a MAP in certain circumstances (eg, when a company is subject to serious penalties, if the taxpayer does not provide evidence of the double taxation).

As a rule, French branches of a non-resident corporation are taxed in the same way as French subsidiaries. However, given that French branches do not have a separate legal personality, specific rules may apply.

Profits realised in France by non-resident companies through French branches may be subject to a “branch tax” (ie, the French branch’s profits are deemed distributed to the shareholders who do not have their tax residence in France). The standard branch tax rate is 26.5 % (in 2021) but may be increased to 75% if the foreign entity is resident in certain NCSTs. However, the application of the French branch tax may be prevented by the provisions of an applicable double tax treaty. Furthermore, profits deemed distributed to non-resident companies located in an EU or EEA state are exempt from branch tax.

A 26.5% withholding tax may apply to a non-resident company that realises capital gains on the disposal of:

  • French real estate properties;
  • French real estate rights;
  • shares in unlisted real-estate companies; or
  • shares in real estate investment trusts.

Unless otherwise provided in a double tax treaty, a 26.5% withholding tax also applies to capital gains realised by non-resident companies on the disposal of “substantial” shareholdings (ie, representing more than 25% of the financial rights) in French companies. However, for capital gains realised by foreign companies located in certain NCSTs, the rate is increased to 75% irrespective of the percentage of financial rights held by the seller.

It must be noted that, in recent case law, the French Administrative Supreme Court ruled that the withholding tax provided for capital gains on “substantial” shareholdings did not comply with the freedom of establishment guaranteed under EU legislation (CE, 14 October 2020, No 421524, “Sté AVM International”). In addition, the Administrative Court of Appeal of Versailles ruled that the same withholding tax did not comply with the principle of free movement of capital also guaranteed under EU law (CAA Versailles, 20 October 2020, No 18VE03012, “Sté Runa Capital Fund I LP”). As a result, this withholding tax on capital gains from sales of substantial shareholdings should not be applicable any more to non-resident companies, whether located in the EU or in a third-party state.

There are generally no change of control provisions that may trigger adverse tax consequences in France.

Subject to French CFC rules, foreign-owned local affiliates that do not carry on any business in France are generally not subject to tax in France (see 1.3 Determining Residence of Incorporated Businesses).

In order to be deductible, management and administrative expenses paid by local affiliates to non-resident affiliates must (i) be incurred under normal conditions, identical to those of the market (arm's-length principle) and (ii) correspond to useful services effectively rendered by the non-resident company (which receives the payment) to the French affiliate company (which pays for services); eg, the services must not be identical to functions already performed by the president/director(s) of the company.

If the transaction is not carried out accordingly, the tax authorities may deny all or part of the deduction of the expenses. The French affiliates should be able to substantiate the services provided.

Some of the interest deduction limitations described in 2.5 Imposed Limits on Deduction of Interest apply to related-party borrowings specifically.

Please refer to 1.3 Determining Residence of Incorporated Businesses.       

Foreign income attributed to a foreign permanent establishment is not subject to French CIT; accordingly, local expenses attributed to the foreign permanent establishment are generally not deductible for French CIT purposes.

Dividends received by a French company from foreign subsidiaries are subject to French CIT at the standard rate (26.5% in 2021).

However, dividends received by a French parent company from a qualifying subsidiary (whether French or foreign) may benefit from the participation exemption regime. 95% of such dividends will be exempt from CIT (leading to an effective CIT rate of 1.325%) if certain conditions are met:

  • the shares of the subsidiary must be in registered form;
  • the parent company must be subject to CIT and hold directly shares representing at least 5% of the distributing subsidiary's share capital;
  • the parent company has held, or commits to holding, such a participation for at least two years;
  • the hybrid mismatch rules (see 2.5 Imposed Limits on Deduction of Interest) do not apply; and
  • the subsidiary is not located in an NCST.

The 5% taxable portion may be reduced to 1% for dividends paid by companies located in the EU or EEA, under certain conditions.

In order to use the intangibles developed by French companies, a foreign subsidiary has to pay royalties to the French company corresponding to an arm’s-length remuneration. If not, the French tax authorities could add back into the taxable profit of the French company an amount equal to the royalties it should have received.

Royalties received are subject to French CIT at the standard rate (unless otherwise provided under the double tax treaty or unless they are eligible for the IP Box).

When a French company subject to French CIT operates a business or holds directly or indirectly more than 50% of the shares, units, financial rights or voting rights in a subsidiary established outside of France in a state where it is subject to a favourable tax regime, the profits of the foreign branch or the foreign subsidiary are subject to CIT in France. The control threshold may be lowered to 5% in certain circumstances.

The low-tax nature of the foreign jurisdiction is assessed by reference to French CIT, and the difference must exceed 40% (ie, assuming a French CIT rate of 25%, a foreign tax rate below 15% could trigger French CFC rules).

Profits of a foreign subsidiary are treated as distributed income received by the French company (in proportion of the shares, units or financial rights it holds in the foreign subsidiary), while profits of a foreign branch are treated as French business profits of French headquarters (provided that no applicable double tax treaty provides otherwise).

Safe harbour clauses are provided:

  • for subsidiaries or branches that are located in an EU member state (provided they are not purely artificial structures intended to avoid French tax); or
  • if the company demonstrates that the main purpose and effect of the foreign subsidiary's or branch’s set-up is not to shift income in a state or territory where it is subject to a favourable tax regime.

Pursuant to the “abuse of law” doctrine (see 7.1 Overarching Anti-avoidance Provisions), the French tax authorities can disregard an entity with no substance and, accordingly, deny the benefit of certain exemptions, favourable tax regimes, deduction of interest or other payments, or the application of an international tax treaty.

A structure in which a holding company is interposed should be organised for sound commercial and economic reasons and should not be implemented solely or, in particular, to obtain a tax advantage.

French companies are subject to CIT on capital gains derived from the sale of shares in foreign subsidiaries (under the same rules as for the sale of shares in French subsidiaries – see 2.7 Capital Gains Taxation), subject to any contrary provisions under applicable double tax treaties.

Historically, French domestic tax law has had two overarching anti-avoidance mechanisms: the “abuse of law” doctrine (abus de droit) and the “mismanagement act” theory (acte anormal de gestion). Additional anti-abuse rules have been specifically introduced in relation to CIT matters and to reorganisations.

Abuse of Law (Exclusive Purpose Test)

The abuse of law principle is a general anti-abuse rule that allows the French tax authorities to disregard any legal transaction (or step thereof) on one of two grounds:

  • because it is a sham transaction (simulation); or
  • because it seeks to benefit from a literal application of the law, going against its spirit, and is exclusively motivated by the avoidance or mitigation of tax liabilities that would have been incurred had such transaction not been implemented (fraude à la loi).

Under such rules, abusive arrangements incur specific penalties of up to 80%. In turn, taxpayers benefit from a specific rights-protective procedure and the onus is on the tax authorities to prove that a given transaction is solely tax driven and has no other purpose, however insignificant.

Corporate Tax Anti-abuse Rules (Principal Purpose Test)

The new anti-abuse provisions introduced by the Finance Act for 2019, transposing Article 6 of the ATAD, seek to disregard arrangements that meet both of the following requirements: (i) they have been put in place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the purpose of the applicable tax law, and (ii) they are not genuine having regard to all relevant facts and circumstances. Unlike the general abuse of law theory, which extends to all taxes provided the exclusive purpose test is met, the new anti-abuse rule applies only to CIT but is broader in scope, targeting principally tax-driven arrangements. It does not incur the specific anti-abuse penalties of up to 80% applicable to the general abuse of law (but other standard penalties could apply).

A specific anti-abuse rule applies with respect to mergers, divisions and transfers of assets, whereby the benefit of tax neutrality can be withdrawn if a transaction pursues tax evasion or tax avoidance as its main or one of its main objectives.

Mismanagement Act

As a general rule, taxable income for CIT purposes is determined by taking into account profits and expenses resulting from transactions carried out in the taxpayer’s own interest. To this end are disregarded so-called abnormal acts of management (acte anormal de gestion), by which an enterprise decides to impoverish itself for purposes that are not in line with its corporate interest (assessed on a standalone basis, as opposed to the level of the group to which it might belong). Traditional examples include the disallowance of expenses that are not incurred for sound business reasons and the reassessment of taxable income when the taxpayer deliberately gives up a potential profit (eg, not charging rentals/interest, selling at a loss, buying at a price above market value).

There is no routine audit cycle per se, and no specific rules on the frequency of tax audits in general. Broadly, tax audits are subject to the constraints of the statute of limitations, and in the case of some taxpayers, the audit cycle may coincide with such period.

The statute of limitations in CIT matters generally expires at the end of the third calendar year following that during which the tax is due (eg, the fiscal year ending on 31 December 2021 may be audited and reassessed until 31 December 2024). By way of exception, due to the COVID-19 health crisis, fiscal year 2017 will be time-barred on 14 June 2021 (instead of 31 December 2020).

An extended ten-year statute of limitations applies in the case of undisclosed activity and this is frequently used when the tax authorities seek to establish the presence of an unreported permanent establishment in France.

Regarding Action 1 (“Address the tax challenges of the digital economy”), France has introduced a tax on digital services as a temporary measure, awaiting a multilateral solution to be reached at international level (see 9.12 Taxation of Digital Economy Businesses for further details). France also implemented a mechanism for the effective collection of VAT in respect to B2C cross-border transactions of electronic services, in line with the OECD’s International VAT/GST Guidelines.

Regarding Action 2 (“Neutralise the effects of hybrid mismatch arrangements”), ATAD 1 and ATAD 2 contain specific provisions for the neutralisation of the asymmetrical effects of such arrangements based on BEPS Action 2, which have been transposed into French domestic law by the Finance Act for 2020 (see 9.6 Proposals for Dealing with Hybrid Instruments for further details).

Regarding Action 3 (“Strengthen CFC rules”), France already has robust rules for countering the shifting of profits into low-tax jurisdictions, which were implemented prior to BEPS. No update is pending in this respect in the near term (see 9.8 CFC Proposals for further details).

Regarding Action 4 (“Limit base erosion via interest deductions and other financial payments”), the Finance Act for 2019 has revamped French interest limitation rules in line with the provisions of ATAD 1 and BEPS Action 4, notably by introducing a general deduction limitation of financial expenses, pursuant to which, net financial expenses deduction is capped at 30% of the adjusted EBITDA (see 2.5 Imposed Limits on Deduction of Interest for further details).

Regarding Action 5 (“Counter harmful tax practices more effectively”), the OECD currently considers that no harmful tax regime is present in French law.

Regarding Action 6 (“Prevent treaty abuse”), French courts have historically considered that the domestic abuse of law principle can apply to double tax treaties, even ones that do not contain a specific anti-abuse provision (see 9.9 Anti-avoidance Rules for further details). Furthermore, the OECD Multilateral Instrument (MLI) already entered into force in respect of certain tax treaties to which France is a party and anti-abuse provisions are now constantly introduced in new tax conventions negotiated by France.

Regarding Action 7 (“Preventing the artificial avoidance of permanent establishment status”), the permanent establishment definition adopted by France in its most recent double tax treaties (eg, with Luxembourg) follows the OECD’s recommendations and notably includes provisions covering commissionaire arrangements and anti-fragmentation rules.

Regarding Actions 8–10 (“Assure that transfer pricing outcomes are in line with value creation”), French tax authorities and courts apply the OECD transfer pricing guidelines and the arm’s-length principle (see 9.10 Transfer Pricing Changes for further details).

Regarding Action 12 (“Require taxpayers to disclose their aggressive tax planning arrangements”), France has transposed into domestic law the EU “DAC 6” directive, which requires intermediaries and taxpayers to report to the French tax authorities specific information on cross-border arrangements meeting certain hallmarks.

Regarding Action 13 (“Re-examine transfer pricing documentation”), country-by-country reporting requirements and master/local file filing requirements have been implemented by France (see 9.11 Transparency and Country-by-Country Reporting for further details).

Regarding Action 14 (“Make dispute resolution mechanisms more effective”), France has elected to apply the mandatory binding arbitration provided for in the MLI.

Regarding Action 15 (“Multilateral Instrument”), France has been particularly proactive on this matter and has participated in the ad hoc group that negotiated the MLI. The MLI was signed by France on 7 June 2017, ratified on 12 July 2018 and entered into effect on 1 January 2019.       

The French government has shown a positive and involved attitude towards BEPS, working consistently towards a comprehensive implementation of BEPS-related measures into domestic law and actively participating in the OECD’s international forums towards the prevention of international tax avoidance. On occasion, France has gone even further than the OECD consensus, as in the case of digital taxation (see 9.13 Digital Taxation for further details).

As a founding member of and active participant in the OECD (which is, incidentally, headquartered in Paris and has appointed a former French official as the head of its Centre for Tax Policy), France plays an important role in shaping the international tax debate on anti-avoidance, harmful tax practices and the taxation of digital multinationals. In turn, French domestic legislation is heavily influenced by the developments on the international stage and the main BEPS recommendations have already been implemented in some form or other.

The main competitive tax policies currently pursued by the French government are (i) the progressive alignment of CIT rates with the OECD average and (ii) the lowering of local business taxes levied on real estate values and turnover, which are seen as stifling economic growth and investment. Such policies should not be directly affected by BEPS, which targets an entirely different set of tax practices.

The key competitive features of the French tax system include:

  • a tax consolidation regime (with a compensation of profits and losses) for French-based groups (see 2.6 Basic Rules on Consolidated Tax Grouping);
  • carry forward of tax losses without time limitation (see 2.4 Basic Rules on Loss Relief);
  • participation-exemption regime for dividends (95% exemption – see 6.3 Taxation on Dividends from Foreign Subsidiaries) and capital gains (88% exemption – see 2.7 Capital Gains Taxation);
  • no withholding tax on interest payments to non-resident companies (NCSTs excluded – see 4.1 Withholding Taxes);
  • a generous R&D tax credit scheme to incentivise research and innovation expenditure (crédit d’impôt recherche) (see 2.2 Special Incentives for Technology Investments); and
  • a “patent box” regime, in line with the OECD’s modified nexus approach, with a preferential 10% rate for certain IP income (see 2.2 Special Incentives for Technology Investments).

As of the latest review of harmful tax practices published by the OECD in November 2020, no French tax features were singled out. The previous French preferred tax scheme for IP income had been highlighted in the 2015 BEPS Action Report on harmful tax practices but has since been amended in line with the OECD’s nexus approach.

France has transposed the provisions of ATAD 1 and ATAD 2 on hybrid instruments. As such provisions are directly derived from BEPS Action 2, French tax legislation is rather consistent with the standard contained in such action.

Interest Payment Mismatches

The provisions of ATAD 1 and ATAD 2, which deal with hybrid mismatches, have replaced the previous (rudimentary) French anti-hybrid rules (see 2.5 Imposed Limits on Deduction of Interest).

Dividend Payment Mismatches

Specific provisions deal with mismatches arising in respect of inbound dividends, which qualify for the French participation-exemption regime. Where such dividends may be tax exempt in France but deductible from the taxable income of the distributing entity (eg, mismatch in the debt/equity classification between jurisdictions), the benefit of the French participation-exemption regime is denied.

The French CIT system is based on the territoriality principle, meaning that a nexus has to be established between the French territory and any taxable income or deductible expenses (including interest charges – see 1.3 Determining Residence of Incorporated Businesses). Thus, interest expenses incurred in connection with an activity carried out outside France (eg, foreign branch of a French company) should not be taken into account for the purpose of French interest limitation rules (see 2.5 Imposed Limits on Deduction of Interest with respect to the domestic rules on interest deductibility).

While France runs a territorial tax regime (see 9.7 Territorial Tax Regime), French CFC rules are a notable exception to this principle and an important anti-avoidance tool (see 6.5 Taxation of Income of Non-local Subsidiaries Under CFC-Type Rules).

Due to their sweeping nature and the fact that they had originally established a quasi-presumption of tax avoidance and profit shifting, French CFC rules have been challenged on several occasions before the French and EU courts over the years and, as a result, been substantially amended (the last change having, however, occurred in 2014). Current CFC rules include safe harbour provisions in favour of:

  • EU entities, provided they are not purely artificial structures intended to avoid French tax; and
  • non-EU entities, if the taxpayer evidences that the main purpose of the foreign CFC is not to shift profits to the low-tax jurisdiction where it is established.

Sweeper CFC rules that would tax the profits of offshore entities regardless of their substance could prove to be harmful, contrary to EU law and would generally risk putting French-resident companies and their foreign branches/subsidiaries at a competitive disadvantage (notably on account of the increased risk of double taxation).

Even prior to the BEPS recommendations and signature of the MLI, the French tax authorities used to apply the domestic abuse of law doctrine (see 7.1 Overarching Anti-avoidance Provisions on the exclusive purpose test) to disregard cross-border arrangements deemed abusive with regard to the provisions of applicable tax treaties, such approach having been confirmed by case law even in the absence of specific anti-abuse provisions in the relevant treaty.

While the new anti-avoidance rules in the MLI are not likely to revolutionise the current interpretation of tax treaties in France, they will probably expand the scope of the tax authorities’ reclassification powers. Indeed, the new MLI anti-abuse provisions are based on a principal purpose test, as opposed to the exclusive purpose test under the French domestic rules previously applied (as in the case of the above-mentioned case law). According to the French tax authorities’ interpretation of the MLI, an analysis allowing to “reasonably” conclude as to the existence of such principal purpose would be sufficient to disallow a treaty benefit. The “reasonable” nature of the analysis is as yet undefined and will have to be tested in court, on a case-by-case basis.

The French transfer pricing regime has not been radically changed as a result of BEPS Actions 8 to 10. Indeed, French transfer pricing rules were already aligned with the arm’s-length principle and the traditional OECD methods of functional analysis and profit allocation, to which both the French tax authorities and tax courts generally adhere. For instance, recent case law on the arm’s-length interest rate between related parties (see 2.5 Imposed Limits on Deduction of Interest) has confirmed that such rate can be evidenced by any means, based on internal or external comparable transactions, in line with the OECD’s transfer pricing guidelines.

With regard to IP and intangibles, there is limited administrative guidance available, one of the main rules being that the making available of an intangible asset should be remunerated via royalties or a cost-sharing agreement. Royalties are generally set as a percentage of the company’s turnover, and case law has admitted that it can range from around 0.5% to 5%, depending on the fact pattern. Tax authorities pay a particular attention to excessive levels of royalties or the lack thereof.

France has already implemented country-by-country (CbC) reporting requirements as part of the Finance Act for 2016 and has signed on 27 January 2016 the CbC Multilateral Competent Authority Agreement, agreeing to automatically exchange information with the other signatories (currently around 88 other countries).

While the CbC threshold is set at EUR750 million turnover (which excludes 85 to 90% of multinational enterprises (MNEs) from its scope, according to the OECD) and the filing requirements are not excessively cumbersome by themselves, French taxpayers need to take into account the fact that the reported financial information could be used by tax authorities in various countries to assess the group’s transfer pricing policy and potentially readjust it. Against this background, CbC rules introduce some legal insecurity for taxpayers, which will need to ensure that data reported over various jurisdictions is consistent and comprehensive, in order to mitigate reassessment risks.

French Digital Service Tax

On 24 July 2019, France introduced a digital services tax (taxe sur les services numériques, or DST), with retroactive effect as from 1 January 2019. The DST is intended as a stopgap measure that should be replaced once an international consensus is reached (in which case, past DST liabilities could potentially give rise to a refund or offset claim for taxpayers).

In January 2021, the French government and the Biden administration indicated that negotiations would continue with a view to reaching an international agreement on the digital tax framework in the course of the year. In the meantime, the DST continues to apply, at a rate of 3%, on turnover attributable to certain digital intermediation and advertising services provided in France by companies with digital revenues exceeding EUR750 million on a worldwide basis and EUR25 million in France.

Definition of the Permanent Establishment

In a landmark decision on 11 December 2020 (Conversant/Valueclick), the French Administrative Supreme Court (Conseil d’État) ruled that the scope of the dependent agent, as defined in the France–Ireland double tax treaty (pre-BEPS and MLI), includes French companies that play a leading role in the negotiation of contracts that are formally signed by an entity based in another country. The nexus rules have thus been reinforced and so-called marketing services companies arrangements, in particular, are increasingly at risk of being reclassified as permanent establishments of the foreign-based principals.

As a member of the OECD/G20 Inclusive Framework on BEPS, France has participated in multilateral negotiations on the proposed two-pillar global solution:

  • Pillar One, focused on new nexus and profit allocation rules in favour of market jurisdictions; and
  • Pillar Two, designed to ensure that MNEs pay a minimum level of tax regardless of where they are headquartered or operate.

A study by the French Council of Economic Analysis (No 54, November 2019), commissioned by the French government to assess the effectiveness of the OECD proposals, has put forward a twofold recommendation: on one hand, to implement a worldwide minimum effective corporate tax rate, in line with Pillar Two, which is seen as a crude but effective method to reduce profit shifting and generate additional tax revenues, and on the other hand, to redesign the current proposals under Pillar One, deemed excessively complex and not sufficiently impactful.

Under domestic rules (and subject to double tax treaties), a withholding tax is applicable on the gross amount of royalties paid by a debtor carrying out an activity in France to persons or entities that do not have a permanent establishment in France. Such withholding tax is levied at the standard CIT rate (ie, 26.5% in 2021), which is increased to 75% if the payment is made in an NCST.

Outbound royalties are exempt from withholding tax if their beneficial owner is an associated company that is established in the EU and meets certain requirements (in particular, a 25% shareholding threshold), in line with the EU Interest and Royalties Directive (see 4.1 Withholding Taxes).

Most of the tax treaties signed by France eliminate or reduce the withholding tax on IP royalties.

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Trends and Developments


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Hogan Lovells (Paris) LLP has a Paris tax team that advises on the structuring and implementation of complex transactions, including mergers and acquisitions (both public and private), finance, private equity, real estate (representing investment funds or sponsors in France or involving French operations and interests) and capital markets transactions. The firm assists clients with tax audits and represents them on the tax aspects of litigation proceedings before French administrative and civil courts. It also advises clients on issues of private wealth tax management in relation to their business development. The firm's lawyers combine their legal skills with market and sector-specific knowledge in order to provide innovative tax-efficient solutions to clients across all industry sectors. In addition, to provide clients with the most comprehensive advice possible, the tax group works closely with lawyers from other practice areas in the Paris office and offices around the world. The firm would like to thank partners Xenia Legendre and Ludovic Geneston for their contribution to the chapter.

The Valueclick/Conversant Case: A Lesson on the Interpretation of Pre-BEPS Tax Treaties and the Agency PE in the Digital Age

In a landmark decision on 11 December 2020, the French Supreme Administrative Court granted France jurisdiction to tax the profits of an Irish resident company providing online advertising services to French clients, marking a new trend in the interpretation of international tax treaties and the concept of permanent establishment under pre-BEPS rules.

Introduction

The year 2020 was somewhat of a turning point in the field of digital taxation. It marked the end of a decade that saw the emergence of several major trends. First, the increasing awareness of the tax authorities and governments worldwide of the tax challenges arising from digitalisation. Second, the inception of a global collaboration to address such challenges, via the OECD’s base erosion and profit shifting package (BEPS), leading to a wide-ranging but incomplete reform of international tax treaties. And third, the recent fragmentation of the co-ordinated approach to solve digital taxation, with a proliferation of digital levies at national level, notably in France.

The Valueclick ruling of the French Supreme Administrative Court is a good example of such trends coming together. It sheds new light on the current attitude of the French courts and tax authorities with respect to the interpretation of tax treaties and the taxable nexus with France.

The Elusive Nature of Online Business and French Efforts to Tax It

It is a given that the current international tax system was primarily designed for the “bricks-and-mortar” economy and is no longer suitable when it comes to the digital businesses that have flourished over the past decades, such as the online advertisement business. France has generally been at the forefront of initiatives to redesign the old set of rules in line with the new online service economy. It has pushed for reform at European Union level, supporting a 2018 draft directive package for the introduction of a “digital” or “virtual” permanent establishment concept (based on “significant numerical presence” in a member state) and a special tax on digital services. Neither has been adopted by the EU, though.

In July 2019, France decided to unilaterally introduce a tax on digital services (taxe sur les services numériques), in response to the stalemate in negotiations at EU and OECD level. The French digital service tax is meant as a stopgap measure that should be repealed once an international consensus is reached.

Furthermore, the French tax authorities have been involved, for several years, in a tug-of-war with certain multinational companies, with a view to bring a portion of the profits derived from French customers within the remit of French corporate income tax. One of their preferred methods has been the characterisation of a permanent establishment (PE) in France, to which a portion of the multinational’s profits could be allocated and taxed.

In a recent Google case, the French tax authorities argued that Google Ireland had a “dependent agent” PE in France, within the meaning of the France–Ireland double tax treaty of 1968. They deemed that the employees of related entity Google France were, in fact, negotiating and concluding contracts in the name of Google Ireland. The French tax authorities lost both in the first instance and on appeal, as the administrative tax courts upheld a legalistic approach to the definition of “dependent agent” PE. In particular, the courts ruled out such PE on the grounds that contracts were ultimately approved by Google Ireland. Despite winning in court, Google agreed to settle the case with the French prosecutors for the record sum of EUR1 billion, which covered the reassessed tax amounts as well as related tax fraud charges.

The Google case is representative of so-called market service company (MSC) arrangements, which have been widespread in the digital sector since the 2000s. As part of such structures, an online advertising activity is deployed from abroad in a so-called market jurisdiction with the help of a local company. Usually remunerated on a cost-plus basis in respect of mere promotion and back-office services, the local company works on behalf of the foreign entity (which books the major share of the profits) and, in practice, exercises more or less extensive powers in negotiating with local clients and preparing contracts (which are then formally approved abroad).

BEPS and the Overhaul of the PE Definition

Following the 2010 Zimmer case and until recently, MSC structures, together with “commissionaire” arrangements, have been generally viewed as more or less immune to PE reclassification in France. Historically, double tax treaties concluded by France (including the one with Ireland) have closely followed the OECD Model Tax Convention. Until 2017, the OECD Model used to provide a narrow definition of the so-called agency PE (ie, the habitual exercise of the authority to conclude contracts in the name of an enterprise).

Following its post-BEPS update of 2017, the OECD Model Convention lays out an expanded definition of the dependent agent. It now includes persons that play the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise. As a result, it is widely recognised that MSC and commissionaire arrangements could no longer avoid PE status under the updated language of the Model Convention.

Signatories to the Multilateral Instrument (MLI), developed by the OECD to bring existing double tax treaties up to BEPS standards, had the option between keeping the existing PE definition or replacing it with the new one (by updating the relevant provisions in the treaties).

As a result, from the point of view of PE standards, tax treaties can be broken down into three categories:

  • post-BEPS treaties that have been designed from the start in line with the 2017 Model (such as the France-Luxembourg treaty, signed in 2018);
  • pre-BEPS treaties that have been updated by the MLI and as a result have replaced the old PE definition with the new one; and
  • other pre-BEPS treaties that have not been updated by the MLI with respect to the specific definition of dependent agent PE.

The France–Ireland tax treaty is part of the last category. Even though some of its provisions have been updated as from 1 May  2019, by operation of the MLI, Ireland has rejected any modification of the agency PE definition. The France–Ireland treaty will thus continue to apply the dependent agent PE provisions in their original 1968 state, unaltered by the MLI, for the foreseeable future (unless either country decides to denounce the treaty – a precedent was set in 2008 with the denunciation of the France–Denmark treaty by the Danish party).

While MSC and commissionaire arrangements would be unlikely to prosper under the revamped tax treaties, the question was whether they could survive unchallenged under pre-BEPS treaties such as the one with Ireland.

The French Supreme Administrative Court (Conseil d’État) has settled this question in the Valueclik decision of 11 December 2020, No 420174, which was rendered in a tax plenary session (reserved for the most important cases). The Court’s landmark ruling came as somewhat of a surprise and has since generated considerable debate in France. In a nutshell, the Court adopted a substance-over-form approach and ruled that a French company is a dependent agent PE where it decides on transactions that are merely endorsed by a foreign enterprise and thus binding on it, despite the fact the French company does not formally conclude contracts in the name of the foreign enterprise.

The Facts of the Valueclick Case

Valueclick Inc. was the US parent (“USCo”) of the Valueclick group, which carried out an online advertising business.

The group provided two main lines of services to its customers. First, an affiliated marketing service, where the online platform operated by the group allows businesses to advertise their products on third-party websites on a continuous basis. Second, an instantaneous advertising campaign service, where advertisers bid in real time to display their ads on websites that a given user is browsing, with the highest bidder winning the auction and the chance to instantaneously display the ad.

The Valueclick group played the role of intermediary between advertisers and publishers, calculating the commissions owed by the former to the latter, on the basis of views and sales generated by the ads.

Valueclick International Ltd was an Irish company (“IrishCo”) wholly owned by USCo. In 2008, IrishCo signed an IP licensing and cost-sharing agreement with USCo, receiving the right to commercially exploit the Valueclick technology in all international markets (outside North America).

The same year, Valueclick France SARL (“FrenchCo”) concluded an intra-group services agreement with IrishCo for the provision of marketing support services and administrative assistance. In consideration for such services, IrishCo agreed to remunerate FrenchCo on a cost-plus basis with an 8% mark-up.

Following a search at FrenchCo’s premises, the French tax authorities proceeded to audit the period from 2008 to 2011. Considering that IrishCo had carried out a concealed activity in France (activité occulte) via a fixed place of business/dependent agent PE (through FrenchCo), the French tax authorities applied the estimated taxation procedure (taxation d’office) and notified IrishCo with French corporate income tax reassessments amounting to EUR1.6 million (increased by 80%, as penalties for concealed activity).

The Decisions of the French Tax Courts in Valueclick

The first-instance Paris Administrative Tribunal held in favour of the tax authorities and ruled that IrishCo had a fixed place of business PE within the premises of FrenchCo, for both corporate income tax and value-added tax purposes. On appeal, the Administrative Court of Appeal overturned the lower court’s judgment and rejected the tax authorities’ claims that FrenchCo was a fixed place of business PE or dependent agent of IrishCo, discharging the latter’s tax reassessments.

The Paris Administrative Court of Appeal’s decision in March 2018 would prove to be in line with its ruling in the Google case a year later. Following a strict legal approach, the Administrative Court of Appeal considered that the formal approval of contracts abroad prevented the characterisation of a French PE. The fact that contracts were entirely negotiated in France and the client accounts managed by French employees were not deemed sufficient to change this analysis. Many criticised the decision of the Administrative Court of Appeal, highlighting the circumstances of the case and the fact that it showed hallmarks of PE avoidance. Nonetheless, it was not unreasonable to contemplate the Supreme Administrative Court ultimately upholding the same position, based notably on the Zimmer doctrine.

In a somewhat unexpected turn of events, the French Conseil d’État took the opposite view, revisiting its earlier case law, notably as regards treaty interpretation in light of subsequent OECD commentaries.

The Supreme Administrative Court deemed irrelevant the fact that FrenchCo did not formally enter into contracts in the name of IrishCo. The Court also disregarded the circumstance that IrishCo provided the template of the contracts concluded with the French advertisers and set out the general pricing conditions. Instead, the Court viewed the French entity as a dependent agent based on the fact that it chose to contract with the advertisers and carried out all of the tasks that were necessary to enter into such agreements, which IrishCo merely endorsed.

The Factual Approach to PE Status Assessment

The Court ruled with regard to Article 2§9(c) of the France–Ireland treaty, according to which a dependent agent is characterised where it “habitually exercises in that State, an authority to conclude contracts in the name of the enterprise”. As a reminder, this language is extremely common in many other pre-BEPS tax treaties, and remains relevant for those that have not been updated by the MLI (ie, France–Ireland, France–Netherlands, etc).

According to the Court’s interpretation thereof, as revealed in the opinion of the Court’s Public Rapporteur, the “authority to conclude contracts” does not necessarily mean the act of materially signing or validating the contracts and thus giving them binding force. Rather, this should be interpreted as the de facto power to decide whether the contract should be signed in the name of the foreign enterprise; in particular, under where such signature is a routine formality.

It should be stressed that, unlike the Paris Administrative Court of Appeal in the Valueclick and Google cases, the Supreme Administrative Court had never previously rejected the classification of agency PE in a situation where contracts were consistently validated on a purely formal basis. However, the Supreme Administrative Court did famously rule, in the 2010 Zimmer case, in favour of a legalistic view of the PE concept (as opposed to a fact-based approach). The decision of the Conseil d’État in the Valueclick case could therefore be seen as a departure from the strict Zimmer doctrine, in favour of a return to a more factual, substance-over-form approach.

Looking at the facts of the case from this perspective, there should be little doubt over the PE status of IrishCo. The role of FrenchCo’s employees was to prospect clients, check their creditworthiness, negotiate with them the terms of the online advertising agreements, and provide them with software technical training and invoicing assistance. IrishCo’s role was limited to providing the general terms of the contracts and the pricing grid. Its validation of contracts negotiated by FrenchCo was pure rubber-stamping (which the French tax authorities were able to evidence before the court).

Substance also must have played a role in the assessment. FrenchCo employed around 50 workers dedicated to the French market, including account managers and sales representatives. IrishCo’s headcount comprised five to seven employees, who were in charge of the group’s worldwide operations, not just the French ones.

In a nutshell, as highlighted by the Public Rapporteur, the Valueclick case was a rather extreme one, where FrenchCo was basically doing almost all of the work of the foreign enterprise.

It is interesting to note that the services agreement between IrishCo and FrenchCo stipulated that FrenchCo was not an agent of IrishCo and did not have the vested power to bind it or contract in its name. Such provisions are naturally dismissed by the courts and the tax authorities where the contractual arrangement does not reflect the genuine nature of the relationship.

The Dynamic Interpretation of Tax Treaties and Its Effects

To further substantiate its opinion, the Supreme Administrative Court has referred in its decision to the OECD commentaries under the Model Convention. In practice, it is quite common for the French courts and tax authorities to rely on the OECD commentaries as a source of “soft law” with persuasive value. However, since at least the Andritz case of 2003, the Supreme Administrative Court has upheld a so-called static interpretation of tax treaties and OECD commentaries. In other words, drawing on the OECD commentaries in order to interpret a tax treaty was allowed, provided the commentary in question pre-dated the treaty. Such static interpretation was also in line with the positions of the German and Spanish Supreme Tax Courts, recently confirmed.

In the Valueclick decision, the Conseil d’État has revised its earlier case law by expressly referring to paragraphs 33 and 32.1 of the commentaries on Article 5§5 of the OECD Model Convention (that was in force at the time of the facts). Such commentaries had been respectively added in 1977 and 2003, and were thus clearly issued after the entry into force of the France–Ireland tax treaty of 1968.

Henceforth, the French Supreme Administrative Court seems to be moving towards a so-called dynamic or “ambulatory” interpretation of tax treaties, by taking into account posterior commentaries. If such approach is confirmed in the future, it would mean that the reading of tax treaties in light of OECD commentaries by the French courts is converging with the positions of the tax courts in the USA and UK, as well as with that of the Court of Justice of the EU.

The Public Rapporteur’s opinion under the Valueclick decision sheds further light on the scope of the dynamic interpretation and its limitations. In particular, the original intention of the parties to the tax treaty cannot be inferred from subsequent commentaries (as they did not yet exist at the time of the signature). Neither can later commentaries be taken into account if they have been issued in connection with an OECD Model Convention that has been adopted after the treaty in question (eg, the new commentaries specific to the 2017 OECD Model Convention cannot be used to interpret the 1968 France–Ireland treaty).

On the other hand, where the commentary is interpretative in nature and seeks to merely clarify a concept that was already present in both the OECD Model Convention and the tax treaty in question, it is only natural to take it into account. This enables tax treaties to “live” and adapt to on-the-ground economic realities and the latest practices of multinationals, including those that the original parties to the convention could not have foreseen at the time of its signature.

The Valueclick decision is a good example of the power of such dynamic interpretation.

Paragraph 32.1 of the OECD commentary (to which the French Supreme Administrative Court referred) states that “the phrase ‘authority to conclude contracts in the name of the enterprise’ does not confine the application of the paragraph to an agent who enters into contracts literally in the name of the enterprise; the paragraph applies equally to an agent who concludes contracts which are binding on the enterprise even if those contracts are not actually in the name of the enterprise. Lack of active involvement by an enterprise in transactions may be indicative of a grant of authority to an agent.”

Paragraph 33 observes that “A person who is authorised to negotiate all elements and details of a contract in a way binding on the enterprise can be said to exercise this authority ‘in that State’, even if the contract is signed by another person in the State in which the enterprise is situated or if the first person has not formally been given a power of representation.”

The commentaries’ sharpness on such issues is a reminder that, even in the pre-BEPS world, the existing concepts and tools are less rudimentary than they might seem in hindsight, and could well suffice to quash some of the more extreme PE avoidance schemes. By adjusting its earlier rules on treaty interpretation, the Supreme Administrative Court is thus contributing to restore pre-BEPS international standards to their full effect.

This could lead, to a certain extent, to a convergence of pre- and post-BEPS interpretations of the dependent agent PE. Undoubtedly, pre-BEPS treaty provisions would never be able to reach the same anti-avoidance standards as post-BEPS ones. However, in light of subsequent OECD commentaries in particular, they could prove effective enough to tackle some of the PE avoidance schemes.

The above raises nonetheless an interesting question regarding the weight to be attributed to the intentions of the parties to the treaty – should a constructive interpretation of the France–Ireland treaty and posterior OECD commentaries by the French courts be allowed to take precedence over the fact that Ireland has expressly elected to exclude any MLI/BEPS modification of the agency PE definition in the treaty? This is where the decision of the French Supreme Administrative Court might be viewed as somewhat contradictory. Indeed, why should a subsequent commentary from the OECD be taken into account for interpretative purposes, while the undisputed current intentions of one of the parties to the treaty are ignored? According to the Public Rapporteur, Ireland’s aims in 2018 are not indicative of its intentions in 1968 (but then again, why should the OECD’s comments be?). Even more telling are his conclusions on this point – as a national jurisdiction, the French Supreme Administrative Court is not bound by the interpretation of the treaty retained by the other party and, should any double taxation arise, the mutual agreement procedure should allow mitigation of it.

Questions Left Outstanding

The Supreme Administrative Court has overturned the decision of the Paris Administrative Court of Appeal but has not definitively decided the issues at stake. Instead, it has referred the case to the same court, which will have to rule again on the facts and merits of the case, based on the principles laid down by the Supreme Administrative Court.

In particular, the Administrative Court of Appeal will have to rule on the allocation of taxable profits to IrishCo’s dependent agent PE in France. This raises transfer pricing questions, notably regarding the level of remuneration that should be paid to such agency PE. For instance, if IrishCo was able to evidence that the cost-plus 8% fee paid to FrenchCo was actually an arm’s-length remuneration, in line with its functions and risks as an agent in charge of prospecting and contract negotiation, then no additional profits would need to be allocated to FrenchCo.

As part of their reassessment, the French tax authorities had estimated the PE’s taxable income on the basis of money collected from customers on French bank accounts, after applying a fixed 80% deduction for expenses. The first-instance Administrative Tribunal had validated this approach – it remains to be seen whether the Administrative Court of Appeal will follow.

Such transfer pricing issues are bound to become more acute if PE reassessments multiply in the coming years, as a result of both BEPS-compliant treaties coming into play and pre-BEPS treaties being reinterpreted in a more extensive manner in the wake of the Valueclick case law.

Conclusion

The Valueclick case is another reminder of the difficulty in applying international tax rules designed for bricks-and-mortar companies to digital businesses. To be able to tax such online businesses in circumstances where local companies established in the market jurisdiction play an important role in the negotiation and sourcing of commercial transactions, while foreign related entities routinely approve the finalised transactions and pocket a large share of the profits, the French tax authorities increasingly seek to characterise a dependent PE where France is a market jurisdiction. While post-BEPS tax treaties generally facilitate such reclassifications, it was unclear whether they could prosper under pre-BEPS treaties, such as the one between France and Ireland.

In the Valueclick case from 11 December 2020, the French Supreme Administrative Court gives the agency PE provisions of the France–Ireland treaty their full and most extensive effect, notably by referring to OECD commentaries issued after the treaty’s entry into force, and thus breaking up with its previous position on the matter. This decision also ignores Ireland’s refusal to adopt the BEPS/MLI definition of dependent agent – what weight does this refusal carry if France is able to override it through its domestic case law?

While it represents the start of a more extensive way of tax treaty interpretation – in particular, through a substance-over-form approach – the Valueclick case does not revolutionise international taxation, nor does it signal the emergence of a digital PE concept that would allow a tax nexus to be established based solely on virtual presence in the market jurisdiction. In the end, any PE reclassification should remain extremely fact-driven, as was the case in Valueclick, where the extreme de facto powers granted to the French subsidiary, coupled with the insufficient substance of the Irish entity and its routine approval of contracts, proved sufficient grounds to justify French PE status.

Noteworthy questions remain outstanding, though, such as the profit allocation to Valueclick’s French PE. Following the Supreme Administrative Court’s decision, the case has been referred back to the Paris Administrative Court of Appeal, which should definitively rule on such issues.

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Law and Practice

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Hogan Lovells (Paris) LLP has a Paris tax team that advises on the structuring and implementation of complex transactions, including mergers and acquisitions (both public and private), finance, private equity, real estate (representing investment funds or sponsors in France or involving French operations and interests) and capital markets transactions. The firm assists clients with tax audits and represents them on the tax aspects of litigation proceedings before French administrative and civil courts. It also advises clients on issues of private wealth tax management in relation to their business development. The firm's lawyers combine their legal skills with market and sector-specific knowledge in order to provide innovative tax-efficient solutions to clients across all industry sectors. In addition, to provide clients with the most comprehensive advice possible, the tax group works closely with lawyers from other practice areas in the Paris office and offices around the world.

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Authors



Hogan Lovells (Paris) LLP has a Paris tax team that advises on the structuring and implementation of complex transactions, including mergers and acquisitions (both public and private), finance, private equity, real estate (representing investment funds or sponsors in France or involving French operations and interests) and capital markets transactions. The firm assists clients with tax audits and represents them on the tax aspects of litigation proceedings before French administrative and civil courts. It also advises clients on issues of private wealth tax management in relation to their business development. The firm's lawyers combine their legal skills with market and sector-specific knowledge in order to provide innovative tax-efficient solutions to clients across all industry sectors. In addition, to provide clients with the most comprehensive advice possible, the tax group works closely with lawyers from other practice areas in the Paris office and offices around the world. The firm would like to thank partners Xenia Legendre and Ludovic Geneston for their contribution to the chapter.

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