2014 Tax aspects of US investments in France

26 March 2014

According to 2012 figures[1] published by the American Chamber of Commerce, The United States are the first investors in France since 2011. In turn,France is the second country in Europe where Americans invest, just after the United Kingdom. 1,240 American companies are carrying out business in France, and they employ over 440,000 employees. The number of jobs created in France by these investors nearly doubled every year (+46% for 2012). On the other side, over  2,500 French companies carry out business in the US, having created more than 500,000 jobs. The US is the first country where the French invest, totalling 17% of their worldwide investments. These numbers are likely to increase due to the Trans-Atlantic Free Trade Agreement which is currently negotiated between the European Union and the US.

There are various ways for a US company to invest in France. A US corporate investor may invest in France directly or through a local company with limited liability (e.g. a société à responsabilité limitée [SARL], a société anonyme (SA) or a société par actions simplifée [SAS]) or a non-resident company, or through a partnership (e.g. a société en nom collectif (SNC) or a société civile immobilière (SCI)) or through a branch. However, the preferred investment option shall be consistently determined with the individual business strategy.

Whatever the way to invest chosen, one should also take into account the French tax treaty (TT) signed with the US on august 31st, 1994,  which was modified by the following amendments:

  • On December 8th, 2004, to settle difficulties of interpretation as regards to partnerships; and
  • January 3rd, 2009, to simplify investments between France and USA (no withholding tax on royalties and dividends if conditions are met).

Taking the above into consideration, let's have a look at the various mechanisms of investment in France and their tax implications.

A. Overview of French business taxes for corporations and permanent establishments (FY 2014)

As soon as a foreign company settles in France through a subsidiary, a branch or a permanent establishment, that French enterprise is subject to the French corporate income tax (CIT) and business tax.

a.      French GAAP

According to the French commercial code, it is compulsory to register a French business with the French Registry of Commerce and Trade (“Registre du Commerce et des Sociétés”). Any enterprise registered with the Registry of Commerce and Trade should keep annual accounts. Otherwise, the French Tax Authorities (FTA) are entitled to proceed with a direct assessment without any prior tax audit.

b.      French CIT rules

i.      Taxable profits

Taxable profits are equal to the difference between the gross operating profit and incidental income,

on the one hand, and deductible costs and expenses, on the other hand.

In principle, expenses incurred by a French enterprise are fully tax deductible. However, to cope with some abuses, the French authorities put in place mechanisms to limit this tax deductibility of financial expenses:

  • Limitation of the rate interest tax deductible: Interest paid to shareholders in respect of amounts made available to the paying company are tax deductible up to the average interest rate granted by French banks in respect of variable rate loans with a duration exceeding 2 years.
  • Thin capitalization rules: Provided that the interest rate is at arm’s length, interest[2] on related party debt is fully deductible if

a)      the debt-equity ratio of 1.5 to1 is respected;

b)      the amount of “related-party” interest does not exceed 25% of the Adjusted Current Profits of the year before taxes increased by the amount of interest paid to related companies;

c)      the amount of interest received from related parties exceeds the interest subject to the thin capitalization mechanism.

When the three cumulative tests are not met simultaneously, the interest deduction is limited. The non-deductible portion of interest is added back to the taxable income of the borrowing entity but can be carried forward to be deducted during subsequent fiscal periods, within the limit of the earnings threshold mentioned above (i.e. 25% of adjusted operating profits) for the next fiscal year, bearing in mind that a 5% discount applies each year to the balance of the interest carried forward as from the second fiscal year, provided that the company files a follow-up return of the deferred interest.

The tax limitation does not apply if the non-deductible interest is less than EUR 150,000, or if the consolidated debt to equity ratio of the group is higher than that of the French company.

  • Limitation of net financial expenses tax deductible: 25% of the net financial expenses related to amounts made available to a company that is not a member of a tax consolidated group are not tax deductible and shall be added-back to the tax profits. This limitation applies only if the net amount of financial expenses is higher than EUR3m.
  • Limitation of tax deductible interest in the event of a share deal: Interest paid in relation to the acquisition by a foreign group of investment equity through entities located in France can be non-deductible if the investment is actually managed abroad i.e. the French entity shall prove that it effectively makes the decisions concerning these investments and has effective control or influence over the acquired company. The non-deductible interest is added-back for the determination of the taxable income as from the FY during which the two conditions previously mentioned must be proved and during the eight FYs following the FY of acquisition.

ii.      CIT rate

Profits (i) generated by a French corporation (such as SAS, a SA or SARL) or (ii) allocated to a French permanent establishment of a foreign corporate shareholder are subject to French corporate income tax (CIT) at a standard rate of 33.33%.

However, the effective CIT rate is:

  • 34.43% if the amount of the corporate tax is higher than EUR 763,000;
  • 36.9% if the turnover exceeds EUR 250m;
  • 38% if the corporate tax is higher than EUR 763,000 and the turnover exceeds EUR 250m. 

iii.      Use of tax losses

Tax losses can be carried forward for an unlimited period. Tax losses are to be offset against profits within the limit of one million euros, plus 50% of the profit exceeding this limit. The part of losses which could not be deducted due to this new limit can be carried forward for an unlimited period.

However, it should be noted that when a substantial change in the company's real business activity occurs, tax losses that remain to carry-forward are forfeited. As long as the real business activity of the SPV remains unchanged, carry-forward losses would not be forfeited. In case of merger, carry-forward losses may be forfeited unless the merger benefits from the favorable tax regime and a prior ruling from the French Tax Authorities for the transfer of losses is obtained.

Please note that carry-back system is also available in France: the option to carry back losses can only concern the loss for the fiscal year in respect of which the option is filed, for the amount of income declared for the prior fiscal year capped at one million euros. 

c.       Cash repatriation

i.      Capital gains on transfer of shares

Two considerations are to be taken into account:

  • When a French enterprise transfers shares booked in its account: Under the French participation-exemption regime capital gains deriving from the transfer of qualifying shares are 88% exempt from CIT provided that certain criteria are met (shares are qualified as participating shares (titres de participation) and have been held for at least 2 years). As a result, the effective tax rate applicable on the transfer of qualifying participation is 4%. Otherwise, capital gains are taxable at the standard CIT rate (33.33%).
  • When a US company transfers the shares of its French subsidiary: If the French company has assets composed at least of 50% of real property located in France (société à prépondérance immobilière), France can apply a 33.33%-WHT. If the company is not a real estate one, no French WHT applies.

 

ii.      Taxation of dividend distributed to a US company

WHT on dividend distributions: In principle, dividends are subject to a 25%- French withholding tax (WHT). A 3%-contribution is due on distributions made by French enterprises subject to CIT in France.

In the case of a branch, a Branch tax applies limited, by virtue of the TT, to 5% on profits realized by the branch. These profits are deemed to be distributed to the US. To this branch tax, a 3% surtax on deemed distribution applies.

However, US shareholders (beneficial owners) of the shareholding may benefit from a lower WHT relief under the TT where dividends are exempt from no WHT if some specific conditions are met or subject to, a 5% or 15% WHT may also apply depending on the case. Consequently, the WHT rate and the beneficiary should be checked with the TT subject to the limitation of benefit (COB) article on a case by case basis.

d.      Business tax

The Territorial Economic Contribution (TEC) is composed with two different taxes:

  • The Business Contribution on Property (BCP) which is due by the company which uses the property for the purposes of its activity. The tax is based on the rental value of the property (i.e., land, constructions and real estate fixtures) used for the purposes of the company's activities.
  • The Business Contribution on Added Value (BCAV) is due, at the rate of 1.5%, from all taxpayers performing an activity within the scope of the BCP, whose turnover exceeds €152.5k during the year in respect of which the tax is assessed. Nevertheless, companies whose turnover does not exceed €50m are entitled to benefit from tax relief. The turnover and added value to be taken into account are those generated over the last 12-month accounting period ended during the taxation year.

The TEC (i.e., BCP + BCAV) is capped at a rate fixed at 3% of the added value.

B. Settlement in France through a permanent establishment (not necessarily branch office)

According to OECD comments, a “permanent establishment” is a fixed place of business, through which the business of an enterprise is wholly or partly carried on. This implies:

  • the existence of a “place of business”, i.e. a facility such as premises or, in certain instances, machinery or equipment;
  • this place of business must be “fixed”, i.e. it must be established at a distinct place with a certain degree of permanence;
  • the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated.

However, in the absence of a fixed place of business, some US companies choose to start French (and European) operations by hiring one or several individuals with job descriptions such as “marketing representative” or “sales representative” and who would be based in France in order to help the companies carry on their business. The US companies will not necessarily rent premises in France.

In such a case, the French tax treatment will depend on the existence, in France, of a “permanent establishment” (P/E).

Example 1: French (permanent) representative

Example 1: French (permanent) representative

From a French tax perspective, a representative (with or without renting premises) may not be necessarily qualified as a permanent establishment if the representative is:

  • Legally independent from the US company i.e. does not enter into agreements with third parties in the name and on behalf of the US company;
  • Economically independent from the US company (e.g. the French Conseil d’Etat ruled on June 20th, 2003, Interhome AG that an agent was dependent in the case where (i)  it exercised its activity only through a “mandate” granted by a Swiss company, and (ii) it was insufficiently remunerated so that the Swiss company was obliged to grant it balancing subsidies); and
  • acting in the ordinary course of his business

Example 2: French permanent establishment / branch

Example 2: French permanent establishment / branch

The rental of premises in France incurs the question as to whether a taxable presence (permanent establishment) can be avoided irrespective of the existence or non-existence of employment contracts (please see above).

According to the French commercial code, it is compulsory to register a French business with the French Registry of Commerce and Trade (“Registre du Commerce et des Sociétés”) as a liaison office or a branch of a US company[1]. In principle, the registry as a liaison office does not lead to any taxation in France if OECD principles are respected. However, the French Tax Authorities could claim that there is a tax permanent establishment and tax accordingly. On the contrary, as soon as the French branch is registered in France, the French tax and GAAP requirements (cf. Paragraph A above) apply as if the P/E was a French corporation and the French corporation tax rules do apply to the branch. In such a case, the portion of profit to be allocated to that establishment must be determined in accordance with the French tax rules.

The most relevant French taxes are (i) corporation income tax and (ii) local taxes, whereas VAT should in many cases constitute a transitory item and not actually trigger a tax burden for businesses subject to it (please see the following sections for current French tax rates.)

Please note that, from a practical point of view, if the French Tax Authorities discover that an undisclosed permanent establishment exists in France, penalties up to 80% apply to the past 10 years where corporation tax was eluded. Thus, the French Tax authorities (FTA) have a hard line regarding undisclosed P/E and do not hesitate to ask for a warrant (Perquisition fiscale) to seize evidence supporting the existence of a P/E (e.g. recent cases with Google or Amazon) and engage a tax fraud procedure.

Recommendation:

In both scenarios - permanent representative or permanent establishment - it should be properly analyzed whether a taxable presence is incurred, triggering tax compliance obligations as well as potentially actual French tax charges.

To minimize potential tax exposure, it would be important to take great care of circumstances when drafting legal documentation (incl. transfer pricing documentation). For instance, depending on the precise circumstances, if an individual is being hired to take care of business relationships with customers in France, specific wording should be included in the contractual arrangements to minimize the risk that an “agency permanent establishment” is being generated. If premises such as a warehouse or premises are being rented, one should check if French establishment simply serves preparatory (auxiliary) activities in order to benefit from the French-US tax treaty protection. However, one should take into account the anti-avoidance clause contained in Article 30 of the French-US tax treaty which limits the protection of the tax treaty to certain taxpayer is when the structuring investment is directly from the US or through entities located in other jurisdictions.

Finally, as it is difficult to determine whether a permanent establishment is constituted in France, it is strongly recommended to ask for a ruling to the French Tax authorities. This allows securing the settlement in France and avoiding any tax penalties (up to 80%).

A. Settlement in France through a corporation

The principal French business entities are:

  • Joint stock companies: société anonyme (SA) or société par actions simplifée (SAS); or
  • Limited Liability Company: société à responsabilité limitée (SARL)

Usually, many investors choose to directly establish (or acquire) a SAS for their French business operations.

Example 3: French SAS subsidiary

Example 3: French SAS subsidiary

Setting up a French SAS is quite easy. It requires a share capital of only 1€. To speed up the process, investors may acquire shelf-companies.

From a corporate perspective, unlike a branch office or other permanent establishment, a SAS entity offers the benefit of a liability limited to the entity’s registered share capital, thus protecting the shareholder’s (other) assets.

For the applicable tax treatment on dividends or capital gains, please refer paragraph A above.

A. The French semi-transparency tax regime for partnership

Please note that under French tax law, there does not exist a tax transparency regime[1]. Indeed, French tax law only provides a semi-transparency regime for unlimited liability entities (SNC, SCI, GIE and general partner of SC).

The main French “partnerships” are:

  • Unlimited liability companies: Société civile immobilière (SCI- for real estate purposes) or Société en nom collectif (SNC)
  • Groupement d’intérêt économique (GIE)
  • Société en commandite (SC) is not very frequently used and is a company set up by at least a limited partner (commanditaire) and a general partner (commandité).

Partnerships are always put in place by, at least, two partners.

The taxable income is determined at the level of the company but tax is paid in the hands of the shareholders in proportion to their rights in the company. Generally, profits are determined in accordance with the French Individual Income Tax rules (i.e. the company may opt to be subject to CIT). When no option for CIT is made, profits are considered as being distributed at every FY closing (though not the case in reality) and the tax regime applicable to non-resident shareholders is, therefore, rather complex, and it is necessary to examine the relevant tax treaty in order to determine if the French WHT will be levied, either on dividends, or on income of partnership type companies.

This leads to the situation where foreign partners of a French partnership are taxable in France on any income received by the partnership, even if the partnership is not engaged in a trade or business in France. For instance, foreign source income received by foreign partners through a passive French partnership are taxable in France.

Some tax treaties (incl. the one entered into with USA) signed by France include specific provisions dealing with French and foreign partnerships. Under such provisions, which are not all drafted in the same manner, French partnerships are generally recognized as resident in France for the purposes of the tax treaty and are therefore eligible to the benefits of the treaty, provided that the partners are themselves French resident.

Example 4: French limited partnership

Example 4: French limited partnership


 

If the GIE did not opt for CIT, as one of two partners of the GIE, the US corporation will have to pay income tax in France regardless of the provisions of the French-US TT. In practice, as the profits are directly taxed in the hands of the partners, no WHT on profit distributions is applicable.

But profits from the alienation of a partnership interest may profit from Treaty protection.

A. Tax Treaty and international tax planning aspects

Some US and other investors choose to implement a European holding entity managing its European subsidiaries. Traditionally, Luxembourg has been a popular jurisdiction for interposing such entity.

However, the French tax authorities thoroughly review the substance of Luxembourg shareholders, applying anti-abuse provisions of domestic French tax laws before applying favorable tax treatment (under EU Directive or applicable tax treaties).

In this respect, please note that new Finance Bill for 2014 provides that, a borrower must be in the position to demonstrate to the FTA that interest paid in France is taxed in the lender’s country at least at a rate of at least 25% of the French CIT (i.e. an effective tax rate of at least 8.33%) that should have been paid if the lender was established in France. This anti-abuse provision[1] should be taken into account in structuring acquisitions. Comments from the FTA are awaited to clarify the scope of this tax and how it applies.

Example 5: LuxCo (SOPARFI) interposition into holding structure

Example 5: LuxCo (SOPARFI) interposition into holding structure

 

Provided the recommendation mentioned just above, to benefit from the protection of the applicable tax treaties, the LuxCo would be set up in the form of a SOPARFI (Société de Participations Financières). Such interposition is usually used in respect of:

  • real estate structuring to benefit from a double dip regarding real estate gains deriving from the transfer of the SCI shares;
  • Participating loans to benefit from an exemption from WHT on interest paid by SCI to LuxCo; or
  • Convertible Preferred Equity Certificates (i.e., debt for Luxembourg tax purposes and equity from the perspective of the investors' jurisdiction) allowing a deduction of interest expenses if they are in connection to taxable income, absence of withholding tax in Luxembourg at the level of the SOPARFI (unless the EU Savings Directive or the Luxembourg final withholding tax on interest paid to Luxembourg resident individuals apply) and potential lower taxation on return on equity at the level of the investors.

A. Final remarks

The structuring of cross-border investments in France should be consistent with business decisions and carefully scrutinized. Revised domestic tax laws and revised tax treaties shall be considered (e.g. France is trying to negotiate with Luxembourg in order to obtain a taxation of real estate gains). BEPS published by the OECD in July 2013 aims, among others, at combatting hybrid instrument and should also be considered. Indirect taxes (such as registration duties) may be significant.

This article is part of the International Tax Bulletin for April 2014.

 


[1] Application of  the OECD proposition in its report “Base Erosion and Profit Shifting”


[1] Except for (i) Company for ships co-ownership, (ii) Company for stallion/racehorse co-ownership,    and (iii) real estate condominium company (Société immobilière de copropriété) where the company is not a taxpayer and ignore as such. Shareholders of such companies are the tax payers.


[1] In case of a tax audit leading to disclose a P/E in France, it is sole case where it can exist a tax P/E without a legal P/E.


[1] 2013 figures are not yet available

[2] i.e. in case there is no limitation of the rate interest tax deductible or if the company can demonstrate that a bank would have lent money applying a same rate.

Authors