Executive summary

On 20 December 2018, the French Parliament approved the Finance Bill for 2019.

Except for the constitutionality review by the Conseil constitutionnel (French Constitutional Council), this Bill is final and expected to be published by 31 December 2018.

Separate from the Finance Bill for 2019, the French Prime Minister Edouard Philippe announced – during a press interview on 17 December 2018 – that a tax on digital activity would apply in France as from 1 January 2019. This new tax, which might impact major digital actors, is NOT included in the Finance Bill for 2019 and should only be discussed before the French Parliament in early 2019.

This Alert summarizes the main corporate tax provisions relating to companies in the Finance Bill.

Detailed discussion

Interest deduction limitation rules

In an effort to comply with the European Union (EU) Anti-Tax Avoidance Directive (ATAD),¹ the Finance Bill provides for the following major changes to the current French interest deductibility limitation rules:

• New general limitation: net interest expenses will be deductible from the taxable income of a company only to the extent that they do not exceed the higher of the two following thresholds: (i) €3 million or (ii) 30% of the adjusted taxable income of the company (i.e., corresponding to the taxable income before the offset of tax losses and without taking into consideration net financial expenses and – to some extent – depreciation, provisions and capital gains/losses), altogether referred to as the “regular threshold.”
• Debt-to-equity ratio: should the company be thinly capitalized and exceed a specific 1.5:1 debt-to-equity ratio (i.e., similar to the current debt-to-equity thin-cap ratio), a portion of the net interest expense, determined by application of the following ratio to the net interest expense, will be subject to the regular threshold:
  • Average amount of indebtedness towards unrelated parties + [1.5 x equity] (numerator)
  • Average amount of indebtedness (denominator)

The remaining portion of the net interest expense will be tax deductible only within the limit of the higher of the two following thresholds: (i) €1 million or (ii) 10% of the abovementioned adjusted taxable income (strengthened threshold). The portion of net interest expense that will be subject to the strengthened threshold will correspond to the difference between: (i) the total amount of net interest expense and (ii) the amount of net interest expense subject to the regular threshold in accordance with the abovementioned computation. According to a specific safe harbor provision, despite the fact that a company is thinly capitalized, it will not be subject to the strengthened threshold if the debt-to-equity ratio of the company is not higher, by more than two percentage points, than the debt-to-equity ratio of the consolidated group to which it belongs (i.e., application of the regular threshold to the total amount of net interest expense).

• Safe harbor provision: 75% of the net financial expense exceeding the regular threshold will still be tax deductible provided that the equity-to-asset ratio of the company is at least equal to, or is not lower, by more than two percentage points than the equity-to-asset ratio of the consolidated group to which it belongs. Note that this safe harbor rule does not apply in case of thin capitalization.
• Interest expense carryforwards: interest expenses that are excluded from the deductible expenses of a given fiscal year (FY) can be carried forward indefinitely (subject to the abovementioned limitations). However, the portion of net interest expense that could not be deducted by application of the strengthened threshold in the case of thin capitalization, can only benefit from the carryforward up to one-third of its amount.
• Deduction capacity carryforwards: when, for a given FY, a company does not fully utilize its deduction capacity (i.e., the amount of net interest expense is lower than the abovementioned thresholds), the unused portion of deduction capacity (i.e., amounting to the positive difference between the applicable thresholds and the net interest expenses) can be carried forward for the five following FYs. However, this deduction capacity carryforward cannot be used to deduct non-deductible interest expenses that have been carried forward. Also, if the company is thinly capitalized, the exceeding portion of the deduction capacity for the said FY cannot be carried forward.
• Reorganizations: interest expense carryforwards as well as deduction capacity carryforwards could be transferred in the case of reorganizations (e.g., mergers) if the tax ruling provided by Article 209 II of the French Tax Code (FTC) is obtained.
• Tax consolidation: the abovementioned new limitation rules will also apply at the level of French tax consolidated groups, subject to certain conditions.
• Repeal of certain current limitation rules: the 25% general reduction, the so-called Amendement Carrez (i.e., applicable upon the purchase of a new shareholding) and the three current thin-cap ratios (i.e., debt-to-equity ratio, adjusted earnings threshold and interest income threshold) are repealed.

These adjustments of the French interest deductibility limitation rules apply to FYs open as from 1 January 2019.

Adjustment of the favorable tax regime applicable to patent-related income

Currently, French corporations benefit from a reduced 15% tax rate that applies to:

• Income derived from the licensing of patents and patentable rights.
• Capital gains realized on patents and patentable rights held for at least two years, unless the disposal takes place between related companies.

The Finance Bill modifies this favorable tax regime in an effort to make it compatible with the so-called nexus approach of BEPS² Action 5, thereby conditioning its application to the actual performance by the claiming taxpayer of research and development (R&D) activities in France.

Per the Finance Bill for 2019, the favorable rate will be reduced to 10% and will apply, on an election basis only, to the net income derived from the licensing of qualifying patents, after deduction of R&D expenses, and after the application of a ratio comparing: (i) the R&D expenses incurred for the creation, or the development of the qualifying patent, either by the claiming taxpayer or by non-related parties to (ii) the total R&D expenses incurred for the creation, the development, or the acquisition of the qualifying patent. Note that this election can be performed on an asset-by-asset basis or on a group of asset basis. This election will also be available at the level of French tax consolidated groups, subject to certain requirements.

Also, should certain conditions be met, a safe harbor provision would allow election of a replacement ratio.

The same tax treatment could apply, still on an election basis, to the net income derived from the sub-licensing of qualifying patents, and to the net gains derived from the transfer, to non-related parties, of qualifying patents, provided that the latter have not been acquired less than two years before.

The favorable regime will no longer cover patentable rights (except for small and medium-sized companies under certain circumstances), but exclusively patents. Yet, it will be extended notably to copyright protected software.

This modified regime will apply to FYs open on or after 1 January 2019 (except for certain specific provisions), irrespective of the date of creation or acquisition of the qualifying patent.

Anti-hybrid provision for royalties

For FYs beginning on or after 1 January 2019, royalties paid for the licensing of intellectual property (IP) rights by a French entity to a related entity that is not a resident of an EU or European Economic Area (EEA) Member State will no longer be fully tax deductible for French Corporate Income Tax (CIT) purposes if the beneficiary entity is not subject to tax on the royalty income at an effective rate of at least 25%.

The portion of the royalty paid that should be added-back to the taxable income of the French paying entity will be determined by applying the following ratio to the total amount of the royalty payment:

i. The difference between 25% and the effective tax rate applicable to the royalties at the level of the beneficiary of the payment; (numerator)

ii. 25% (denominator)

As a consequence, should the royalties be subject to a 12.5% effective tax rate at the level of the beneficiary entity, the deduction of 50% of the royalty payment will be denied in France at the level of the paying entity.

This limitation will only apply if the tax regime applicable to the royalties at the level of the beneficiary entity is considered as harmful by the OECD.³

Also, in the case of sub-licensing, the effective tax rate will be assessed at the level of the ultimate licensor.

Adjustment of the tax consolidation regime

The Finance Bill amends the current French tax consolidation regime as follows:

1. Waivers of debts and subsidies between members of a tax consolidated group: these transactions which are currently neutralized at the tax consolidated group level will no longer benefit from such neutralization.
2. Capital gains on share transfers: the current neutralization at the tax consolidated group level of the taxable portion of capital gains on share transfers eligible to the participation exemption regime is repealed.
3. Dividends not subject to the parent-subsidiary regime: such dividends will be tax exempt up to 99% of their amount in the following cases:
   • The distribution is performed within a French tax consolidated group (i.e., these distributions are currently fully neutralized at the tax consolidated group level)
   • The dividend is distributed to a French company, by a company that is a resident for tax purposes in the EU or EEA (provided that the EEA country has concluded a treaty with France which includes a mutual assistance provision) and that could be part of a French tax consolidated group for more than one FY if it were subject to CIT in France. In the latter case, the 99% exemption applies irrespective of whether the French beneficiary is tax consolidated or not. Yet, if it is not tax consolidated, this must not result from the mere absence of option for the French tax consolidation regime while that option was technically possible.
4. At cost-transactions: the Finance Bill legalizes the ability to perform sales and provide services at cost within the same tax consolidated group.
5. Brexit consequences: in order to soften the major consequences that the Brexit will have on French tax consolidated groups, the Finance Bill provides for various mechanisms, such as:
   • The possibility to transfer shares/substitute a nonresident parent company (in the case of a horizontal consolidation) in order to prevent the termination of the French tax consolidation.
   • Postpone some of the consequences triggered by the Brexit to the closing of the FY.
6. Merger of the parent company: the merger of the parent company of a French tax consolidated group into another company belonging to the same tax group will no longer trigger the termination of the said tax group provided that certain conditions are met.
7. Conversion from one type of tax consolidation to another: it will be possible – under certain conditions – to substitute a vertical tax consolidated group to a horizontal tax consolidated group, and vice versa, without triggering the termination of the tax consolidation.

Also, in the absence of tax consolidation, the non-deductible share of expenses applicable to certain dividends that benefit from the parent-subsidiary regime will be reduced from 5% to 1%. This decrease will apply to dividends received by French companies, that are not members of a French tax consolidated group, from foreign companies that are resident for tax purposes in the EU or in the EEA (provided that the EEA country has concluded a treaty with France which includes a mutual assistance provision) and that could be part of a French tax consolidated group if they were subject to CIT in France. However, this reduced non-deductible share of expenses will only apply if the non-tax consolidation of the French beneficiary companies does not result from the mere absence of option for the French tax consolidation regime while that option was technically possible.

These adjustments of the French tax consolidation regime will apply to FYs open as from 1 January 2019 except for provisions detailed in paragraphs 5 to 7 that will apply to FYs closed as from 31 December 2018.

Implementation of the general anti-abuse provision from the EU ATAD⁴

For FYs beginning on or after 1 January 2019, a new anti-abuse provision will be applicable as a result of the transposition of article 6 of the ATAD.

Consequently, regarding the assessment of the CIT liability, no account will be taken of an arrangement or a series of arrangements which, having been put into place for the main purpose, or one of the main purposes, of obtaining a tax benefit that is contrary to the object or purpose of the applicable legal provisions, are not genuine considering all relevant facts and circumstances.

Also:

• The 80% penalty applicable under the current French GAAR regime provided by Article L 64 of the Tax Procedure Code (i.e., exclusive purpose test) will not apply to this new anti-abuse provision. However, an 80% penalty could still apply if the French Tax Authorities (FTA) demonstrate that the taxpayer committed fraudulent acts.
• A tax ruling with implicit consent from the FTA (after six months) will be available to the taxpayers for transactions performed as from 1 January 2019.
• Article 145, 6-k of the FTC (i.e., specific anti-abuse provision dedicated to the French dividend participation exemption regime will be repealed) to prevent the duplication of rules.
• This new anti-abuse provision will not apply to certain reorganizations (e.g., mergers) in order not to duplicate with Article 210-0 A, III of the FTC.

New anti-abuse provision for all other taxes than CIT

A new anti-abuse provision for all other taxes than CIT will allow the FTA to disregard acts which, by seeking to benefit from a literal application of provisions or decisions, against the initial objective sought by their authors, were driven by the main purpose of avoiding or reducing the tax burden which would have normally been borne by the taxpayers, due to their situation or their real activities, if those acts had not been entered into.

This new anti-abuse rule providing for a main tax purpose test will be applicable to transactions performed as from 1 January 2020 and subject to a tax reassessment notice issued as from 1 January 2021.

Despite the introduction of this new anti-abuse provision for all other taxes than CIT and the new ATAD derived anti-abuse provision for CIT, the current French GAAR (i.e., exclusive purpose test) is not repealed. As a consequence, the FTA will have the choice between using either the current French GAAR or – depending on the tax involved – one of the two new anti-abuse provisions to reassess a taxpayer.

Although the referral to the abuse of law Committee will be available under this new anti-abuse provision, the 80% penalty applicable under the current French GAAR regime (i.e., exclusive purpose test) will not apply. However, the FTA might apply an 80% penalty if demonstrating that the taxpayer committed fraudulent acts.

Increase of the last CIT installment to be paid by large companies

The last CIT installment⁵ due by large companies is based on a percentage of the estimated profits for the current FY (instead of the previous FY). For FYs open as from 1 January 2019, this last installment will be due on the basis of higher rates:

• 95% (instead of 80% currently) for companies with revenue over €250 million, but less than or equal to €1 billion
• 98% (instead of 90% currently) for companies with revenue over €1 billion, but less than or equal to €5 billion

The 98% rate currently applicable to companies with revenue over €5 billion remains unchanged.

Withholding tax (WHT) on domestic dividend distribution

As from 1 July 2019, the following will be deemed to be a distributed income subject to the French domestic WHT applicable on dividends: any payments of any kind, up to the portion that corresponds to a distribution of income arising from a shareholding (or an assimilated income referred to in articles 108 to 117 bis); performed, by any means, by a French resident, directly or indirectly to a nonresident, provided that the following conditions are met:

a. The payment is performed in the course of a temporary transfer of the shares/rights of the French resident or any other transaction that gives rise to a right or an obligation to resale/return these shares/rights or any rights on this shareholding.

b. The transaction is performed within less than a 45-day period, during which the right to the payment arises.

Such WHT is paid by the French paying resident upon the payment of the deemed distribution.

The beneficiary of the payment can get reimbursed of the WHT imposed provided that he can demonstrate that the payment corresponds to a transaction, the main object and effect of which are neither to avoid the application of a WHT nor to obtain a tax benefit.

Information as regards this payment will have to be filed by the French paying resident by 31 January of the year following the payment.

Elimination of double taxation

The Finance Bill for 2019 transposes into French domestic law the provisions of the Directive 2017/1852 dated 10 October 2017 as regards mechanisms to settle double taxation arising as a result of the application of double tax treaties concluded between EU Member States.

As a result, an out-of-court settlement will be available for both companies and natural persons consisting in discussions between the French and the foreign tax authorities involved. Failure for the tax authorities to reach an agreement within two years (or three years depending on the situation) will lead to the setting up of an advisory committee that will issue an arbitral decision.

This mechanism will be available as from 1 July 2019 as regards double taxation (i) derived from income received as from 1 January 2018 for natural persons; and (ii) for FYs open on or after 1 January 2018 for companies.

Repeal of the burden of proof’s reversal resulting from an abuse of law Committee decision in favor of the FTA

When a French taxpayer is reassessed on the ground of the current French GAAR, abuse of law procedure (i.e., article L.64 of the French Tax Procedure Code), the latter can choose to bring the matter in front of the abuse of law Committee. Currently when the abuse of law Committee issues a decision in favor of the FTA, the burden of proof shifts from the FTA to the taxpayer (i.e., the FTA no longer has to demonstrate that the taxpayer committed an abuse of law, but instead, it is on the taxpayer to demonstrate that he did not commit an abuse of law).

For reassessment notices issued as from 1 January 2019, this shifting of the burden of proof will be repealed except in the case of serious irregularities in the taxpayer’s bookkeeping.

Tax neutrality of share-for-share transactions benefiting from the favorable CIT regime

For FYs closed as from 31 December 2018, shares received by the contributor in exchange for his contribution in a share-for-share transaction benefiting from the French favorable CIT regime (i.e., Article 210 B of the FTC) will be deemed to have been held by the latter as from the date the contributor acquired the contributed shares.

Provision withdrawn from the initial Draft Finance Bill

Please note that the improvement of the capital gain participation exemption regime initially announced in the first draft of the Finance Bill for 2019, and commented as such in the EY Global Tax Alert issued on 25 September 2018,⁶ has not been maintained in the final version of the Finance Bill for 2019.

Endnotes

1. Article 4 of the EU Directive 2016/1164 dated 12 July 2016.

2. Base erosion and profit shifting.

3. Organisation for Economic Co-operation and Development.

4. EU Directive 2016/1164 dated 12 July 2016.

5. The last installment is equal to the difference between: (i) various rates – depending on the revenue of the companies – applied to the forecasted profits for the current FY and (ii) and the total amount of the first three installments already paid.

6. See EY Global Tax Alert, French Government releases draft Finance Bill for 2019, dated 25 September 2018.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Société d’Avocats, Paris

• Eric Verron | eric.verron@ey-avocats.com
• Xavier Dange | xavier.dange@ey-avocats.com

Ernst & Young LLP, French Tax Desk, New York

• Frédéric Vallat | frederic.vallat@ey.com
• Mathieu Pinon | mathieu.pinon1@ey.com
• Viviane Boissard | viviane.boissard@ey.com

Ernst & Young LLP, Financial Services Desk, New York

• Sarah Belin-Zerbib | sarah.belinzerbib@ey.com

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