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In early 2017, the Court of Justice of the European Union (“C.J.E.U.”) issued its decision in the Euro Park Service case1, striking down a provision of French tax mandating government approval in all cross-border mergers, including those involving companies resident in other E.U. states. When major tax reform was adopted at the end of 2017, the two Amending Finance Bills dated December 29, 2017 (“Finance Bills”) introduced major changes in the French tax rules applicable to restructurings. The new rules apply as of January 1, 2018. This article explains the rules facilitating wholly domestic and cross-border mergers.
Greater Flexibility in Restructurings
- Favourable tax regime for mergers
The favourable French tax regime applicable to mergers, demergers and partial contributions of assets (“apport partiel d’actif”) between companies subject to corporate income tax (“C.I.T.”), consists of the following tax advantages:
- the merged or transferor (of shares) company is not subject to C.I.T. on capital gains generated by the transfer of assets to the absorbing or beneficiary company;
- the merging or transferee company does not report any gain or loss upon receipt of the assets of the absorbed or contributing company;
- the merging or transferee company’s basis in the assets acquired is the same basis as in the absorbed or contributing company;
- shareholders of the merged or transferor (whether companies or individuals) benefit from a tax deferral on their capital gains; and
- the transaction is subject to fixed registration duties (€375 or €500 depending on the amount of the share capital of the absorbing or recipient company) instead of registration duties at progressive rates (up to 5%).
Subject to prior approval of the French tax authorities, the existing tax losses of the absorbed company may be transferred to the merging company and carried forward indefinitely if:
- the reorganization is motivated by commercial business reasons and its main purposes are not tax purposes;
- the business generating the losses was not subject to significant changes during the loss-generating period, and the business is carried on by the absorbing company for a minimum period of three years without significant changes; and
- the losses were not generated by the management of movable assets or real property by holding companies.
- Prior law involving cross-border mergers
Under prior law, all reorganizations involving a foreign entity were subject to an advance ruling requirement under Section 210 C of the French Tax Code (“F.T.C.”) in order to benefit from the French tax deferral regime of Section 210 B.
Notwithstanding French tax law, in the Euro Park Service case, no approval was sought by the taxpayer when a French subsidiary was merged into its Luxembourg parent company. The French company did not report taxable gains realized from the transaction. Consequently, the French tax authorities treated the merger as taxable and imposed tax and penalties on the Luxembourg Parent. The basis for this position was that the French company failed to seek required prior approval before transferring its assets, and in any event, the merger was not justified by valid commercial reasons. Rather, it was carried out for tax evasion or avoidance purposes. This arguably enabled the French tax authorities to ignore the general rule of the Merger Directive. Member States are permitted to disallow tax deferral under the Merger Directive where tax evasion or tax avoidance is a principal objective of the cross-border merger.
The case was referred to the C.J.E.U. for a preliminary ruling on whether French law transposing Article 11(1)(a) of the Merger Directive was precluded by the freedom of establishment under Article 49 of the Treaty on the Functioning of the European Union. The court ruled that the French law as applied was invalid. The policy of the Merger Directive is to promote cross-border mergers by eliminating restrictions, disadvantages or distortions arising from domestic provisions. The provision relied on by the French tax authorities is an exception to the general rule and should be applied only in limited circumstances when it is clear that tax avoidance is present as a principal purpose.
- New merger regime for cross-border mergers
As of January 1, 2018, all cross-border mergers and partial contributions of a complete line of business (see the definition under Complete Line of Business, below) are eligible for this regime provided the following conditions are met:
- Record keeping
When a company is absorbed or benefits from a partial contribution of assets, the booking of the transferred assets must comply with accounting regulations applicable to all companies registered in France.
Accordingly, the asset value recorded in the accounts of the transferee company depends on (i) control at the time of the reorganization and (ii) the type of restructuring (i.e. whether the parent company is absorbing its subsidiary (“fusion à l’endroit”) or the subsidiary is absorbing its parent (“fusion à l’envers”)).
Transferred assets should be recorded at book value when the entities are placed under common control or where they are separately controlled and the reorganization is à l’envers (i.e., after the reorganization, the main shareholder of the absorbed company controls the absorbing company or the contributing company takes the control or increases its control of the beneficiary company). In contrast, transferred assets must be recorded at fair market value when the entities participating in the transaction are separately controlled and the reorganization is à l’endroit (i.e., after the reorganization, the main shareholder of the absorbing company maintains control over this company or the contributing company either loses its control over the line of business or it does not take control of the company benefitting from the contribution). As an exception to these rules, the contribution of a complete line of business must be recorded at the fair market value if an undertaking exists to sell the shares in exchange for a contribution to a separately controlled entity.
If a restructuring is undertaken between entities that have no common control before the restructuring but are held by the same individual or group of individuals, these entities are deemed to be separately controlled, and the transferred assets must thus be recorded either at the book value if the restructuring is à l’endroit or at the fair market value if the restructuring is à l’envers.
When the assets are recorded at book value, the merging or transferee company must record, in its balance sheet, the value of assets in the books of the absorbed or contributing company as well as the depreciation allowances and provisions related to these assets. In other words, the carrying value of the assets carries over from the transferor and accumulated depreciation account carries over, as well.
Under the favourable regime, current assets transferred to the absorbing entity or the entity benefitting from the contribution of a complete line of business must be recorded at their value in the books of the absorbed or contributing company. Failing this (i.e., if the current assets are registered for their market value), the profit equal to the difference between the market value and the book value is to be added to the merging or transferee company’s income.
The abovementioned record-keeping rules apply on a mandatory basis. If they are not complied with, the favourable tax deferral regime may not be applied.
- Deferred taxation
The merging or transferee company must take over the obligations of the absorbed or contributing company as to the profits that benefitted from a tax deferral and which must be added back to the taxable income subject to C.I.T.
- Capital gains on depreciable assets
The merging or transferee company must add back the capital gains related to depreciable transferred assets (i.e. the difference between the transfer value and the net book value in the absorbed or transferring company’s books) to its taxable income subject to C.I.T., in equal share over a five-year period.
- Subsequent sale of non-depreciable assets
The merging or transferee company must calculate the capital gain derived from the subsequent sale of non-depreciable transferred assets using their value in the balance sheet of the merged or transferee company (rather than their transfer value).
- Information on tax deferrals
Companies that restructure under the favourable tax regime must attach a form to their C.I.T. returns which indicates all deferred capital gains under this regime at the time of the transaction and ensures their follow-up. A register of the gains must be maintained and made available to French tax authorities upon request. Failure to comply with these rules will result in a penalty equal to 5% of the amounts omitted.
If these conditions are met, a tax ruling is now only required for a cross-border restructuring that does not involve a complete line of business. Consequently, when the partial transfer of assets involves a complete line of business, the tax deferral regime applies automatically, subject to the potential application of the new anti-abuse provision discussed in section New Anti-Abuse Provision, below.
Consequently, the French tax authorities are no longer entitled to require as a condition for granting an advance ruling that the foreign company benefitting from a transfer of shares must retain those shares for as long as the transferor company keeps shares received in exchange for the contribution. However, in order for the cross-border transaction to benefit from the favourable tax regime, the assets must be allocated to a French permanent establishment of the foreign transferee company and the French transferor company must file a specific in return.
- Record keeping
- Special conditions for cross-border transactions
Two special conditions have been introduced with respect to cross-border transactions.
- Allocation to a permanent establishment located in France
Mergers, demergers, and partial transfers of assets to a foreign company must be allocated to a French permanent establishment of the foreign company in order for the favourable tax regime to apply. All assets and liabilities that are transferred to the foreign company must be registered in the balance sheet of its French permanent establishment.
It should be noted that this requirement, in the case of partial transfer of assets, only covers transfers of a complete line of business. It does not cover a transfer that is deemed to involve a complete line of business (see the definition under Complete Line of Business, below) but does not constitute a permanent establishment.
- Specific filing
Whenever the favourable tax regime applies to a merger, demerger or partial transfer of assets to a foreign company, the French transferee or transferor company must electronically file a special return to enable the French tax authorities to understand the purpose of the transaction and its consequences.
It must provide the following information to the French tax authorities:
- the date and nature of the transaction;
- the names and addresses of the companies involved, including the address of any permanent establishment located in France of the foreign company involved as well as their financial ties before the transaction and the exact nature of the activity carried out by the foreign company;
- the motives and purposes of the transaction, in particular the improvements that are foreseen as well as the related reorganizations, if any, realized prior or after the transaction; and
- the tax and economic consequences of the transaction, in particular for activities, means and functions maintained in France or transferred abroad.
This return must be filed together with the income tax returns of the tax year during which the transaction is realized. Failure to file this specific return gives rise to a penalty of €10,000 for each transaction.
- Allocation to a permanent establishment located in France
Partial contribution of assets: three-year holding requirement repealed
Section 23 of the second Finance Bill defines a partial transfer of assets as a transaction in which a company transfers, without being dissolved, one or more lines of business (or “branches of activity”) to one or more existing or new companies, leaving at least one line of business in the transferring company, in exchange for the pro-rata issue to its shareholders of securities representing the capital of the companies receiving the assets and liabilities and, if applicable, a cash payment not exceeding 10% of the nominal value. This definition is now in line with the definition provided by the E.U. Directive 2009/133 dated October 19, 2009.
Until December 31, 2017, the tax deferral regime applied automatically to the contribution of an autonomous (or “complete”) line of business provided that the transferring company undertook (i) to hold for at least three years the shares issued by the transferee company in remuneration of this contribution and (ii) to compute the capital gain derived from the subsequent sale of the shares received by carrying over the tax value of the transferred assets in the balance sheet.
- Complete line of business
A line of business (or branch of activity) is defined by the E.U. Merger Directive as “all the assets and liabilities of a division of a company which from an organizational point of view constitute an independent business, that is to say an entity capable of functioning by its own means”.
According to French case law, the existence of a complete line of business must be ascertained both in the transferor company and the transferee company. All the component parts that are essential to the line of business must be transferred, as they exist in the transferring company according to conditions that enable the transferee company to have a durable disposal of all these elements. For example, a line of business is deemed “complete” even though ownership of the trademark or the operating premises is not transferred provided that the transferee company obtains a guaranteed right to use the trademark or the operating premises for a long-term period.
In order for the favourable tax regime to apply regarding C.I.T., the transfer must include all assets and liabilities directly or indirectly related to the line of business. For the French tax authorities, all the employment agreements must be transferred. However, the administrative Supreme Court (“Conseil d’Etat”) has held that only contracts of employees necessary for the activity to be carried out must be transferred. This determination takes into account the nature of the activity and the characteristics of the employment agreements. The Conseil d’Etat also has held that it is necessary to transfer only accounts receivable that are essential to the independent functioning of the transferor and transferee companies.
Assets and liabilities that are common to several lines of business must be allocated between these lines according to criteria that are appropriate in consideration of the nature of each element transferred, such as the turnover or the total payroll.
According to these principles, the line between the transfer of a complete line of business subject to the tax deferral regime and a simple transfer of assets which generates taxable capital gains is sometimes blurred.
Under French domestic law, a shareholding may also qualify as a complete line of business when:
- the interest represents more than 50% of the share capital of the company, provided that the transferor company does not receive a cash payment exceeding either 10% of the par value of the shares received in exchange for its contribution or the capital gain derived from the contribution,
- the transferred interest provides the beneficiary company with direct ownership of more than 30% of the voting rights when no other shareholder holds a higher interest, or
- the contribution benefits a company already holding more than 30% of the voting rights when this company thus acquires the highest percentage of voting rights of the company.
It should be noted that concurrent transfers of interests in the same company are added when determining if the 30% threshold has been met.
- New tax regime applicable to partial transfers of assets
The Finance Bill repeals the three-year holding requirement when the contributed assets qualify as a complete line of business. This is a revolution in French tax law and will facilitate both French and cross-border restructurings. However, more will be required in order for the French tax deferral regime to be fully compliant with the Merger Directive.
Capital gains derived from a subsequent sale of shares issued in consideration of a transfer still must be calculated with reference to the tax value of the assets in the balance sheet of the transferor company. This methodology is not included in the Merger Directive and appears to be contrary to its spirit. Due to this rule, the partial transfer of assets may continue to result in double taxation. First, taxation occurs at the level of the transferee company. When the contributed assets are registered at market value, the transferee company must add back to its taxable income subject to C.I.T. potential capital gains related to depreciable assets, using the market value booked as the hypothetical sales price. The gain is added back in equal shares over a five-year period. The transferee company must also compute capital gains derived from the sale of non-depreciable assets using the value they had in the books of the transferor company. Second, taxation occurs at the level of the transferor company when capital gains generated by the sale of shares issued in consideration of the transfer are computed based on costs equal to balance sheet values of the contributed assets.
However, when the transferred shares qualify as a controlling interest, double taxation can be reduced. When a controlling interest is sold after being held for two years, only 12% of the capital gain is subject to C.I.T. The starting date of this two-year holding period is unclear. It may be either the date of acquisition of the assets by the transferor company or the date of the transfer.
- Advance rulings for assets that are not a complete line of business
Where the transferred assets do not represent one or more complete lines of business, the transaction can still benefit from the favourable tax regime provided that an advance ruling is obtained from the French tax authorities. Advance rulings are granted where:
- the transaction is economically justified by a business purpose and, in particular, would (i) allow the transferee company to operate on an autonomous basis, (ii) improve the structure, or (iii) to set up an association between various parties through a commitment to keep all shares received for at least three years;
- the conditions provided by Section 210-O-A of the F.T.C. are met (in particular, the transaction does not fall within the scope of the new general anti-abuse provision and the new filing requirements introduced for cross-border transactions are met (see Prior Law Involving Cross-border Mergers, above)); and
- the transaction is structured to allow future French taxation of the deferred capital gains.
New anti-abuse provision
A new general anti-abuse provision is introduced whereby any “merger, demerger or transfer of assets having as a main purpose, or as one of its main purposes, tax fraud or avoidance” will not benefit from the favourable tax regime. The provision applies to domestic and cross-border mergers and related transactions. It is similar to the presumption of fraud or tax evasion provided in Section 15, 1-a of the E.U. Directive of 2009.
This provision emphasizes the importance of a valid business purpose. Under a new procedure, a taxpayer may request an advance ruling from French tax authorities that a proposed reorganization does not fall within the scope of the general anti-abuse provision. (see New Ruling Process, below). The reorganization or rationalization of activities carried out by the companies is considered a valid business purpose. Presumably, transactions that are initiated by outside tax advisers may have more difficulty in meeting this requirement.
Due to the existence of this anti-abuse provision, the French tax authorities may no longer be entitled to follow the special procedure for abuse of law (“abus de droit”) leading to a related penalty of 80%. since, according to Supreme Court case law, abus de droit may only be used by the French tax authorities when there is no other basis for the tax reassessment.
New ruling process
When a taxpayer wishes to ascertain whether a proposed restructuring will benefit from the favourable tax regime and is exempt from the anti-abuse provision, it may now request a formal ruling from the French tax authorities. The request must be made in writing. The request must include a detailed description of the contemplated transaction.
If a formal answer from the French tax authorities is not received within six months of the submission of the request, the transaction is deemed valid and the application of the favourable tax regime can no longer be challenged on the grounds of the anti-abuse provision.
De-mergers or split-ups
Split-ups may also benefit from the favourable tax regime provided additional conditions are met.
A split-up can be defined as a two-step transaction whereby a company (i) transfers all of its assets and liabilities (i.e. a complete line of business) to two or more existing or newly created companies (the beneficiary companies) in return for shares and then (ii) distributes the shares received in exchange for a contribution to its shareholders. A transaction of this type is often referred to as a spin-off or a split-up. According to Conseil d’Etat, shares are not deemed to be a complete line of business.
Prior to the Finance Bill, in order for the split-up to benefit automatically from the favourable tax regime, several conditions needed to be met. First, the company undergoing the split-up must have had at least two complete lines of business. Second, certain of its shareholders were required to commit to hold the shares of each transferee company for at least three years. The required holding period was applicable to shareholders holding at least 5% of the voting rights of the split-up company or shareholders holding at least 0.1% of the voting rights who were appointed as managers, directors or supervisory board members. Finally, each transferee company must have come away with one or more complete lines of business. If one of these conditions was not met, an advance ruling from the French tax authorities was required before tax-free treatment was allowed.
The Finance Bill repeals the requirement to hold the shares for at least three years when each of the transferee companies receives at least one complete line of business. When the transferred assets do not constitute a complete line of business, the distribution of shares can still benefit from the favourable tax regime provided an advance tax ruling is granted by the French tax authorities.
Conclusion
A sea change has taken place in French tax law regarding merger transactions. Among other things, mandatory rulings as to the absence of abusive tax planning were eliminated and objective standards were adopted for proper record keeping to easily allow for a retroactive review of the validity of the transaction. When comparing the new rules for cross-border mergers with the prior ruling procedures, some French tax advisers will regret the loss of certainty that was provided by the ruling procedure under the old law. Once the ruling was granted by the French tax authorities under the old law, certainty existed that the favourable tax regime applied. Now, in the absence of a ruling, uncertainty may exist concerning the application of the special tax regime when it is not clear that a complete line of business has been transferred.
1 ECJ n° C-14/16, Judgment of the Court, Euro Park Service v Minister of Finance and Public Accounts.