French Tax Update – March 2014

In this French Tax Update, we will catch up on the recent developments pertaining to two generally hot topics under French tax law: the controlled foreign companies ("CFC") rules, and the abuse of law (abus de droit, "AoL") procedure. More specifically, we will focus on recent case law affecting the CFC safe harbor rules, and on the advisory opinions issued during the last few months by the Committee in charge of AoL matters (Comité de l'Abus de Droit Fiscal, "AoL Committee"), inter alia with respect to management packages and certain financing transactions.

Recent Case Law Affecting French CFC Rules

During the last 15 months or so, French tax courts have issued various decisions that have, potentially, a significant impact on the application of the French CFC rules (article 209 B of the French tax code (Code général des impôts, "FTC")).

Basic Operation Of The French CFC Rules

The French corporate tax rules are on a strict territoriality basis, i.e., only profits generated in France are liable to tax.

Article 209 B introduces an exception to the above territoriality principle, and it may be summarized as follows:

if a French corporate taxpayer owns, directly or indirectly, more than a certain threshold (currently 50 percent) of the share capital or voting rights or financial rights of a non-French entity; and such non-French entity benefits from a so-called "privileged tax regime" in the jurisdiction where it is located (i.e., its effective tax rate in such jurisdiction is more than 50 percent lower than the effective French tax rate which would have been applicable in similar circumstances); then the French corporate taxpayer would be deemed to receive fully taxable dividends, from such non-French entity, in proportion to its participation in the latter. When the non-French entity is located within the European Union, a specific safe harbor rule applies whereby article 209 B is applicable only if the participation of the French corporate taxpayer, in the above entity, is an artificial scheme targeting the avoidance of French tax legislation.

When the non-French entity is located outside of the EU, article 209 B is disapplied if the French taxpayer can evidence that the principal purpose and effect of the operations, effected by the above entity, do not consist of a transfer of profits to a tax-privileged jurisdiction ("General Safe Harbor"). Article 209 B provides that, inter alia, such evidence is deemed to be provided when the non-French entity has, principally, an effective industrial or commercial activity in the jurisdiction where it is located ("Deemed Safe Harbor")

Case Law Interpretation Of The Safe Harbor Rules

The case law referred to, at the beginning of this section, concerns the interpretation of the above safe harbor rules, and although they relate to a period where the wording of article 209 B of the FTC was a bit different, the resulting principles are valid under the current version.

The case law refers to two different situations, both involving a French bank:

In one case, the potential CFC subsidiary, based in Guernsey, had a private banking activity; the local effective rate of taxation was about 4 percent, and, accordingly, article 209 B would have been applicable unless the safe harbor rule could protect the French bank. In the other case, the potential CFC subsidiary, based in Hong Kong, was active in the currency markets of the surrounding region; the effective taxation rate in Hong Kong was de minimis, i.e., as with the Guernsey entity, article 209 B would have been applicable if the safe harbor rule was not an effective defense. Without going into the procedural details, the cases were first decided by the lower courts, and afterward, the Supreme Court (Conseil d'Etat) voided these decisions and referred them back to the lower courts. They were finally decided in summer of 2013.

In both cases, the initial query was whether, for the purposes of the safe harbor rule, one should refer to the "purpose" or to the "effect" of incorporating the non-French...