1. France Establishes Its Own List of Non-Cooperative Countries or Territories

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1 Number February 2010 Client Alert Latham & Watkins Tax Department France Reinforces its Set of Tax Measures Against Non-Cooperative States All exchanges are likely to be affected by this very coercive set of rules. Implementing the recommendations resulting from the G20 summits held in 2009 in a context of deep international crisis, France has reinforced its set of measures aiming at fighting against tax fraud and evasion with the corrective finance law for The new legislation targets transactions made by French residents with countries or territories qualified as non-cooperative, i.e., those countries which do not apply international standards of transparency in tax matters. All exchanges are likely to be affected by this very coercive set of rules which creates in particular an increase in taxation to the detriment of recipients of French source revenues located in non-cooperative countries or territories (NCCT). The text also limits the deductibility of sums paid by French operators to such persons. Furthermore, the holding of stakes by French companies in entities located in NCCTs is also penalized. 1. France Establishes Its Own List of Non-Cooperative Countries or Territories The initial list of NCCTs targeted by the new set of rules corresponds to the one established by the Organisation for Economic Co-Operation and Development (OECD), except for those countries which, as of January 1, 2010, had signed with France an agreement on mutual administrative assistance providing for an exchange of information on tax matters. This list, which was published on February 17, , proves to be very limited. Only eighteen States and territories are mentioned, mainly Caribbean and Pacific islands as well as some Central America States (see list on page 7). Based on the OECD works, this list stands only for It will be updated every January 1 by ministerial order. Countries and territories that sign an agreement on mutual administrative assistance with France in the interim will be withdrawn from the list. On the contrary, countries and territories which signed an agreement but did not comply with their transparency commitments will be added to the list. Lastly, countries and territories to which France had proposed to open negotiations before January 1 of the previous year will also be added to the list if such offer had no effect. For all other countries, their withdrawal or addition to the list will be based on OECD works. The initial list for 2010 does not include any member of the European Union (EU), such as Luxembourg. According to the French government, as of 2011, the text of the law should allow for the inclusion of EU Member States that prove to be Latham & Watkins operates as a limited liability partnership worldwide with affiliated limited liability partnerships conducting the practice in the United Kingdom, France and Italy and affiliated partnerships conducting the practice in Hong Kong and Japan. Under New York s Code of Professional Responsibility, portions of this communication contain attorney advertising. Prior results do not guarantee a similar outcome. Results depend upon a variety of factors unique to each representation. Please direct all inquiries regarding our conduct under New York s Disciplinary Rules to Latham & Watkins LLP, 885 Third Avenue, New York, NY , Phone: Copyright 2010 Latham & Watkins. All Rights Reserved.

2 non-cooperative. However, during the debates before the French Parliament, the Minister of the Economy did not support the amendments which would have avoided any ambiguity on this issue and the inclusion of an EU country or territory would in any case probably not be compatible with EU law. Finally, it is expressly provided that the States which will have signed agreements as of January 1, 2010 but will not have ratified them as of January 1, 2011 will be included into the list applicable as of Switzerland may be concerned if the ratification process of the agreement on mutual administrative assistance entered into with France, recently resumed, is not completed before the end of The Beneficiaries of French Source Income Paid Into NCCTs Will Be Subject to a Withholding Tax at a Rate of 50 Percent as of March 1, 2010 As a preliminary remark, it should be noted that the withholding tax (WHT) at a rate of 50 percent on French source income referred to hereinafter may only be levied subject to more favorable provisions of applicable tax treaties and/ or EU tax law. The protection of tax treaties or EU tax law should however remain limited to the very rare situations where the NCCT has signed a tax treaty with France or is located within the EU. The withholding tax on French interest paid into NCCTs will increase to 50 From March 1, 2010, the scope of the WHT on French source interest and like revenues paid to non-residents will be limited to interest and revenues paid into NCCTs, but its rate will be increased to 50 percent (instead of a current rate of 18 percent). Interest paid to beneficiaries located in a cooperative state will thus no longer from this same date be subject to any French WHT. - Notion of payment into a NCCT: The WHT will only be applicable to income and revenues ( ) paid out of France into a non-cooperative country or territory. The French legislator has not mentioned which payment had to be considered, although it is a crucial criterion for purpose of determining whether the WHT is due. A ruling issued by the French Tax Administration on February 18, specifies however that the payment to be considered is the direct payment made by the French paying agent (the last French paying agent in case of a payment chain in France) (i) to an account opened in the books of a financial institution located in a NCCT or, (ii) in the absence of payment to an account, to a person located or established in such a NCCT. In a case of payment to an account the most usual situation the sole relevant fact will therefore be the location of the financial institution (representative office or branch of a financial institution, ) in the books of which the account is opened and not the location of the effective beneficiary, whether an individual or an entity, of the relevant income or revenues. - Safeguard clause: Cognizant of the necessity not to penalize the market transactions made in France (in particular bond issues), the French government has created a safeguard clause. The latter provides that any interest paid into a NCCT will not be subject to the WHT if the borrower is able to demonstrate that the main purpose and effect of the transaction at hand was not to locate revenues in a NCCT. The drafting of this clause, which requires the proof of a non-fiscal effect, does not provide an absolute guarantee. The aforementioned ruling however creates a presumption of non-fiscal purpose and effect for (i) debt securities offered within the frame of a public offer or an equivalent offer realized in a cooperative State, (ii) debt securities listed on a French or foreign regulated market or multilateral trading system which is neither located in a NCCT nor 2 Number February 2010

3 managed by a company located in a NCCT and (iii) debt securities admitted, upon issue, to the operations of a French or foreign central depository or operator of a securities settlement system which is not located in a NCCT. The safeguard clause should thus cover almost all market transactions but does not address syndicated loans. However, for these latter transactions, the inclusion into the bank documentation of a provision requiring that the interest be paid to an account opened in the books of a financial institution located in a cooperative State should enable to avoid the WHT on interest. - Grandfather clause: As a counterpart to the limitation of the scope of the WHT to the sole French income source interest and like revenues paid into NCCTs, the WHT exemption previously available, under certain conditions, to interest and revenue related to loans contracted outside of France by French companies or securitization organisms 4 is abolished. It is, however, maintained for loans which have been entered into before March 1, 2010 (and the maturity date of which has not been extended from this date). Interest paid in this respect will still continue to benefit from the WHT exemption under ordinary conditions and for the whole period of the loan, regardless of the interest beneficiaries. The aforementioned ruling has specified in this respect that the WHT exemption will be applicable to sums drawn down after March 1, 2010 with respect to credit facilities contracted before this date, within the limit of the maximum amount initially agreed upon. This grandfather clause has also been extended to loans contracted after March 1, 2010 but fungible with a loan entered into before this date. According to the aforementioned ruling, this provision concerns the issues of debt securities which have characteristics similar to debt securities already issued and thus regarded as fungible ( assimilable ) with the initial issue. The ruling also specifies that when a loan entered into before March 1, 2010 is novated after this date by a change of creditor or debtor within the meaning set forth under article 1271 of the French Civil Code or any other equivalent foreign law provision, the novated loan remains fungible with the loan initially entered into for the application of the grandfather clause, provided that the novation does not modify the main characteristics of the initial loan and, in particular, that it does not extend its maturity. Distributions paid by French companies into a NCCT will be subject to a WHT at a rate of 50 Dividends and other distributions paid by French companies to non-resident shareholders are in principle subject to a WHT at a rate of 25 percent 5, subject to more favorable provisions in tax treaties entered into by France. The new set of rules increases the WHT rate to 50 percent when these revenues are paid into a NCCT, as of March 1, No safeguard clause similar to the one created for the payment of interest is included. The increased rate of 50 percent should also be applicable to income that the French tax legislation qualifies as deemed distributions for tax purposes. This is in particular the case for sums that are divested by a company but that must be reinstated into its taxable result pursuant to a specific tax provision prohibiting their tax deductibility. It must be noted in this respect that the new set of rules provides for a general principle of non-deductibility of the sums paid or due by French companies to persons located in a NCCT (see below, section 3). This prohibition, though moderated by a safeguard clause, could in some cases result in a triple penalization of the flows towards NCCTs: (i) application of a 50 percent WHT at the time of the payment of such sums, (ii) reinstatement of these sums into the taxable basis of the French debtor company and (iii) application of another 50 percent WHT on the deemed 3 Number February 2010

4 distribution corresponding to the reinstatement. This sanction would thus be very detrimental and a clarification from the French Tax Administration on this issue would be welcome. Capital gains realized in France by persons located in a NCCT will be subject to a WHT at a rate of 50 - French real estate capital gains: French real estate capital gains realized occasionally by non-residents, including capital gains on the shares of company the assets of which are mainly composed of French real estate, are in principle subject to a WHT at a rate of This rate is reduced to 19 percent for the sale of shares of REITs or of other listed real estate companies realized by companies resident in the EU, Iceland or Norway 6. As of March 1, 2010, the rate of the WHT on French real estate capital gains realized by sellers located in a NCCT will increase to 50 - Capital gains on the sale of shares: Until now, non-resident shareholders were exempt from taxes on capital gains realized on the sale of shares issued by French companies subject to corporate income tax. Apart from the above mentioned case of capital gains realized on the sale of shares of real estate companies, the only exception to this exemption principle applied to capital gains realized on the sale of significant shareholdings. Indeed, subject to more favorable provisions of tax treaties entered into by France, capital gains on the sale of shares in a French company subject to corporate income tax were only treated as a French source income when the seller had held more than 25 percent of the financial rights of such French company at any time during the five years preceding the sale. The gain was then taxed by means of a 18 percent WHT. As of March 1, 2010, capital gains on the sale of shares in French companies subject to corporate income tax will be treated as French source income, regardless of the level of shareholdings held by the seller. These capital gains will be subject to a 50 percent WHT when the seller is located in a NCCT. No safeguard clause is included for this provision. This extension of the scope of the WHT could result in the taxation in France of some investment structures which, to date, avoided such French tax, in particular those organized under the form of French or foreign transparent funds for which the unit holders of the funds were protected by the absence of significant shareholdings in the French underlying company. When the seller is located in a cooperative state, the current set of rules, i.e., a 18 percent WHT only in the case of a significant shareholding, will be maintained. French source royalties and other remunerations for services paid to persons located in NCCTs will be subject to a WHT at a rate of 50 Subject to more favorable provisions in tax treaties, non-residents without permanent professional installation in France are subject to a WHT at a rate of percent on the following French source income: (i) sums paid in remuneration for any services performed or used in France; (ii) nonsalaried income paid in remuneration for a professional activity carried-out in France and treated as non-commercial profit for tax purposes; and (iii) revenues derived from industrial or commercial property or from similar rights (Article 182 B of the French Tax Code (FTC)). Remunerations paid in consideration for artistic or sports services performed or used in France are subject to a WHT at the specific rate of 15 As of March 1, 2010, the sums paid to persons located in NCCTs in the form of royalties or as a consideration for any services, including artistic and sports services, will be subject to an increased WHT rate of 50 4 Number February 2010

5 This increased rate will not be applicable if the debtor is able to demonstrate that the payments are made in consideration for genuine transactions, the main purpose and effect of which is not to locate these sums in a NCCT. However, the safeguard clause is not available for income treated as non-commercial profit from a French tax standpoint or derived from industrial or commercial property. 3. The Deductibility of Sums Paid Into NCCTs Is Limited for Fiscal Years Beginning January 1, 2011 Interest, royalties and remunerations for services paid or due to persons located or established in a NCCT will be tax deductible at the level of the French debtor only if the latter is able to demonstrate that these sums (i) represent normal consideration for genuine transactions and (ii) the main purpose and effect of the transactions was not to locate expenses in a NCCT. Income paid on an account managed in a financial institution established in a NCCT will also be affected by this set of rules, regardless of the location of the beneficiary. Every fiscal year, a detailed statement of these expenses will be included in the company s corporate income tax return. The non tax deductibility of such sums is all the more detrimental as these sums will most likely be qualified as deemed distributions, thus attracting the 50 percent WHT on distributions into NCCTs. This could also lead for certain income, as mentioned above, to the application of a double WHT (see above, section 2). In addition, the use of the location of the creditor of the payments as a criterion (regardless of the effective location of the payments) could prove to be penalizing for the debtor, in particular in the case of syndicated loans. Indeed, the borrower could find itself being the debtor of a WHT in a case of a transfer of the loan by a lender located in a cooperative country or territory to a lender located in a NCCT, even though this transfer may have taken place without the debtor being aware. It must however be noted that the presumption of non-fiscal purpose and effect created by the aforementioned ruling for certain debt securities (see above, section 2) will also be applicable for purpose of the deductibility of the relevant sums. For these debt securities, only the demonstration that the sums represent normal consideration for genuine transactions will therefore be required. In addition, interest which will continue to benefit from the WHT exemption pursuant to the grandfather clause (see above, section 2), i.e., interest from loans contracted before March 1, 2010 and loans entered into after March 1, 2010 but fungible with contracts entered into before this date, do not fall within the scope of this new set of rules. Thus, they will remain deductible for tax purposes under ordinary conditions, even after January 1, The Holding by French Companies of Stakes in Entities Established in a NCCT Is Penalized The participation exemption regime will no longer apply to dividends received from subsidiaries located in a NCCT for fiscal years beginning January 1, The French participation exemption regime currently provides, subject to certain conditions, for a quasi-exemption for dividends received from subsidiaries. Only a lump sum equal to 5 percent of the gross dividends is taxed at the ordinary corporate income tax rate, resulting in an effective tax rate of 1.72 This exemption regime will no longer apply to dividends received by French companies from their subsidiaries located in NCCTs. For fiscal years beginning January 1, 2011, these dividends will be subject to the ordinary corporate income tax rate, a currently effective rate of 34.43%. 5 Number February 2010

6 The long-term capital gains and losses regime will cease to apply in the case of sales of shareholdings in subsidiaries located in NCCTs for fiscal years beginning January 1, The capital gains realized on the sale of qualifying shares held for at least two years are currently exempt, subject to the taxation at the ordinary corporate income tax rate of a 5 percent lump sum, resulting in an effective tax rate of 1.72 This regime will no longer be available for capital gains realized on the sale of shares of companies located in NCCTs for fiscal years beginning January 1, These capital gains will be treated as short-term capital gains and subject to corporate income tax at the ordinary rate. Capital losses realized on the sale of such shares will not be deductible from the taxable result subject to the ordinary corporate income tax rate, but only offsetable against capital gains of the same nature. The CFC rules provided for by article 209 B of the FTC are reinforced as of January Article 209 B of the FTC aims at preventing structures by which a French company locates all or part of its profits in a legal entity located in a tax haven. This text enables a tax consolidation of the losses/profits made by the foreign entity with those made by the French company, by exception to the principle of territoriality normally applicable to French corporate income tax. The safeguard clause provided for by article 209 B of the FTC, which prevents this consolidation when the foreign entity has a local effective industrial and commercial activity, is adapted in the case of location of the subsidiary in a NCCT. French companies will, however, be able to avoid the presumption of tax evasion by demonstrating that the main purpose and effect of the transactions made by the local entity is not to locate profits in a NCCT. The offset against French corporate income tax of the withholding taxes borne by the foreign entity with respect to passive income it has itself received will not be permitted if such passive income is sourced in a NCCT. It should be noted that, as of January 1, 2010, a similar set of rules applying to individuals pursuant to article 123 bis of the FTC is adapted in the same way. 5. Information and Documentary Obligations of Companies Are Reinforced For fiscal years beginning January 1, 2010, new documentary obligations relating to transfer pricing are created for large companies. The text also provides for an additional documentary obligation for any transaction made with NCCTs. 6 Number February 2010

7 Endnotes 1 Law n as of 30 December 2009, Official Journal of 31 December Order of February 12, 2010 by the Minister of the Economy, Industry and Employment and the Minister for the Budget, Public Accounts, the Civil Service and State Reform with respect to application of section 2 of Article A of the French Tax Code, Official Journal of February 17, RES n. 2010/11 (FP et FE) dated February 22, Pursuant to article 131 quater of the French Tax Code (FTC). 5 This rate is reduced to 18 percent for individual beneficiaries that are resident of the EU, Iceland and Norway. 6 This rate is reduced to 16 percent when the seller is an individual who is resident of one of these states, whether he realizes such capital gains directly or indirectly through a French tax transparent entity. If you have any questions about this Client Alert, please contact one of the authors listed below or the Latham attorney with whom you normally consult: Xavier Renard xavier.renard@lw.com Paris Olivia Rauch-Ravisé olivia.rauch-ravise@lw.com Paris Sonia Reeb-Blanluet sonia.reeb-blanluet@lw.com Paris List of the Non-Cooperative Countries and Territories as of January 1, 2010 (Ministerial Order of February 12, 2010, Official Journal of February 17, 2010) Anguilla (Caribbean) Belize (Central America) Brunei (Asia) Cook Islands (Oceania) Costa Rica (Central America) Dominica (Caribbean) Grenada (Caribbean) Guatemala (Central America) Liberia (Africa) Marshall Islands (Oceania) Montserrat (Caribbean) Nauru (Oceania) Niue (Oceania) Panama (Central America) Saint Kitts and Nevis (Caribbean) Sainte Lucia (Caribbean) Saint Vincent and the Grenadines (Caribbean) The Philippines (Asia) 7 Number February 2010

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