Paris Tax Alert. French Government presents 2014 Budget.

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1 September 2013 Paris Tax Alert. French Government presents 2014 Budget. Following French Prime Minister Jean-Marc Ayrault s concession that the break in tax increases promised by President François Hollande for 2014 will be postponed to 2015, the French Government released its 2014 Budget on 25 September Consistent with the objective of reining France s deficit, the bill includes a mix of measures aiming at reducing public expenditures as well as new taxes and new anti-avoidance rules. It also revamps the taxation regime for capital gains realised by households on the sale of securities previously introduced by the Finance Act for 2013 and gives a significant boost to the equity savings plan (plan d épargne en actions). The key measures of this 2014 Budget are summarised below. Anti-avoidance measure targeting hybrid instruments and artificial indebtedness As anticipated in our Tax Alert of 19 September 2013, the Finance bill includes an anti-avoidance measure targeting hybrid instruments and artificial indebtedness. It would create a new limitation on the deduction of interest accrued by a French company to a related enterprise, that is, broadly, an enterprise controlling the borrower, controlled by the borrower or under common control with the borrower. To retain the right to deduct such interest, the borrower would need to show, upon request from the tax authorities, that the lender is subject to tax on the interest income accrued to it in an amount at least equal to one fourth of the corporate income tax computed under standard rules. Where the lender is domiciled or established outside France, the term of the comparison is the income tax charge the lender would have borne under standard rules had it been domiciled or established in France. This condition must be satisfied in respect of the fiscal year in which the interest is accrued by the French borrower, which presumably means that an interest charge will not be allowed in deduction if the corresponding interest income is taxable to the lender, but the taxation is deferred to a subsequent taxable period. Contents Anti-avoidance measure targeting hybrid instruments and artificial indebtedness 1 New tax assessed on the gross operating profit (excédent brut d exploitation) of companies... 2 New 50% tax on high employment income... 3 Increased control on transfer pricing... 3 New taxation regime for capital gains realised by households on the sale of securities... 4 Extension of the tax regime of the equity savings plan (Plan d épargne en actions)... 5 Other measures... Error! Bookmark not defined. Subsequent process... 6 This measure is applicable to fiscal years closed as from 25 September The justification for these new rules is rather terse: interest should be allowed as a deductible expense for the borrower only if, symmetrically, it results in income subject to a minimal tax charge for the lender, thereby contributing, in Paris Tax Alert / French Government presents 2014 Budget 1

2 particular, to combating artificial indebtedness schemes. If the explanations given by the Government are not very explicit, the heading under which the new rules are presented, and their mechanics, show that two types of tax planning structures are particularly targeted: > schemes in which a French company borrows debt from an affiliated entity that is either exempt from corporate tax (such as an exempt fund) or subject to a minimal tax charge on interest income (or a deferred tax charge) because of specific rules or a very low tax rate (provided by the tax legislation of its place of residence, particularly in the case of a tax haven), the interest income so received being then paid out as dividend or exempt income. The OECD recently mentioned such a situation as one that needs to be remedied by the States in its February 2013 Addressing Base Erosion and Profit Shifting report. > schemes in which there is a mismatch in the characterisation of a hybrid instrument between France and the state of residence of the lender this is typically the case with certain jurisdictions that treat subordinated, long-dated, profit-participating debt instruments as equity, yielding exempt or low-taxed dividends, while the remuneration on the same instruments is treated as deductible interest in France. There again, the OECD report on base erosion and profit shifting describes and criticises a tax planning technique relying on a hybrid debt / equity loan structure. While there is certainly merit in cracking down on tax fraud involving abusive financing schemes, the very wide scope of the proposed rules goes certainly beyond what is required and there is a substantial risk that genuine, commercially-driven transactions will be caught in the net. Financings granted by funds, for instance, in particular FCPRs in France, to subsidiaries in which they invest would generally not satisfy the test; attention will also need to be given to certain securitisation transactions, in which the securitisation vehicle is typically not taxable on interest received (even though the investors themselves are taxed). It can be regretted that, while the government intends to go after artificial indebtedness structures, such a much broader-reaching measure is proposed rather than relying on general anti-abuse rules, which allow the tax authorities to set aside the effects of an artificial, tax-driven transaction. Also, the absence of a grand-fathering provision for debt already in place and the fact that the rules will apply to fiscal years closed as from 25 September 2013, that is, potentially including interest accrued before that date, are prejudicial to the stability of the French tax legislation. New tax assessed on the gross operating profit (excédent brut d exploitation) of companies Presented as a way to make up for the loss of revenues that will result from the cancellation of the IFA (imposition forfaitaire annuelle), to be effective as from 2014, and consistent with the originally announced decrease in the rate of French corporate income tax, the bill introduces a new tax on businesses, assessed on their excédent brut d exploitation (a French accounting Paris Tax Alert / French Government presents 2014 Budget 2

3 position, close to EBITDA) at a rate of 1% - the decrease in the corporate income tax rate, however, is not included in the bill. This new tax would be due by companies whose turnover exceeds 50 million. For companies in a consolidated tax group, the 50 million threshold would be determined on a consolidated basis and the tax would be due by the head company. The tax would be assessed on the added-value generated by the relevant company as retained for the computation of the cotisation sur la valeur ajoutée des entreprises (CVAE), reduced by wages and salaries and other taxes due in respect of such added-value (to the exclusion of income taxes). Accordingly, financial charges and depreciation allowances (other than certain depreciation allowances in respect of leased assets) would generally not be deductible from this new tax s basis. The new tax would be payable at the same time as the balance of corporate income tax due in respect of the relevant fiscal year. It would not be deductible for corporate income tax purposes. The new tax would apply for fiscal years closing as from 31 December New 50% tax on high employment income As announced by President Hollande, the bill introduces a new temporary 50% tax on high salaries. This new tax will replace the former heavily debated 75% tax on high income earners that was found unconstitutional by the French Constitutional Council on 29 December By contrast to the former 75% tax, the tax would be borne by the employing companies rather than by their employees. It would apply on the fraction of the total amount of compensation exceeding 1 million per year and per employee. It will apply to salaries but also to certain other types of compensations such as directors fees, pension benefits, profit-sharing agreements and other stock based incentives such as stock options and free shares. The tax would be temporary and would only apply to compensations paid in respect of 2013 and The new tax would be capped at 5% of the relevant company s turnover realised during the year in respect of which the tax is due. The tax will have to be declared and paid no later than 30 April of the year following that in respect of which it is due. Increased control on transfer pricing Following the publication of an internal report evaluating France s transfer pricing rules against those of its major OECD trading partners, which found the French rules too lax, the French government announced on 6 June 2013 plans to match current higher international standards. A first step has been achieved with the inclusion, in the draft legislation on tax fraud and major economic and finance crimes currently pending before Paris Tax Alert / French Government presents 2014 Budget 3

4 Parliament, of mandatory transfer pricing documentation rules for large corporations. The 2014 Budget takes a further step in this direction by shifting the burden of proof on taxpayers in situations involving so-called business restructurings. The new measure would apply where: (i) a French entity transfers one or more function or risk to (a) a related party, or (b) an entity located in a lowtax jurisdiction (i.e. subject in this jurisdiction to a corporate income tax charge lower than 50% of the corresponding French taxation), or (c) an entity located in a so-called non cooperative jurisdiction ; and (ii) the French entity s gross operating profit (excédent brut d exploitation) for one of the two fiscal periods following the transfer is reduced by more than 20% as compared to its average gross operating profit for the three fiscal periods preceding the transfer. In such situations, the transferring entity would be required to demonstrate that it has received an arm s length compensation for the transfer, by providing, upon request from the French tax authorities, appropriate information to determine the income made before and after the transfer by all the parties to the transfer. The French tax authorities would otherwise be entitled to tax the arm s length profit which should have been left with the French transferor. This new measure is drafted in very broad terms and would apply irrespective of the size of the transferor, the nature of the transfer, or the localisation of the transferee (in France or abroad). It would not be applicable to the transfer or concession of an individual asset, without any transfer of risk or function. However, to the extent that the concepts of risk and function are economic terms, not defined in the French tax code, it may be difficult, in practice, to draw a line between the two situations. This new measure would apply to fiscal years closed as from 31 December 2013, that is including fiscal New taxation regime for capital gains realised by households on the sale of securities The taxation of capital gains realised by households on the sale of securities was completely overhauled by the 2013 Finance Act. Pursuant to the 2013 Finance Act, such gains are currently generally subject to the progressive income tax rates (up to 45%) but may benefit from a progressive exemption depending on the holding period of the relevant securities (from 20% up to 40% after a 6-year holding period). A favourable tax regime was also introduced in order to reduce such taxation to a flat rate of 19% for entrepreneurs meeting certain conditions. Following severe criticism of this reform, President Hollande announced on 29 April 2013 further changes to the taxation of the capital gains realised by individuals. Under the new legislation, the capital gains derived from the sale of eligible securities (in particular shares) would remain taxable at the progressive tax rates but would benefit from the following progressive exemptions: Paris Tax Alert / French Government presents 2014 Budget 4

5 > 50% of the capital gain would be exempt between two and eight years of holding (vs. 20% to 40% in the current legislation); > 65% of the capital gain would be exempt after eight years of holding. These progressive exemptions may be increased in certain specific situations as follows: > 50% of the capital gain would be exempt between one and four years of holding; > 65% of the capital gain would be exempt between four and eight years of holding; > 85% of the capital gains would be exempt after eight years of holding. The benefit of these increased rates of exemption would be subject, in particular, to the condition that the company whose securities are being sold is a small or medium-sized enterprise (SME), with less than 10 years of existence, subject to corporate income tax, which carries on a commercial, industrial, professional or farming activity (other than the management of its own real estate property or investments in securities). This regime would also apply to certain intra-family transfers and to sales of stakes in SMEs by retiring managers. The new legislation would be applicable to capital gains realised as from 1 January 2013, to the exception of the capital gains that would be (totally or partially) exempted under the current legislation, which would then be subject to the new legislation only as from 1 January Taxation of Gains distributed by French Funds The capital gains tax regime would be applicable to capital gains distributed to French resident individuals by French funds, possibly with the benefit of the 50% and 65% rebates where the fund has been invested for at least 75% of its assets into shares and the required holding periods have been satisfied. More worryingly, the Finance bill provides for a 30% withholding tax on distributions of gains of French source by French funds to non resident investors. This would create a tax leakage whereas such leakage only arises for shareholdings above 25% in case of direct investment or generally does not arise in case of investments through non-french funds. It would thus put at a disadvantage French funds when compared to other forms of investments. Extension of the tax regime of the equity savings plan (Plan d épargne en actions) Equity savings plans (plans d épargne en actions or PEA ) allow a taxpayer to benefit from a tax exemption on dividends or capital gains derived from qualifying portfolio investments, to the extent that the taxpayer does not withdraw his or her investment from the plan during a 5-year period. Paris Tax Alert / French Government presents 2014 Budget 5

6 Under the current legislation, the external funding of a PEA is limited to 132,000 and the funds invested in the PEA must only be used to purchase qualifying equities. Under the new legislation, the 132,000 ceiling would be increased to 150,000 and an additional PEA would be created in order to invest, up to 75,000, in the acquisition of shares in SMEs. Other measures The Finance bill includes other notable measures, among which: > changes to the capital gains tax regime for immovable properties; > the possibility offered to local authorities (conseil généraux) to increase the rate of the registration duties levied on transfers of immovable properties from 3.80% to up to 4.50% (which would bring the aggregate rate on the transfers from 5.09% currently to 5.81%); > changes to the favourable tax regime applicable to certain social and productive investments made overseas (régime de défiscalisation des investissements productifs et des logements sociaux outre-mer, Dispositif Girardin ). Subsequent process The Finance bill released by the Government has been submitted to the French Assemblée nationale, which will review and amend it as from 15 October 2013, before passing it on to the Senate, and subsequent reviews of both chambers are to be expected until a common draft is adopted and voted into law, probably in mid-december. Paris Tax Alert / French Government presents 2014 Budget 6

7 Contacts For further information please contact: Edouard Chapellier Tax Partner (+33) (0) Thomas Perrot Tax Partner (+33) (0) Authors: Edouard Chapellier, Thomas Perrot This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2013 Please refer to for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters and for other marketing and business communications. We use your contact details for our own internal purposes only. You have a right of access to, and rectification of, all information relating to you. Should you wish to exercise these rights, please let us know by ing us at marketing.paris@linklaters.com. If you no longer wish to receive this newsletter or other marketing communications or if you wish to be removed from the list, please let us know by ing us at marketing.paris@linklaters.com. Linklaters LLP is a limited liability partnership registered in England and Wales with registered number OC The term partner in relation to Linklaters LLP is used to refer to a member of the LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP and of the non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on 25 rue de Marignan Paris Telephone (+33) Facsimile (+33) Linklaters.com Paris Tax Alert / French Government presents 2014 Budget 7 A /0.15/26 Sep 2013

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