France: Final administrative regulations under earnings stripping rules
France: Earnings stripping rules
The French tax authorities on 13 May 2020 released the guidance (BOI-IS-BASE-35-40-20200513 et seq.) regarding the new earnings stripping rules—as effective for financial years opened on or after 1 January 2019.
This report provides a discussion about the final administrative regulations under the earnings stripping rules.
The new measures implement into French domestic law the earnings stripping rules provided by the EU Anti-Tax Avoidance Directive (ATAD 1) and replace the former thin-capitalization mechanism as well as the general 25% “haircut” (rabot). In contrast to many other EU Member States, the new French limitation rules provide for a capping of the net financial charges (“NFC”) to a percentage of the “tax EBITDA” (the tax result subject to standard corporate income tax rate before interest, tax, depreciation and amortization expenses and offset of tax losses), which is either 30% or 10% for NFC due on related-party debt that exceeds 1.5 times the equity—and de minimis thresholds of €3 million and €1 million, respectively, also apply.
- An additional amount equal to 75% of the NFC in excess of the 30% tax adjusted EBITDA is deductible when the conditions of a safe harbor provision are met.
- Thin capitalized companies are subject to more restrictive rules (lower thresholds as well as stricter rules regarding the carryforward of non-deductible NFC).
- The adjusted EBITDA tests, as well as the safe harbor provisions, are assessed either at the level of the stand-alone company (when it does not belong to a tax consolidation group), or at tax consolidation group level.
Read in-depth discussion (February 2019) about the French earnings stripping rules: TaxNewsFlash
The draft comments of the French tax authorities were initially published on 31 July 2019 for public consultation. The final regulations include anticipated clarifications regarding the practicalities of the earnings stripping regime and about certain technical criteria.
The following discussion addresses the main clarifications and simplifications provided by the final regulations.
New earnings stripping regime—summary of the key steps
The key steps of the mechanism are illustrated in a chart [PDF 50 KB] prepared by KPMG Advocats.
1. Does the French entity (or tax consolidation group) fall above or below the 1:1.5 thin capitalization ratio?
Whether or not the French taxpayer (stand-alone company or tax consolidation group) is thinly capitalized determines which cap applies to the NFC—i.e. either €3 million or 30% of the adjusted tax EBITDA (standard rules) or, for NFC corresponding to related-party debt in excess of 1.5 times the equity, €1 million or 10% of the adjusted tax EBITDA (thin capitalization rule).
In addition, the carry forward of non-deductible NFC is stricter when the taxpayer (stand-alone company or tax group) is thinly capitalized. A special safe harbor clause may be available, provided the concerned taxpayer belongs to a consolidation group for financial accounting purposes (refer to the following discussion under number 2, below) and its debt-to-equity ratio is lower than the one of its financial consolidation group (see number 3, below).
2. Does the French taxpayer (stand-alone or tax consolidation group) belong to a consolidated group for financial accounting purposes?
The application of the two safe harbor provisions (a specific thin capitalization safe harbor provision and additional deduction safe harbor provision) is reserved to French taxpayers (1) belonging to a consolidation group for financial accounting purposes (either as an effect of mandatory legal provision or further to a voluntary election) or (2) as fully consolidated entities.
The French tax authorities have expressly stated that financial consolidation accounts to be taken into consideration are the ones established at the level of the ultimate consolidated company. Thus, using consolidated financial accounts determined at an intermediary level will not comply with the French requirements.
If the French taxpayer does not belong to such a financial consolidated group, it cannot benefit from either of the two safe harbor provisions. On the contrary, if it does, it can verify to what extent the safe harbor provisions can be effectively applied.
However, a specific regime has been introduced to take into account French “autonomous” companies, defined as French entities:
- Over which no company exercises an exclusive control; and
- Which do not own related entities or establishments abroad.
In this specific situation, the French tax authorities have indicated that in addition to the general rules (i.e., NFC capped to 30% of the tax EBITDA or €3 million) a “75% additional deduction” automatically applies. This automatic additional deduction leads to prevent “autonomous” companies from carrying forward the non-deductible portion of the NFC and the unused “tax EBITDA” capacity.
3. Does the “thin capitalization”-related safe harbor provision kick-in?
This provision allows the taxpayer to escape the more restrictive limitations (in particular the reduced cap of €1 million / 10% of the tax EBITDA on NFC from related-party debt) when the debt-to-equity ratio of the French taxpayer is not higher than that of the worldwide financial consolidated group to which it belongs (with a leeway of two percentage points).
4. Can the “additional 75% deduction” safe harbor provision apply?
In a last step, the “additional deduction” safe harbor provision allows the deduction of 75% of the non-deductible portion of NFC after application of the higher limitation of €3 million or 30% of the tax EBITDA when the equity to assets ratio of the French taxpayer is higher than that of the worldwide financial consolidated group (or lower by not more than two percentage points).
Requirement for consolidated financial data determined at French level
The guidance confirms that the new French earnings stripping rules require the preparation of a consolidated financial balance sheet at the level of the French tax consolidated group so as to determine whether it falls above or below the 1:1.5 thin capitalization ratio (Step 1).
In addition, specific consolidated financial balance sheets are also needed (one, at the level of the stand-alone entity or of the tax consolidation group, another at the level of the financial consolidated group but including only fully controlled entities) to allow assessment of the two safe harbor provisions (Steps 3 and 4) and to verify whether the ratios of the French entity are better than the ones of the consolidated group for financial accounting purposes to which it belongs.
In this respect, the French tax authorities have confirmed that an audit or approval by an external auditor is not necessary for the required consolidated financial information, but indicate that supporting documentation must be kept and provided on the authorities’ first request.
In any case, the “legal” consolidated accounts of the group (from which the required financial information is inferred) must be validated by an external auditor.
Acceptable international accounting standards
While the French legal provisions only refer to consolidated financial statements established in accordance with French GAAP or IFRS, the French tax authorities extended the boundaries of what are acceptable consolidated financial statements to ones established under the following international accounting standards:
- Accounting standards of the EU Member States
- US GAAP
- ASBE (Chinese accounting standards)
- K-IFRS (South Korean accounting standards)
- Canadian GAAP
- Japanese accounting standards
In the context of “Brexit,” the French tax authorities have specified that UK GAAP can still be used during the transition period. This extension is subject to validation of the consolidated financial statements by an external auditor who complies with the French equivalent professional standards.
Flexibility regarding data used for application of safe harbor provisions
In principle, the French tax authorities have admitted that the specific balance sheet data used to assess the safe harbor tests may be freely assessed:
- Either at the opening date; or
- At the closing date of the concerned financial year
The choice made by the taxpayer may be changed each financial year. However, for a given financial year, the taxpayer must use data from the same balance sheet to determine its own ratios and the consolidated group ratios.
In addition, the French tax authorities have specified that when the fiscal year (FY) closing date of a stand-alone company does not match the FY closing date of its financial consolidated group, the data used for the application of the safe harbor provisions must be extracted from the last legal consolidated accounts available at the FY closing date of the stand-alone company.
Impact of negative equity at consolidated group level
The French tax authorities also identify several situations when the negative position of the consolidated group’s equity presumes the application of the “thin capitalization” safe harbor provisions.
No withholding tax on non-deductible portion of net financial charges
On a last note, the French tax authorities confirmed that the non-deductible portion of the NFC in application of the new earnings stripping rules should not qualify as constructive dividends, possibly entailing withholding tax consequences.
For more information, contact a tax professional with KPMG Avocats in France:
Marie-Pierre Hôo | + 33 (0) 1 55 68 49 09 | firstname.lastname@example.org
Patrick Seroin Joly | + 33 (0) 1 55 68 48 02 | email@example.com
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