New rules on the deduction of acquisition debt in France
The French Finance Act for 2014 imposes a new restriction on interest deductions paid to a party that is directly or indirectly related to a French borrower. This adds to previous French measures which aim to limit or prevent the deduction of financial expenses (such as the rules on thin capitalisation) and may have impact on current and future financing arrangements set up by UK investors as part of their French investments.
Under the new rule, interest deductions will only be allowed if the French borrower demonstrates that the lender is, for the current financial year, subject to a corporate tax on the interest income that equals 25% or more of the corporate tax that would be due under French tax rules. When the lender is domiciled or established outside of France, the corporate tax determined under French law equals the tax liability that the lender would have owed on the interest had it been resident or domiciled in France. The French borrower will have to prove a ‘sufficient level of taxation’ imposed on the related-party lender when requested by the French tax authorities. This new mechanism adopted on 30 December 2013 applies retroactively to tax years closed as from 25 September 2013.
Originally, this provision was aimed at counteracting hybrid arrangements which exploit the differences of characterisation of an income flow, which thereby give rise to an inconsistent tax treatment in France and another country, e.g. deductible interest in France but exempt dividend in another state. However, its scope is much wider than this and raises numerous concerns regarding its application to non-taxable entities (investment funds, pension funds and partnerships) and back-to-back loans.
The scope of the measure will be clarified by the French tax authorities, notably with respect to the factors to be taken into account in determining the effective tax on the interest income at lender level. In particular, it is currently uncertain whether the effective taxation would be determined on a net basis, after deduction of other expenses, or whether the 25% threshold would be considered before or after the offset of tax losses or tax credits. We expect further guidance from the French tax authorities in the near future. However, its retrospective effect means that UK funds with investments in France may need to review their past financing arrangements now to assess the impact of the new measure.
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New rules on the deduction of acquisition debt in France
The French Finance Act for 2014 imposes a new restriction on interest deductions paid to a party that is directly or indirectly related to a French borrower. This adds to previous French measures which aim to limit or prevent the deduction of financial expenses (such as the rules on thin capitalisation) and may have impact on current and future financing arrangements set up by UK investors as part of their French investments.
Under the new rule, interest deductions will only be allowed if the French borrower demonstrates that the lender is, for the current financial year, subject to a corporate tax on the interest income that equals 25% or more of the corporate tax that would be due under French tax rules. When the lender is domiciled or established outside of France, the corporate tax determined under French law equals the tax liability that the lender would have owed on the interest had it been resident or domiciled in France. The French borrower will have to prove a ‘sufficient level of taxation’ imposed on the related-party lender when requested by the French tax authorities. This new mechanism adopted on 30 December 2013 applies retroactively to tax years closed as from 25 September 2013.
Originally, this provision was aimed at counteracting hybrid arrangements which exploit the differences of characterisation of an income flow, which thereby give rise to an inconsistent tax treatment in France and another country, e.g. deductible interest in France but exempt dividend in another state. However, its scope is much wider than this and raises numerous concerns regarding its application to non-taxable entities (investment funds, pension funds and partnerships) and back-to-back loans.
The scope of the measure will be clarified by the French tax authorities, notably with respect to the factors to be taken into account in determining the effective tax on the interest income at lender level. In particular, it is currently uncertain whether the effective taxation would be determined on a net basis, after deduction of other expenses, or whether the 25% threshold would be considered before or after the offset of tax losses or tax credits. We expect further guidance from the French tax authorities in the near future. However, its retrospective effect means that UK funds with investments in France may need to review their past financing arrangements now to assess the impact of the new measure.
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