The French tax authorities (FTA) have progressively escalated the aggressiveness of their tax law investigation and enforcement practices over the past few years. Reassessments and penalties, electronic audit tools, broader investigations, international information-sharing and raids conducted in cooperation with police — the FTA is looking to engage every weapon in their arsenal to the fullest extent to combat tax fraud and raise much-needed revenue.
As Audrey-Laure Illouz explains, many of these powers are not new but they are being wielded with more severity than ever before. Companies doing business in France need to ensure their tax positions are sufficiently supported and documented to withstand the heightened potential of an FTA challenge.
What has prompted the FTA to increasingly toughen their approach to tax enforcement?
Obviously the ongoing economic uncertainty in Europe is a significant factor. Following the 2008 financial crisis, it was felt that the FTA should do more to curb tax evasion. Tax audits lacked efficiency, reassessed tax amounts were low, and penalties were not big enough to deter larger companies from engaging in dubious tax practices. Inspections tended to neglect areas with potential for non-compliance and high reassessments such as value added tax (VAT) and cross-border activities.
The FTA has worked to change its attitude and approach toward tax audits in response to France’s budgetary constraints and the fight against tax fraud, and also in response to the French Court of Auditors’ conclusion, issued in 2012, that French tax audits are not sufficiently efficient.
Is the FTA’s increasingly hardline approach getting results?
Yes, the FTA appears to be succeeding in raising more revenue. In 2012, tax audits conducted on companies taxable in France permitted the FTA to collect more than 9 billion euros (EUR) in additional tax assessments and EUR 3.2 billion in penalties. Previously these amounts were relatively stable from year to year. In 2012, they increased over 2011 by 14 percent.
What specific steps is the FTA taking to beef up its tax audit processes?
For one thing, the FTA has reorganized its audit department in charge of international groups into teams by sector of activity (e.g. industries, chemicals, financial institutions). Supporting these teams are tax inspectors with particular specializations, such as transfer pricing, IT audits, and financial issues. Increasingly, this department conducts simultaneous, coordinated tax audits on companies belonging to the same group.
Further, the FTA now uses every procedural means at its disposal to collect information. They make extensive use of information exchange with foreign tax authorities, based on tax treaties or European Union Directives. They rely on data supplied in filings of other taxpayers. They research the Internet and social networking sites for information posted by the company or its employees about the nature of the company’s activities in the country. A newly proposed obligation in the Draft Finance Act of 2014 would require taxpayers to declare any tax optimization schemes that they have implemented and the tax rulings obtained in foreign countries.
In cases of suspected tax fraud, the FTA even conducts surprise “dawn raids” to investigate taxpayers’ premises. This procedure was initially confined to serious acts of fraud. Now the FTA does not hesitate to apply it against large corporate groups, particularly as a means of gathering evidence of a foreign company’s permanent establishment in France, a foreign company’s lack of substance, or the existence of a VAT fraud scheme.
With new rules about electronic accounting records set to take effect, it seems the FTA will soon have another powerful way to access taxpayer data.
That is correct. Until now, taxpayers could opt to submit their accounting documents in a “dematerialized” (electronic) format by providing the FTA with a copy of the files containing their accounting entries. Starting on 1 January 2014, all businesses that use IT systems to keep their accounts will be required, in the event of a tax audit, to submit their accounting records in a dematerialized format as soon as the audit begins. This new requirement covers the computerized entries of the general accounts in French GAAP, which in principle include the general ledger, the journal and annual accounts ledger. (As before, taxpayers also may be subject to a formal IT tax audit under a separate procedure.)
Looking ahead, proposals under Draft Finance Bill for 2014 would go further to require taxpayers to provide consolidated accounts and analytical accounts in the scope of a tax audit.
In addition to higher reassessments, is the FTA’s new approach resulting in more frequent application of penalties?
The FTA is being more systematic in levying France’s 40% penalty for deliberate compliance failures. This penalty applies where the FTA considers that the taxpayer “knew or could not have been unaware” that it was not in compliance with tax law. Until recently, the 40% penalty was applied only in 13% of all tax audits, which was not considered to be a sufficient deterrent. Now, given the FTA’s tendency to view any sort of tax optimization as akin to tax fraud, the FTA are applying the 40% penalty much more often.
A proposal under the Amended Finance Bill for 2013 provides for an extension of the cases where the 80% penalty for abuse of law will apply (i.e. general anti-avoidance rule). The proposal would extend the procedure’s scope. The procedure now applies to schemes/operations that are “exclusively” motivated by tax reasons; the proposal would sweep in schemes/operations that are “mainly” motivated by tax reasons. This change has proven controversial, especially over how it would be delimited. Whether it will be enacted remains to be same.
Like most of the world’s tax authorities, the FTA seems particularly focused on cross-border payments between related parties. What new measures are being introduced to address transfer pricing issues?
The Amended Finance Bill for 2014 would require taxpayers to file transfer pricing documentation within six months after the filing of their corporate tax returns. Until now, such documentation only had to be available in the event of a tax audit. If adopted, the change would enable the FTA to issue transfer pricing reassessments without visiting the companies’ premises. They could even reassess on the basis of information found in transfer pricing documentation received from other companies.
Further, the Draft Finance Bill for 2014 proposes to introduce a form of exit charge on certain restructurings that involve the transfer of functions and risks offshore, unless the taxpayer can demonstrate that it received arm’s length compensation. The burden of proof would lie with the taxpayer.
Finally, the Draft Finance Bill for 2014 would increase the penalty for failing to provide transfer pricing documentation in the scope of a tax audit from 5% of the reassessed profits to 0.5% of the turnover.
Beyond transfer pricing, this bill would also deny tax deductions for interest paid to a related company located abroad where the payment is not subject to a tax that equals 25% of the theoretical corporate income tax that would be due if the payment were taxed in France.
In this aggressive tax audit environment, how can companies defend themselves against assessments and penalties?
It’s highly advisable to conduct a regular tax health check: to determine any tax exposures, to ensure your facts and arguments are complete and well supported, and to verify that contemporaneous documentation is in place to confirm the business reasons behind your transactions and structures. It is also necessary to prepare in advance the IT file with the accounting entries in order to have it as from the first day of the tax audit and verify that the ERP is able to issue this file under the format required by the French tax legislation.
Companies should also consider pursuing certainty over their proposed transactions where possible, for example, by negotiating advance pricing agreements or applying for the specific types of advance rulings that are available in areas such as mergers, transfers of tax losses, and creation of permanent establishments.
On certain specific issues, taxpayers should also have their facts, arguments and documentation ready to pursue their disputes through the courts. The FTA has issued strict guidelines to its tax inspectors on these issues, so taxpayers are unlikely to resolve these matters with their auditor or at the administrative appeal level. Along with transfer pricing, these specific issues relate to items such as cross-border reorganizations, salaries of research and development employees, deductibility of interest related to hybrid instruments and structures, and the tax positions of holding companies.
Although litigation entails considerable time and cost, the upper-level appeal courts tend to take a more balanced approach to these issues and taxpayers are more likely to receive a favorable outcome.
What is the overall impact of the FTA’s tough new approach to tax audits?
The combined effect of these new audit approaches and legislative measures is that it is becoming increasingly difficult for French companies to deal with tax audits. Due to the lack of dialogue with taxpayers and the FTA’s suspicious attitude toward cross-border transactions, international groups are often presumed to be engaging in tax optimization considered as tax fraud. While the fight against tax fraud is important, the FTA should remember that the vast majority of taxpayers aim to comply with the tax laws.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
This article represents the views of the author only, and does not necessarily represent the views or professional advice of Fidal, Direction Internationale.
* FIDAL is an independent legal entity that is separate from KPMG International and KPMG member firms.
Audrey-Laure is a Tax Partner with Fidal, Direction Internationale. Currently, she is in charge of the Tax Audits and the Litigations group at Fidal. With over 15 years experience, she has developed a strong expertise on international tax matters including; French and cross-border transactions, reorganizations, business structuring, mergers and acquisitions, and corporate tax consulting. In addition, she has an excellent knowledge of the latest and newest trends with regards to the French Tax Authorities (tax reassessments, IT Tax Audit, tax raids, mass litigations, etc.)
Audrey-Laure is an attorney-at-law and a member of the Hauts de Seine Bar. She has a degree in Taxation and Business Law from the Paris University School of Law.
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