As a reminder, the Finance Act for 2014 introduced a provision that prohibits the deduction of interest expenses when the corresponding gross interest income is not subject, at lender’s level during the same financial year (FY), to income tax that is equal to at least 25% of the French standard corporate income tax (referred to as “the minimum taxation” requirement).
Initial draft guidelines for implementing this rule confirmed that the criteria for minimum taxation apply to the gross interest income at the lender level (i.e., before deduction of any expenses or tax loss carryforwards), taking into account both the tax base (i.e., potential allowances) and the nominal income tax rate.
The final guidelines, published on 5 August 2014, adopt the guidelines as initially proposed, but with certain clarifications and amendments. Specifically, the final guidelines address:
- Computation of the “French standard corporate income tax” upon which the minimum taxation standard is based
- What is the effect when entities share joint control over the French taxpayer
- What are the consequences where there is a difference between the borrower’s and lender’s FY closing dates
- What are the consequences arising from delayed taxation of the interest income at the lender’s level
- How do these measures interact with the CFC rules
- Qualifications of the non-deductible interest expense
- Type of documents that can support a showing of sufficient taxation at the lender’s level
Additional information on these topics is provided in the following discussion.
Determination of the “sufficient taxation” standard
French corporate taxpayers are subject to corporate income tax (standard rate of 33 1/3 %), to which additional levies may apply, depending on certain thresholds—i.e., the social contribution of 3.3% of the portion of corporate income tax exceeding €763,000; and an “exceptional” corporate income tax surcharge of 10.7% applicable to large corporate taxpayers (i.e., those with turnover > €250 million).
Under the final guidelines, the minimum taxation to which the lender’s effective taxation is to be compared must take into account the standard corporate income tax rate, as well as the additional surcharges (noted above) that would have applied to the foreign lender, had it been a French corporate taxpayer.
In practice, the minimum taxation rate will therefore range between 8% (with application of the standard French corporate income tax rate) and 9.5% (based on the standard corporate income tax rate plus the 3.3% social contribution and 10.7% exceptional levy).
As noted by tax professionals with Fidal,* potentially affected taxpayers need to consider a case-by-case analysis in order to determine the corporate income rate that the borrower would have been subject to on application of the French tax rules. Note that difficulties may arise in certain situations, notably with respect to the application of the “exceptional” corporate income tax levy—i.e., computation of the €250 million on a cumulated basis for companies belonging to a French tax consolidated group. How would this computation be determined for foreign companies?
Application of limitation in instances of joint control
If the French borrowing company is jointly controlled by several entities, the final guidelines indicate that each of the related lenders that jointly control the French borrower must prove that each satisfies the above-mentioned “minimum taxation” standard on the share of interest it receives.
If this cannot be demonstrated for one of the related lenders, only the deduction of the interest paid to this company would be disallowed (the interest paid to the other related parties that satisfy the “minimum taxation” standard would remain deductible).
It has been observed that the tax authorities here (1) provide a reminder that these measures apply only with respect to joint control, and (2) note that only the deduction of the interest on the loan of the lender that is not subject to a minimum taxation is disallowed.
Different FY closing dates for the borrower, lender
In principle, the deduction of interest at borrower’s level requires that the lender is subject to a minimum taxation during the same financial year (FY).
When the lender and the borrower close their FY on different dates—for example, the borrower closes its FY on 31 December and the lender on 31 May—the French tax authorities seem to accept that the borrower immediately deducts the entire amount of interest paid during the FY, without limiting the deductible amount to the interest paid during the period 1 January – 31 May, as provided in this example.
This measure is generally viewed as being taxpayer-favorable; however, it requires a taxpayer to verify in advance that the lender will effectively be subject to a minimum taxation when it closes its own FY.
Delayed taxation at lender’s level
The accounting and tax rules applying to the borrower and the lender may differ and may cause an interval between the time of taxation of the interest income at the level of the lender and its deduction at the level of the borrower.
In such instances, the interest expense is deductible only at borrower’s level when it becomes taxable at lender’s level.
In this situation—and contrary to a typical instance when the borrower does not need to file any documentation (supporting the minimum taxation) with the French tax authorities—a supporting file must be appended to the annual corporate income tax return for the year during which the interest expense is deducted.
Combination with CFC rules
Under French controlled foreign company (CFC) rules, profits derived by a controlled foreign company established in a “low tax” jurisdiction are taxable in France (Article 209 B of the French tax code).
In instances when interest paid to the lender is taxable in France because of application of the CFC measure, the final guidelines indicate that such interest is fully deductible at the level of the borrower.
Tax professionals with Fidal* have observed that the initial draft guidelines conditioned the deduction of the interest income in France to the taxation of the corresponding interest income at the level of the lender. The final guidelines no longer require taxation at the level of the lender, but only taxation in France—a more relax approach, especially when the CFC is not a subsidiary of the borrower.
Absence of qualification as constructive interest
Whereas the initial draft guidelines were silent on this matter (which resulted in uncertainties), the final guidelines explicitly indicate that the interest expense disallowed (under this measure) does not qualify as a constructive dividend.
This clarification removes a risk of simultaneous application of both domestic withholding taxes and the 3% contribution on dividend payments.
Documents supporting the “effective taxation” of interest income
In order to deduct interest, the borrowing company must be able to demonstrate that the interest payment was included into the taxable income of the lender and subject to a “minimum taxation.”
From a practical standpoint, the final guidelines indicate that appropriate supporting documents could include the accounting entries of the lender (showing that the interest has been duly booked and included into taxable income) and its corporate income tax return.
For more information, contact a tax professional with KPMG’s French Tax Center or with Fidal* in Paris:
Gilles Galinier-Warrain, French Tax Center, KPMG LLP, New York
Olivier Ferrari, Tax Partner
+33 (0)1 55 68 14 76
Patrick Seroin, Tax Partner
+33 (0)1 55 68 15 93
* Fidal is a French law firm that is independent from KPMG and its member firms.