The high court held that banks (like any other company) are free to choose how they fund their business (i.e., by debt or equity).
The position of the French tax administration was that a French branch of a foreign bank must be allocated a certain amount of “free capital” (i.e., an amount computed by applying the head office’s Cooke ratio to the risk-weighted assets of the branch).
When capital allocated by the bank’s head office to the French branch was lower than the computed minimum capital allocation, the tax authorities would make a re-assessment—with the amount of the re-assessment being equal to the market rate of interest as applied on this deemed insufficient equity.
Taxpayer banks challenged the tax authorities’ position, asserting that: (1) it was not founded in law or under income tax treaty rules; (2) it was discriminatory; and (3) the computation method was “excessive” in that the head office ratio included both tier 1 and tier 2 elements so that, in several cases, the tax authorities demanded “free capital” with rates as high as 12% to 13%.
The high court agreed with the taxpayers that, absent a provision in the French tax law allowing such re-assessments (other than the general thin capitalization rules), the banks could choose whether to fund their business using either debt or equity. The high court also confirmed that no applicable treaty in these cases included any rule that would allow the re-assessments.
Read an April 2014 report [PDF 584 KB] prepared by Fidal*
*Fidal is an independent legal entity that is separate from KPMG International and its member firms.