Corporations - Doing business - Taxable result

This chapter is not exhaustive and is limited to broadly outline the tax consequences of the main events occurring when doing business in France. It does not constitute a tax advice or a client - attorney relationship. Materials are not suitable for tax analysis. Visitors are invited to consult a tax lawyer before taking any decision.  


 Who is taxable?
 Taxable result computation
 Surrender of a debt - Subsidiary
 Interest
 Depreciation
 Reserves
 Royalties
 Capital gains – tax exemptions
 Payment of long term capital gain tax by installments
 Capital gains on shares disposal
 Long term capital gain reserve – 2,5% exceptional tax
 Dividend
 Gift to foundations and non-profit organizations
 Pension
 Business gifts
 Tax regime applicable to lavish expenses
 Alternative Minimum Tax


 Who is taxable?
  
According to the tax law provisions the following type of companies are subject to corporate income tax:

- stock companies (SA), simplified stock companies (SAS), private limited companies (SARL), limited stock partnerships (SCA).

But also:

- non trading companies whose activity is either commercial or professional - limited partnerships for the part attributed to the limited partners - limited liability company whose sole shareholder is a corporation.

Exceptions:

- limited liability companies whose shareholders are family members which elected to be subject to partnership tax regime
- limited liability companies "EURL" whose sole shareholder is an individual.

(Création /structure)

Election for corporate tax is available for:
- partnerships
- limited partnerships
- limited liability company "EURL" whose sole shareholder is an individual
- limited liability companies previously subject to the partnership tax regime.

The election must be made within a 3-month period following the beginning of the FY for which the company wants to be subject to corporate tax. The election must be made in writing and is irrevocable. 
 
 
 

 Taxable result computation

Tax is calculated on the turnover plus the capital gains minus operating expenses, depreciation, amortization and reserves Subject to the application of the relevant tax treaties, French corporate income tax applies only to profits derived from enterprises exploited in France (application of the territorial rule). The election for worldwide tax consolidation is the only exception to this territorial rule.
(See more : Worldwide tax consolidation).

Standard fiscal year is 12 months. Exceptions apply at creation and dissolution.  
 

 Surrender of a debt - Subsidiary

Traditionally case law allows the tax deduction of the surrender of a debt or subsidy by a parent company in favour of a subsidiary up to its negative net worth (Conditions apply). French administrative Supreme Court recently ruled that this tax deduction may also apply to a second tier subsidiary up when it meets the conditions above and up to the negative net worth of the first tear subsidiary, its mother company. It is not necessary that the entities involved in the surrender belong to the same French tax consolidation. 

 

 Interest

Interest on loans is deductible for tax purposes as long as they are contracted for the business and in the interest of the enterprise.

New thin capitalisation rules applicable to fiscal years starting January 1st 2007

BACKGROUND:

To comply with EU rules and case law (ECJ 2002 "Lankhorst-Hohorst Gmbh - CE 2003 n°233894 SARL Coreal Gestion - Freedom of establisment) and the tax treaties signed by France (CE 2003 Andritz - International treaty) new thin-capitalization rules applies to tax years closed as from January 1st, 2007.
           
The new rules only apply to related entities i.e. :
- One company owns directly or indirectly more than 50% of the financial rights of the other company,
- One company controls the other company,
- Two companies are controlled, as indicated above, by the same third company.

The new rules do not apply to:
- Inter company loans between not related companies as defined above,
- Loans granted through «cash pooling »,
- Lease-back,
- Interest due to a financial establishment.

Maximum interest rate deductible:
 - Interest rate not exceeding the average rate on loans with an initial duration of more than two years granted by banks,
- Interest rate similar to the interest rate applicable the borrowing entity may have obtained from an independent financial institution for a similar loan.

Interests exceeding the above limits are definitively not tax deductible.

Maximum amount of deductible interest:
The interest paid to one or several related parties during a tax year are deductible up to the highest of the 3 following limits:
- 1,5 x Equity capital on opening or closing balance,
- Average amount of loans granted by related parties,
- 25% of the restated current profit (interest, depreciation, leasing),
- Amount of interest received from related parties.

Non deductible interest may be carried forward.

Thin capitalisation rules applicable to fiscal years closed not later than December 31, 2006

Interests paid on loans from shareholders are not tax deductible when:

 The share capital is not fully paid up

 The interest rate exceeds the average interest rate on loans with an initial duration of more than two years granted by banks to French companies.
Until December 2002 this limitation did not apply to interest paid by cash pools established in France. However by a decision dated December 11, 2002, the European Commission stated that the special tax regime applicable to cash pooling centers breaches the EU state aid rules. As a consequence French tax authorities issued new guidelines on February 28, 2003 (BOI 4 C-2-03) modifying this tax regime. The limitation of the maximum interest rate deduction has been restored for cash pooling centers with a retroactive effect as of January 1st, 2003.

 Another limitation to the tax deductibility of interest applies to interest paid to shareholders holding either more than 50% of the financial or voting rights or controlling the company. These interest are deductible only if the total amount of the loans does not exceed 150% of the share capital of the company i.e. debt: equity ratio of 1.5/1. This limitation does not apply to parent companies as defined under French parent subsidiary regime.

Accordingly with 2 decisions of the French Supreme Court, French tax authorities published guidelines providing that the tax deductibility of the interest paid by a French subsidiary to its foreign mother company will no longer be challenged on the basis of the French thin capitalization rules (i.e. debt: equity ratio of 1.5/1 except when the parent company is a French company).

However French thin cap rules will continue to apply to interest paid to parent companies established in non EU Member State which have not concluded a tax treaty with France or which have concluded a tax treaty which does not contain a non discrimination clause. French thin cap rules will also continue to apply where tax treaties do not prohibit or expressly authorized the application of these rules.

According to the new regulations the French thin cap rules will continue to apply to 58 countries:

The new guidelines also confirm that the French transfer pricing rules (art. 57 CGI) does not allow the French tax authorities to determine whether or not a debt/equity ratio is acceptable.

However French tax authorities indicate that these new guidelines do not apply to French Permanent Establishments of foreign companies (e.g. Advance payments of a foreign bank to its French branch).

Withholding tax

As of January 1st, 2004, interest payments between associated companies of different EU Member States with a minimum uninterrupted 2 years old cross-shareholdings of at least 25%, will only be taxed in the EU Member State in which the recipient company or permanent establishment is established (No longer any withholding tax). Greece, Portugal and Spain will, in a transitional period, continue levying withholding tax on interest.
 
 

 Depreciation

There are two depreciation methods: straight-line and declining balance methods.

Depreciation according the straight-line method is calculated on the asset purchase price.

The depreciation is a percentage of depreciation proportional to the economic useful life of the asset expressed in years Declining balance is mostly allowed for industrial assets, equipment used for R&D, hotel installations.

A temporary 50% increase of declining balance depreciation coefficients applies to assets acquired or produced between December 4, 2008 and December 31, 2009.
As a result companies have the right to calculate declining balance depreciation by multiplying the straight line depreciation rate with the following coefficient:
- 1,75 when period of utilization is between 3 and 4 years ;
- 2,25 when period of utilization is between 5 and 6 years ; 
- 2,75 when period of utilization is over 6 years.

To be tax deductible, depreciation must be booked in the accounting records.

Accelerated depreciation is allowed for qualifying software which can be fully depreciated over a 12-month period.
It is also available for investments in favour environment or R&D.

No depreciation is allowed for land or goodwill.
 
Depreciation of building

In a decision of July 10, 2007, the French Supreme administrative Court provides key details on tax consequences of a change of the partners in a SCI with respect of depreciation and capital gains.

The acquisition by a company subject to CIT of all the shares of a SCI hold before by individuals triggers the application of the CIT rules instead of the tax rules applicable to real estate earning “Revenus Fonciers” made by individuals.

In practice, the SCI must recalculate the depreciation plan of the buildings as from their acquisition or construction by the SCI. It must also calculate hidden capital gains which are taxable as a consequence of the application of the new tax rules should the depreciation have been booked.

Depreciation by components

For fiscal years starting on January 1st, 2005 or later, the increase or decrease of the taxable result resulting from the introduction of the depreciation by component method is spread equally over the current year and the 4 subsequent fiscal years. The company may elect to not spread when the increase/decrease is 150 000 euros or less.

French tax authorities published guideline 4 A-13-05 providing tax consequences on the harmonization of the French statutory GAAP with IFRS accounting standards which apply to accounting years starting on or after January 1st, 2005.

Most important features of the Guidelines are:
- New IFRS rules apply to all companies whatever its legal form (e.g. partnerships subject to corporate income tax, French PE of non French companies etc....)
- Definition of fixed assets for tax purposes (Identifiable, positive economic value, controlled by
the company, reliable valuation)
- Definition of acquisition costs of fixed assets
- Application of the "per components" depreciation method
- Determination of the depreciation period
- Tax consequences of the "per components" depreciation method

Company car

Tax allowance for the depreciation of company cars decreases from 18 300 € to 12 300 € for cars whose CO2 emissions > 200g/km (first release into traffic after June 1st 2004 and acquired, rented or leased from June 1st, 2004).

Environmental friendly equipments

Straight line depreciation over a 12 month period for environmental friendly equipments acquired or manufactured before January 1st 2006 is extended until December 31, 2006.

Environmental friendly equipments

French Supreme Administrative Court recently held that acquired authorizations to market pharmaceutical products and related rights could be depreciated. As a result of this decision, tax rules now correspond to the IFRS accounting rules which permit the depreciation of this type of assets for consolidated account purposes.

Hotels – Bars – Restaurants

For tax years closed as from 31/12/2006, businesses belonging to this sector, restaurants for collectivities and hotels not for tourist excluded, may depreciate over 24 months the equipment and fixtures purchased or self-produced between 15/11/2006 and 31/12/2009 in order to comply with legal standards. Benefit is limited to 200 000 € over 3 years.
 
 

 Reserves

 Tax deductibility
 Reserve for price increase
 Reserve for investment
 Reserve for depreciation of shares eligible to the participation exemption regime
 Hotels – Bars – Restaurants- Reserve on compliance costs with standards

Tax deductibility

Reserves for risks and expenses are tax deductible provided that:
- the contingency to be covered is itself tax deductible;
- the expense or liability is precisely identified and very likely
- to the related events are in progress at the time the provision is booked i.e.at the FY end.

Special regulated reserves e.g. reserve for inventory price increase, or reserve for commodity market fluctuation follow specific tax rules.

Tax deductibility relies on facts analysis and is subject to proper justifications. To be tax deductible, reserves must be recorded in the books.
 
Reserve for inventory price increase – Cap of the annual allocation

For fiscal years starting on January 1st, 2005 or later, the yearly allocation to the reserve for price increase is capped to a maximum of euros 15 millions increased by 10% of the yearly allocation in excess of the euros 15 millions cap.

Reserve for investment

Companies which “Participation” agreement provides for a payment higher than the legal amount may book a reserve for investment equal to 50% of the excess amount. When there is a “Participation” agreement calculated at the group level, the reserve may be shared among the entities belonging to the same tax consolidation in proportion of their contribution to the special reserve for “Participation”.

Reserve for depreciation of shares eligible to the participation exemption regime

Reserve for depreciation of shares eligible to the participation exemption regime is currently deductible according to the long term capital loss rules.

According to the new rules, the tax deductibility of reserves for depreciation of shares will be limited to the value of the latent capital gains on shares eligible to the participation exemption regime existing at the closing of the tax year.

New rules apply to fiscal years closed on December 31, 2005 onward. However they will only affect the results of FY 2005 and 2006 when applicable to shares which will be fully exempted of capital gain tax on sale as of 2007.

Hotels – Bars – Restaurants- Reserve on compliance costs with standards

For tax years closed as from 31/12/2006, businesses belonging to this sector, restaurants for collectivities and hotels not for tourist excluded, when subject to Personal Income Tax may book a tax deductible reserve to comply with standard. The reserve is limited to 15 000 € per tax year.
 
 

 Royalties

For enterprises subject to personal income tax, income derived from patents licensing and the disposal of patentable know how and/or manufacturing processing techniques benefit from the 27% reduced rate (16% plus social surtaxes).

For enterprises subject to corporate tax, the income derived from the licensing of patents, of patentable know-how and/or of manufacturing processing techniques benefit from the reduced rate. The proceeds of the sale of patents, patentable know-how and/or manufacturing processing techniques are subject to the standard rate.

The reduced rate is equal to 15,225% (15% plus addtional social tax of 1,5%) or 15,72% when the 3,3% social taxes apply i.e. when the Corporate Income Tax is higher than 763 000 euros. (2005 figures).

To benefit from the reduced rate, patents, patentable know-how and manufacturing processing techniques must be recorded as assets and held for more than two years.

When the licensee is taxable in France, the deduction of the royalties is limited to mirror the benefit of the reduced rate applicable to the derived royalties at the licensor level. This limitation does not apply when the licensee is not taxable in France.

As of January 1st, 2004, royalty payments between associated companies of different EU Member States with a minimum uninterrupted 2 years old cross-shareholdings of at least 25%, are taxable in the EU Member State in which the recipient company or permanent establishment is established (No longer any withholding tax). Greece, Portugal and Spain are allowed, during a transitional period, to continue to withhold tax on royalties.
 
 

 Capital gains – tax exemptions

For the tax years closed on or after January 1st, 2004, the “business” capital gains made by the holders of revenues in the categories of industrial and commercial revenues “BIC”, agriculture “BA” or non commercial activities “BNC” may be totally tax exempt when their yearly sales do not exceed 250 000 euros (Industrial, commercial and agriculture) or 90 000 euros (services and non commercial activities). Partial tax exemption is available when the annual sales are more than 250 000 – 90 000 euros and 350 000 – 126 000 euros.

As of January 1st, 2006 and for tax years beginning January 1st 2006 or later, capital gains derived from businesses turnover is considered VAT excluded. In addition the new provision is not cumulative with other exemption regimes.

Listed SME: Capital gains on the sale of “Titres de participation”

IMPORTANT: Law to promote growth and investments published on August 11, 2004 provides that capital gains derived from the sale of a complete branch of activity made between July 16, 2004 and December 31, 2005 are tax exempt if its tax basis for registration duties does not exceed EUR 300,000. The exemption only applies to small businesses subject to income tax, to corporations subject to income tax when at least 75% of the capital is owned directly or indirectly by individuals, non profit driven organizations, local administrative units and EPIC. Qualifying sales of goodwill may also be exempt of registration duties.
Capital gain on businesses sold between January 1st, 2005 and December 31, 2005 are eligible for the temporary tax exemption only when the vendor and the acquirer are not related parties.
This provision is made permanent as of January 1st, 2006. Benefit of the new rules is contingent to a minimum period of activity and cannot be combined with other tax exemptions or capital gain tax deferral. Full exemption benefit to business transfers with a value lower than 300 000 €. Proportional exemption applies to business transfers with a value between 300 000 € and 500 000 €. 
 
 
 

 Payment of long term capital gain tax by installments

It is now possible to pay by installments the long term capital gain tax on the sale of all the assets dedicated to a professional activity if the price is also paid by installments.
 
 

 Capital gains on shares disposal

As of January 1st, 2005 the tax rate for capital gain is reduced to 15%. It will be further reduced to 8% for fiscal years starting in 2006 for capital gain on eligible shares (e.g. shares of subsidiaries). Capital gain will be 95% tax exempt for fiscal years open in 2007 onward.

Rules applicable to tax years closed not later than December 30, 2006:
Long term capital gain for shares in subsidiaries called “Titres de participation”

Definition of "Titres de participation":
 
 =  Shares treated as "Titres de participation" for book purpose i.e. long term investment to control 
  or influence the issuing company, or
= When booked as "Titres de participation" the following shares: 
  - Shares acquired in a take-over bid for cash or shares by the company who initiated the offer, or 
  - Shares benefiting from the participation exemption regime (5% of the capital of the subsidiary), or 
  - When the acquisition cost of the stock holding is at least 22.8 M€ 
 

Two different tax regimes now apply:
 
  = 95% capital gain tax exemption for fiscal years open as of 1/1/2007 onward i.e. regular corporate tax rate applies on the remaining 5% of the capital gain  (In  2006 CGT was 8%). 
  = 15% Capital gain tax on stock holdings witch acquisition cost is at least 22.8 M€ when they are NOT entitled to the participation exemption regime.

Acquisition costs:

Since January 1st, 2005 the acquisition costs were for book purpose either deductible the year of payment or incorporated into the acquisition cost and non deductible. The tax treatment complied with the accounting treatment.

Rules applicable to tax years closed as of December 31, 2006:

For tax year closed as from 31 December 2006, 33, 33% capital gain tax on stock holdings which acquisition cost is at least 22.8 M€ when they are NOT entitled to the participation exemption regime.

Long term capital losses existing on January 1st 2007 which may be carried forward may first offset capital gains taxed at 15%. The excess may then offset 45 % (15/33.33) of capital gains made on the same type of shares and taxed at the 33.33% normal rate.

Acquisition costs:

 - For tax years closed as from 31 December 2006, the acquisition costs of  « titres de participation » incurred the year of the acquisition are incorporated into the acquisition price and depreciated over 5 years for tax purpose whatever the option for book purpose. The definition of the acquisition cost remains identical for book and tax purpose.

When the « titres de participation » are sold before 5 years, the acquisition cost left are no longer tax deductible (Capital gains on "Titres de participation" are 95% tax-exempted) When sold after 5 years, the capital gain equals the sale price minus the acquisition cost reduced by the acquisition expenses. 5% of this gain is taxable at the regular tax rate.

For tax year starting on January 1st, 2006 and assuming that they meet the legal requirements, profit paid by FCPR and dividend paid by SCR to corporations liable of corporate income tax, benefit from graduated exemption of the long term capital gain on the sale of shares booked as “Titres de participation. In addition this graduate exemption will now fully apply to selected capital gains made by FCPR and SCR (Conditions apply).

As of January 1st, 2006, corporation subject to corporate income tax will benefit from the progressive capital gains tax exemption on the sale of their shares in Venture funds "FCPR" and/or related to the capital gains made by the Venture funds on the sale of their own shares.

It is no longer requested to transfer to the special reserve for long term capital gain, the capital gains taxed on and after January 1st, 2004.

Capital gain on the sale of partnerships

 
CAPITAL GAIN / LOSS - SUMMARY

 Long term capital gain reserve – 2,5% exceptional tax

The balance of the long term capital gain reserve at the end of the first fiscal year ending on or after December 31, 2004 must be transferred to an “other reserve” before December 31, 2005 up to 200 millions euros. The transferred amount will be subject to a 2,5% exceptional tax after a rebate of 500 000 euros. Losses deducted from the long term capital gain reserve as well as the amount transferred to the share equity account since September 1st, 2004 are also subject to the 2,5% exceptional tax.

The 2,5% exceptional tax is deducted from the “other reserve” account it was transferred to. 50% of the exceptional tax must be spontaneously paid on March 15, 2006. The balance is due on March 15, 2007. The 2,5% exceptional tax is not tax deductible.

Until December 31, 2006 companies may decide to transfer more money to the « other reserve » if the balances of their long term capital gain reserve is higher than 200 millions euros.

IMPORTANT: Companies required to transfer earnings from RSPVLT to an ordinary reserve account, which close their books after June 30, 2005, will avoid the cost generated by a specific general shareholder meeting while paying a 2,5% exit tax, instead of 5%, if they hold their annual regular shareholder meeting before December 31, 2005, before the end of the legal 6 months period following the end of the closing of the books.

The taxable basis of the exit tax is equal to:

  Amount transferred* from RSPVLT to an ordinary reserve account 
- 500 000 euros
+ Earnings transferred from RSPVLT to share capital since 9/1/2004
+ Losses offset against RSPVLT since 9/1/2004 
 
  EXIT TAX BASIS

* Transfer is mandatory up to euros 200 millions, optional above.

After transfer, the earnings transferred from the RSPVLT to an ordinary reserve are exempt from equalization tax if dividend-up. 
 
 
 

 Dividend

  dividend  also to:
- distributions within tax consolidation regime (tax consolidation).
- distributions between companies located in the EU (International).
- distributions to non residents (International).
 
 

 Gift to foundations and non-profit organizations

For the computation of the income tax for the tax year open as of January 1st, 2003 (Law voted July 21, 2003) the tax deductibility of donations made by companies to foundations and non-profit organizations is increased to 60% of the donation paid (before 100%, 90% or 40%), up to a maximum of 0,5% of their sales (before 0,225% or 0,325%).
 
 

 Pension

As of January 1st, 2004 (Law 2003-775 dated August 21, 2003 - available in French) the payment of regular social security pension premiums (including voluntary payments, up to 12 trimesters, for the validation of study years and years during which the employee subscribed during less than 4 trimesters) and additional pension premiums required by law (e.g. Agirc, Arrco) are tax deductible whatever the amount. Accordingly, as of January 1st, 2003, these mandatory premiums paid by employers are no longer subject to social taxes nor to CSG/CRDS whatever the amount.

However premiums and allocations paid by employers for pension schemes and protection schemes not requited by law are deductible for income tax and social taxes only up to a maximum threshold.

Reserve funds, 3% of the individual yearly growth salary plus 7% of the ceiling of the social security (for 2004, 29 712 x 7% = 2 080 €) up to a maximum of 3% of 8 times the ceiling of the social security (for 2004, 3% x 8 x 29 712 =
7 131 € per year with a minimum equal to 7% of the ceiling of the social security i.e., 29 184 x 7% = 2 043 € per year.
Pension scheme not required by law, 8% of the individual growth salary up to 8 times the ceiling of the social security i.e. for 2004, 8% x 8 x 29 712 = 19 016 € per year.
 
 

 Business gifts

For Corporate Income Tax the business gifts are tax deductible when offered for the development of the business and assuming that their value is not excessive. The appropriateness of the value is a matter of circumstances (Business traditions, kind of business, size, growth….)

The amount of the business gifts must be disclosed on the “miscellaneous business expenses” report when they exceed 3000€ during the fiscal year except when the gifts are specially created for advertising purpose and their individual value does not exceed 30€. In addition a permanent advertising message must be visible.

VAT regime.
 
 

Softening of tax regime applicable to lavish expenses (secondary home)

Two provisions soften the non-tax deductibility of expenses related to secondary home as per article 39-4 of the French tax code “CGI”.
When secondary home are used both for housing of the manager and head office, tax deductibility is expressly authorized according to article 39-4 CGI.

Expenses related to homes included in a production facility and used for reception of customers are now tax deductible. Castle and wine yards are specifically targeted by this provision.
All businesses including services should benefit of these new provisions.

Come into force : Fiscal Years closed as of December 31, 2008.

 Alternative Minimum Tax

As from January 1st 2006, Minimum alternative tax is deductible from the taxable result and no longer from the corporate income tax. Consequently the after tax cost of the alternative minimum tax is increased by 2/3 for profitable companies and generate a potential gain of 1/3 for non profitable companies.

Minimum alternative tax of 2005 and before, not yet credited against corporate income tax, remain deductible from corporate income tax due for 2005, 2006 and 2007.

IFA rates