Tax on inbound investments into France

Out-Law Guide | 04 Feb 2020 | 4:32 pm | 8 min. read

The tax consequences for inbound business investments into France will depend upon whether the investor is acquiring business assets or the shares in a French company.

Acquiring business assets

A buyer may prefer to purchase assets rather than shares. A buyer of business assets can receive a step-up in the tax basis of the acquired business assets, whereas they cannot obtain a step-up in the tax basis of the target company's assets if they acquire shares.

The acquisition of business assets and liabilities may create a permanent establishment in France for a foreign buyer. In such a case, the permanent establishment is taxed in France on the taxable profit deriving from the activity performed in France.

If the seller previously realised tax losses linked to the business assets and liabilities sold, these tax losses cannot be transferred with the business assets except in the case of the sale of a full line of business within the meaning of the tax-deferral regime applicable to mergers and spin-offs. In this case the tax losses linked to the transferred activity can be transferred upon specific authorisation from the French tax administration subject to certain conditions. Alternatively, if the tax losses are not transferred, the seller can continue to offset them against its future taxable benefits, provided that the sale of business assets and liabilities did not trigger a change in the nature of the seller’s activity.

Intangible assets can be amortised if it can be proved that the benefits such assets have for the company will cease at a certain date. They are, in principle, depreciable over their period of normal use. As an example, patents can be amortised on a straight-line basis over a minimum period of five years, provided that the same depreciation accounting is retained. Development costs and software development costs must be amortised on a straight-line basis over a minimum period of five years. Goodwill cannot be depreciated.

Buying shares

The transfer tax on the acquisition of shares in a company is usually lower than the transfer tax on the acquisition of business assets. Special rules apply on the acquisition of real-estate companies.

If shares are acquired, the tax losses of the company can continue to be carried forward regardless of the percentage of share capital the buyer acquires. However, the company can lose tax losses if it goes through a significant change in its actual activity, its purpose, its tax regime or the disappearance of its means of production, which entail the cessation of business.

A buyer of shares will acquire the tax history of the target company. Any potential tax risk is transferred with the company. The acquisition of shares will require a more in-depth audit of the company’s tax situation and the negotiation of tax guarantees in protect against liability in the event of a tax audit for a period when the buyer did not hold the target company.

Shares in a company cannot be depreciated. However, a provision for depreciation can be booked if the market value of the shares is lower than the book value. This provision is not deductible for tax purposes on shares subject to the participation exemption tax regime. The deduction is subject to limitations for shares in real-estate companies.

The seller will often prefer a share deal since capital gains on the shares will generally benefit from the participation exemption regime under certain conditions, including a two-year holding period with an effective corporate income tax rate between 3.36% and 3.84%, whereas capital gains on business assets will be subject to corporate income tax at a rate between 28% and 32.02%. The participation exemption regime does not apply to real-estate companies.

Transfer taxes

Transfers of shares are subject to a 0.1% transfer tax for a non-listed company. The acquisition of shares in a real estate company is subject to a 5% transfer tax.

There is also a financial transaction tax at 0.3% due upon the acquisition of listed companies’ shares when the listed companies have a market capitalisation in excess of €1 billion on 1 December of the year preceding that during which the transfer occurs.

Business transfers are subject to transfer tax at the rate of 3% after the application of a €23,000 allowance and 5% over €200,000.

The acquisitions of buildings are in general subject to a transfer tax between 5.09006% and 6.40665%, depending on the type and location of the building. A reduced rate of 0.815% applies if an undertaking to resell the building within five years is made and met by the buyer.

The acquisition of business assets and liabilities constituting a full line of business within the meaning of the tax-deferral regime applicable to mergers and spin-offs is exempted from transfer tax.

Except for real-estate companies, some operations are exempted from the transfer tax, such as some intra group transfers.

VAT

The acquisition of business assets may be subject to VAT, in general at the 20% standard rate, unless the transfer of the business assets constitutes a transfer of a going concern, when it will be exempted from VAT.

The acquisition of a building considered as new or developable lands are subject to VAT at the 20% standard rate, along with a transfer tax at 0.815% (or a fixed fee of €125 if the buyer commits to erecting a building and completing the construction within a period of four years and complies with such a commitment).

Should the acquiring company be a French company or an overseas company?

If assets are acquired, transfer tax will, in principle, be due in France regardless of whether the purchaser is a French company or an overseas one.

If the acquisition is debt-financed and leveraged in France, a French holding company may be desirable.

The French holding company and the target company may constitute a tax-consolidated group if they are both established in France. Forming a tax-consolidated group will enable the two companies to offset the losses of the holding company deriving from the interest expenses of the acquisition company against the profits of the target company. This is subject to the rules limiting the tax deductibility of financial expenses. A tax-consolidated group requires a minimum, direct or indirect ownership of 95% of the target company.

Distributions between companies in the same tax-consolidated group are only taxed on 1% of their gross amount.

Aside from the tax-consolidated group regime, the French holding company regime is attractive, given its 95% exemption on dividends and 88% exemption of capital gains realised in connection with shares (except for real-estate companies), either French or foreign (subject to a 5% ownership or more for at least two years).

France also has a large network of tax treaties to protect against double taxation. The corporate income tax standard rate will be reduced to 28% in 2020 (31% for the portion of profit exceeding €500,000 for company with a turnover exceeding €250 million), 26.5% in 2021 and 25% by 2022.

However, a foreign company may prefer acquiring the target company directly, especially if the double tax treaty between its state of residence and France prevents France from taxing the capital gain on the sale of the shares and the foreign buyer can benefit from an exemption from withholding tax on dividends paid by the French target company.

In case of an asset deal, a French acquisition company may be preferable if the acquired business would be likely to constitute a permanent establishment of a foreign buyer.

Interest

An acquisition company may get tax relief for interest on borrowings to acquire the target company (whether French or foreign) or on loans from shareholders subject to various restrictions.

There is a maximum tax deductible rate of interest for payments to related parties for intra-group loans.

The anti-hybrid rule means that interest on related-party loans is tax-deductible only if the borrower can prove that such interest is subject to income tax in the hands of the lender at a rate equal to at least 25% of the French standard corporate income tax rate (ie, at least 7% for 2020).

The 'Charasse amendment' restricts the deductibility of financial expenses borne by a tax-consolidated group when a tax-consolidated company acquires the shares of a company joining the tax group from an entity that is not part of the French tax group but that controls the acquiring company or is under common control with the acquiring company.

The interest expense deduction limitation means that borrowing costs (such as interest expenses) are deductible only up to the greater of 30% of the tax earnings before interest, tax, depreciation and amortization (EBITDA) or €3 million. This limit is 10% of the tax EBITDA and €1 million for thinly-capitalised entities.

French source interest paid to a company established in another jurisdiction is, in principle, not subject to withholding tax in France, except where the beneficiary is a resident of a non-cooperating jurisdiction as defined by French law and established in a specific list or paid into a bank account located in a non-cooperating jurisdiction.

Dividends

Dividends are not deductible for corporate income tax purposes.

French source dividends paid to a company established in another jurisdiction are, in principle, subject to a 30% withholding tax (28% for dividends paid in 2020 and 25% for dividends paid in 2022), except where the recipient company is located in a country that has concluded a double taxation treaty with France providing for an exemption or reduced withholding tax rate.

If the recipient company is located in a non cooperating jurisdiction or the dividend is paid into a bank account located in a non-cooperating jurisdiction there will be a 75% withholding tax.

Under French domestic legislation, dividends paid to a company satisfying the EU parent subsidiary directive conditions are, in principle, exempted from any withholding tax if the parent company has held at least a 10% participation in the French company for at least two years (5% participation when the EU parent company cannot offset the withholding tax in its country of residency).

Royalties

Royalties are tax deductible for the payer. However, France introduced on 1 January 2019 a limitation of the deductibility of royalties paid to a related ultimate beneficiary that is not a resident of an EU or European Economic Area (EEA) state and that benefits from a local tax regime listed as harmful by the OECD and offering a local effective tax rate below 25%.

The non-deductible portion of the royalties is computed with a ratio equal to 25% less the effective tax rate divided by 25%.

Royalties may be subject to withholding tax in France at the corporate income tax standard rate (31% or 33.33% in 2019 and 28% or 31% in 2020) unless a double taxation treaty provides otherwise. If the royalty is paid to a non-cooperating jurisdiction there will be a withholding tax of 75%.

Royalties have to be negotiated at arm’s length to avoid the assumption of hidden profit distribution by the French tax authorities.

Capital gains on share disposals

Under French domestic law, the disposal of shares in an operating French company (a non-real-estate holding company) by a non-resident company is not taxable, unless the seller’s holding exceeds 25% of the French company at any time within the five-year period before the sale.

In general, double taxation treaties concluded with France deny France the possibility to tax the capital gain on the sale of French company shares. However, some double taxation treaties include specific provisions allowing France to tax capital gains deriving from a substantial shareholding (generally at least 25% of the French company's share capital). In such a case, foreign selling companies are subject to a withholding tax at a rate corresponding to that of the standard rate of corporate income tax (28% for 2020, 26.5% for 2021 and 25% for 2022). EU or EEA selling companies may be able to obtain the benefit of the participation exemption regime.

Special rules apply to transfers of shares in real-estate companies. These are defined as  private companies, the whole assets of which consisted directly, over the three-year period before the year during which the sale occurs, of more than 50% in French real property, rights relating thereto or shares of other real-estate companies.

This guide is based on Eglantine Lioret and Valérie Farez's contribution to Lexology's Getting The Deal Through series