HMRC’s retrospective change on VAT and contract terminations: practical options for businesses
Out-Law Guide | 11 Nov 2020 | 4:34 pm | 1 min. read
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, but cannot usually 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.
Intangible assets can be amortised if it can be proved that the benefits the 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.
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.
The acquisition of shares will require a more in-depth audit of the company's tax situation and the negotiation of tax guarantees to protect against liability in the event of a tax audit for a period when the buyer did not hold the target company.
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 where these 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 to 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.
French transfer tax is due if the company of which the shares are transferred is established in France, or if the transfer deed is executed in France. Transfers of shares in a non-listed company holding predominantly real estate assets or real estate rights located in France is subject to French transfer tax even if the company is established abroad or the transfer deed is executed abroad.
Transfers of shares are subject to a 0.1% transfer tax for a non-listed company. For transfers of shares classified as 'parts sociales', the transfer tax rate is 3% on the transfer price after the application of a €23,000 allowance, to be pro-rated according to the portion of interest sold. Shares classified as parts sociales are interests in companies whose share capital is not divided into shares such as société à responsabilité limitée, société en nom collectif and société civile.
The acquisition of shares in a non-listed real estate company is subject to a 5% transfer tax.
Transfers of shares in a listed company are not subject to a 0.1% transfer tax if they are transferred without concluding any transfer deed unless the listed company falls within the scope of the 0.3% financial transaction tax.
The financial transaction tax at 0.3% is due on 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 the year in which the transfer occurs.
Business transfers are subject to transfer tax at a rate of 3% after the application of a €23,000 allowance, and 5% over €200,000.
Acquisitions of buildings are generally subject to a transfer tax between 5.09% and 6.40% depending on the type and location of the building, plus a 0.1% property insurance contribution. Additional transfer tax may also be applicable on transfers of offices in Ile de France and Paris - the rate varies between 5.19% and 6.5%, depending on the territory and the nature 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.
Except for real-estate companies, some operations are exempted from the transfer tax. These include some intra-group transfers, and 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.
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 exempt from VAT.
Transfers of buildings considered as new or developable lands are subject to VAT at the 20% standard rate or 5.5% in certain circumstances; or 10% when new buildings are acquired by certain institutional investors. There is also 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.
Under certain conditions, the parties may opt for VAT on transfers of buildings that are in principle exempted from VAT.
If the 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. However, 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.
A tax-consolidated group requires a minimum direct or indirect ownership of 95% of the target company. This minimum shareholding can be achieved via one or several EU subsidiaries. Distributions between companies in the same tax-consolidated group are only taxed on 1% of their gross amount.
There are other reasons, aside from the tax-consolidated group regime, why a French holding company may be attractive. These include its 95% exemption on dividends and 88% exemption on capital gains realised in connection with shares, either French or foreign, subject to a 5% minimum ownership condition for at least two years. This does not apply to real estate companies.
Within a tax-consolidated group an anti-avoidance provision - the 'Charassee amendment' - may deny, for a nine-year period, the deduction of part of the interest charge borne by a tax-consolidated group with respect to the acquisition of shares in a member of the tax-consolidated group by another member of the group.
France also has a large network of tax treaties to protect against double taxation. 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 then 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 the 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.
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.
New anti-hybrid rules were introduced on 1 January 2020. Although quite complex, the objective of these rules is to address hybrid mismatch situations between 'associated' entities where, as a result of hybrid instruments, the borrower would be either in a situation of interest deduction in one state without any corresponding taxation in the other or in a situation of double deduction of interest in both states. A hybrid instrument is one which is treated differently for tax purposes by different jurisdictions, for example in instrument treated as debt in one jurisdiction and equity in another.
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 tax earnings before interest, tax, depreciation and amortisation (EBITDA) or €3 million. This limit is 10% of tax EBITDA or €1m for thinly-capitalised entities. A company is 'thinly-capitalised' if the average amount of related party debt exceeds 1.5 times its net equity.
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 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 withholding tax of 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% stake in the French company for at least two years. The participation requirement is reduced to 5% when the EU parent company cannot offset the withholding tax in its country of residency.
From 1 January 2020, foreign loss-making parent companies are allowed to claim for a reimbursement of the withholding tax paid on dividends. To do so, the foreign company must be located in a state that:
Royalties are tax deductible for the payer. However, the royalties deduction is limited when these are 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 Organisation for Economic Cooperation and Development (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 of 28% in 2020 and 25% in 2022, 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.
From 1 January 2020, a foreign loss-making parent company is allowed to claim for a reimbursement of the withholding tax paid on dividends and royalties in certain situations.
Under French domestic law, the disposal of shares in an operating French 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 prevent France from taxing 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. A 'substantial shareholding' for these purposes is 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, which is 28% for 2020 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.
This guide is an abbreviated version of the text for France written for Lexology - Tax on inbound investment 2020. Reproduced with permission from Law Business Research Ltd.
HMRC’s retrospective change on VAT and contract terminations: practical options for businesses