31.

France

Introduction
Statutory rules on transfer pricing adopt the arm’s-length principle for cross-border
related party transactions. In addition, a considerable number of court cases deal with
issues relevant to transfer pricing, which aids in the interpretation and application
of the legislation. In parallel with increased resources within the tax administration,
recent legislative developments emphasise the focus of the French Tax Administration
(FTA) on transfer pricing issues through new rules for documentation as well as tax
measures against tax evasion.

Statutory rules
The following main statutory rules address transfer pricing:

• Section 57 of the French tax code (CGI – Code Général des Impôts);
• The concept of acte anormal de gestion (an abnormal act of management) also
allows the FTA to deny tax deduction for expenses which are not related to normal
acts of management or could not be deemed to have been incurred for the benefit
of the business. The courts decide whether this concept applies by comparing the
commercial practices of the company under review with what they judge to be
“normal” acts of management;
• Sections L 13 AA, L 13 AB and L 13 B of the Tax Procedure Code, which set out
transfer pricing documentation requirements; and
• Section L 188 A of the tax procedure code.

The FTA also released a transfer pricing guide dedicated to small and medium
enterprises in November 2006.

In theory, the tax authorities may choose whether to apply Section 57 or the concept
of acte anormal de gestion when questioning a transfer pricing policy. In reality, this
element of choice is likely to be removed by the limitations of each regulation. Section
L 13 B reinforces the French Revenue powers of investigation by imposing information
requirements in case of a tax audit involving transfer pricing. This law facilitates the
application by the French Revenue of Section 57. Section L 188 A extends the statute of
limitations when the French Revenue requests information from another state under
the exchange of information clause of the applicable tax treaty.

Section 57 – Indirect transfer of profits

Section 57 was introduced into the French tax code on 31 May 1933, and has been
regularly updated since this date.

Section 57 provides that “To determine the income tax owed by companies that either
depend on or control enterprises outside France, any profits transferred to those

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enterprises indirectly via increases or decreases in purchase or selling prices, or by any
other means, shall be added back into the taxable income shown in the companies’
accounts. The same procedure shall apply to companies that depend on an enterprise
or a group that also controls enterprises outside France”.

It may be applied only in relation to cross-border transfer pricing issues. Enforcement

of Section 57 requires the tax authorities to prove that a dependent relationship existed
between the parties involved in the transaction under review and that a transfer of
profits occurred. However, it is not necessary to prove dependency when applying
Section 57 to transfers between entities in France and related entities operating in
tax havens.
F
Dependency can be legal or de facto. Legal dependency is relatively easy for the tax
authorities to prove. It is defined as direct control by a foreign entity of the share
capital or voting rights of the French entity under review. It can also mean dependency
through indirect control, such as through common management. De facto control
results from the commercial relationship that exists between two or more enterprises.
For example, where the prices of goods sold by A are fixed by B, or where A and B use
the same trade names or produce the same product, there does not have to be any
direct common ownership. However, the fact that a large proportion of two or more
companies’ turnover results from transactions conducted between themselves does
not necessarily mean that there is de facto dependency. The Tax Administrative Court
of Paris ruled on 13 February 1997 that there was de facto control in the following
situation: One French company in charge of the distribution of books published by a
Swiss corporation was using personnel and equipment provided by a subsidiary of the
Swiss entity, had the same management as the Swiss entity, and had authority on the
choice of books to be distributed.

A transfer of profits may be inferred where, for example, transactions occur at prices
higher or lower than prevailing market prices. This includes all types of transactions,
including commodities, services, royalties, management services or financing.

Acte anormal de gestion

This concept, which derives from Section 39 of the CGI, was developed by the Conseil
d’Etat (CE), the French supreme tax court in charge of corporate income tax issues.

For the determination of taxable income, expenses are tax deductible only to the extent
that they are incurred for the benefit of the business or within the framework of normal
commercial management.

To invoke the concept of an acte anormal de gestion, it is necessary to prove that a

transfer of profits has taken place and that there was a deliberate intention to move
profits or losses from one taxpayer to another. It may be applied to domestic and
international transfer prices as well as to corporations or branches.

Under this concept, a tax deduction may be refused for charges not incurred for the
benefit of the business or not arising from normal commercial operations.

Section L 13 AA – Transfer pricing documentation requirements

The Amended Finance Act for 2009, passed on 31 December 2009, introduced into
French law new requirements for transfer pricing documentation. Following the
adoption of the new documentation requirements, the FTA recently released specific

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guidance to clarify the transfer pricing documentation law (Regulation 4 A-10-10). The
new general transfer pricing documentation requirements apply to tax years beginning
on or after 1 January 2010 and to any one of the following types of entities located
in France:

a. With turnover or gross assets on the balance sheet exceeding EUR 400 million;
b. That hold directly or indirectly more than 50% of capital or voting rights of a legal
entity mentioned in (a);
c. With more than 50% of their capital or voting rights held directly or indirectly by a
legal entity mentioned in (a);
d. That benefit from a ruling granting a worldwide tax consolidation regime; and
e. That are part of a French tax group in which at least one legal entity of the tax
group meets one of the requirements mentioned under (a), (b), (c) or (d).

The regulations state that the permanent establishments are also within the scope of
the transfer pricing documentation requirements.

The new law requires formal and compulsory transfer pricing documentation,
including the following information:

1. General information on the group:

• General description of the activity, including changes occurred during the
audited years;
• General description of the legal and operational structures forming the group
identifying the related companies engaged in the intragroup transactions;
• Description of the functions performed and of the risks borne by the related
companies to the extent they have an impact in the audited company;
• Identification of main intangible assets having a link to the audited company
(e.g. patents, trademarks, trade names, know-how, etc.); and
• Broad description of the transfer pricing policy.

According to the administrative regulations, such general information should allow the
FTA to understand the economic, legal, financial and fiscal environment of the group.
The main entities of the group must be presented, with a level of detail depending on
the importance of their activity within the group, but also depending on how much
their functions and assets impact the group’s transfer pricing policy.

2. Specific information on the audited company and on the transfer pricing policy. In
particular, the following elements should be provided:
• Description of its activities, including changes that took place during the
audited period;
• Information on operations carried out with related parties, including nature
and amount of flows (global flows per category of transactions; this covers
royalties in particular);
• List of cost-sharing agreements, advance pricing agreements (APAs) and rulings
obtained having an impact on the results of the company;
• Description of the transfer pricing policy with an explanation on the selection
and application of the retained method, in compliance with the arm’s-length
principle and with the analysis of the functions performed, of the risks borne
and of the assets used by the audited company; and
• Where relevant, an analysis of the comparability elements taken into account in
the application of the retained transfer pricing method.

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According to the regulations, such specific information should allow the FTA to assess
whether the transfer pricing policy applied is compliant with the OECD’s arm’s-
length principle.

The audited company may also provide any other relevant documents.

The complete set of documentation should be maintained and provided immediately

upon request (which could be the first day of a tax audit). The regulations, however,
provide for a 30-day extension if the documentation is not available or incomplete,
with a possible additional extension of 30 days.
F
The FTA may assess a maximum penalty of 5% on the transfer pricing adjustment in
the case of missing or incomplete documentation, with a minimum of EUR 10,000 per
audited year. If there is no transfer pricing adjustment, the penalty imposed is EUR
10,000 per audited year for missing or incomplete documentation.

Therefore, it is advisable for companies within the scope of the new regulations to
maintain contemporaneous documentation in anticipation of tax audits considering
the stricter deadlines and penalties.

Companies outside the scope would remain subject to documentation requests during
tax audits. Even if penalties are lower and deadlines not so strict, these companies
would still be at risk of arbitrary reassessments for not having a transfer pricing
documentation in place.

Section L 13 AB
Operations that are conducted by French companies with an associated entity situated
in a non-cooperative state or territory are subject to an additional documentation
obligation. The French company must notably provide the financial statements of the
associated entity.

Section L 13 B
Because of the new documentation requirements, Section L13 B is now applied
mainly to small and medium businesses (SMBs). The Economic and Financial Act,
published on 13 April 1996, contains procedures for transfer pricing examinations.
This legislation gives the FTA a clear right to request information on the taxpayers’
transfer pricing policy in the course of a tax examination when it has evidence upon
which to presume that an indirect transfer of profits abroad has occurred, as defined
by Section 57 of the French tax code. This procedure applies only in the course of a
normal examination.

Four types of information may be requested under this procedure:

1. The nature of the intercompany transactions;

2. The method for determining prices for transactions;
3. The activities of the foreign enterprises, companies or joint ventures; and
4. The tax treatment of the intercompany transactions.

Requests shall include a notification of the expected response time to the audited
enterprise. The time allowed for response, which shall be no less than two months, may
be extended upon justification to a total of no more than three months.

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If an enterprise has responded inadequately, the administration may demand

additional information within 30 days with a formal notice. This notice shall specify
the desired additional information and mention the penalties in case of non-response.
Thereafter, the sanctions imposed on the taxpayer will be twofold:

1. A EUR 10,000 fine for each period under audit; and

2. The right for the FTA to reassess the taxpayer’s profits on the basis of the
information at its disposal. (This procedure, however, remains controversial. The
burden of proof of the dependence and of the non-arm’s-length character of the
transactions rests with the FTA).

On 23 July 1998, the FTA published a regulation commenting on the provisions of

Section L 13 B. This regulation specifies in particular that resorting to Section L 13 B is
neither obligatory nor systematic — it takes place only if the tax inspector has not been
provided with sufficient explanations during the tax audit.

Regarding the transfer pricing method used, any method invoked by the enterprise
can be considered acceptable, provided that it is justified by contracts or internal
memos describing the method, extracts of the general or analytical accounts, economic
analyses (notably on the markets), the functions fulfilled, the risks assumed and the
comparables retained. The FTA still broadly interprets elements required to justify the
transfer pricing method.

Section L 188 A
Section L 188 A provides for an extension of the statute of limitations and is open to the
authorities when they request information from foreign tax administrations before the
end of the initial statute of limitations. The new statute of limitations expires at the end
of the year following the year when the information requested is obtained or, failing
response, at the end of the fifth year following the year that is audited. For example, if
the financial year corresponds to the calendar year, intragroup transactions conducted
in 2001 may, in principle, be investigated within the framework of the authorities
investigating a company, up to 31 December 2004. If a request for information is put
to a foreign tax authority in December 2005, these transactions may remain open to
reassessment for the years 2006 and 2007.

The extension of the statute of limitation applies if there is a request for information
bearing on intragroup transactions or on entities established in countries with
favourable tax regimes (French tax code Section 209 B), but also in cases of requests
for information with relevance to the foreign assets, credits, income or activities of a
French taxpayer.

Other regulations
In addition to the legislation specific to transfer pricing described above, the following
texts and regulations are relevant to the issue:

• The terms of various tax treaties; and

• Sections of the French tax code that deal with related issues such as transactions
with entities in tax havens.

Section 238 A limits the deductibility in France of commissions and other payments
paid to entities located in tax havens. A company is deemed to benefit from a privileged

390 France International Transfer Pricing 2012

tax regime when the difference between the foreign corporate tax and the tax that
would have been paid in France exceeds 50%.

Under Section 209 B, income which is transferred under certain conditions to a

company or a permanent establishment which enjoys a privileged tax regime has to
be recaptured in France and is subject to corporate income tax. This anti-tax-haven
regulation was amended in the Finance Bill for 2005 and was commented upon in an
administrative regulation on 16 January 2007. The scope of Section 209 B has been
reduced. For instance, the French controlled foreign company (CFC) rules may not
be applied if the foreign company is located in a member state of the European Union
(EU) and if the arrangement in question is not an artificial arrangement set up only to
F
obtain a tax advantage. In this new regulation, the FTA makes a reference to the ICI
and Cadbury Schweppes ECJ cases to explain the meaning of “artificial arrangements”
mentioned in the EU safeguard clause (Administrative regulation: 4 H-1-07).

• Sections of the French tax code that deal with specific measures against states or
territories considered to be non-cooperative:

As from 1 January 2010, new Section 238 0-A defines, from a French perspective, non-
cooperative states or territories (NCST) as a country or territory that:

a. Is not a member of the EU;

b. Has been reviewed and monitored by the OECD Global Forum on Transparency and
Exchange of Information;
c. Has not concluded at least 12 administrative assistance agreements/treaties that
allow a complete exchange of information for tax purposes; and
d. Has not concluded such an agreement/treaty with France.

The NCST list is updated annually to take into account, in particular, the effective
implementation of the tax information exchange agreements.

As of 1 January 2011, NCST are the following states or territories: Anguilla, Belize,
Brunei, Cook Islands, Costa Rica, Dominica Grenada, Guatemala, Liberia, Marshall
Islands, Montserrat, Niue, Oman, Panama, Philippines, Republic of Nauru, Saint
Vincent and the Grenadines, Turks and Caicos islands.

Withholding tax on passive income is increased to 50% for operations with NCST.
Amounts paid to entities located in an NCST may also not be tax deductible for French
corporate income tax purposes.

• The first pure transfer pricing regulation was issued on 4 May 1973, in the form of
a note. (This regulation is the main element of the FTA doctrine, and in April 1983,
the tax authorities finalised and published this commentary on their interpretation
of the transfer pricing legislation once the Section 57 was amended to cover
transactions with tax havens.);
• A new regulation published on 23 February 2006, on bilateral and EU mutual
agreement procedures;
• Regulations published on 7 September 1999, on bilateral advance pricing
agreements and 24 June 2005, on unilateral advance pricing agreements; and
• The tax authorities’ commentary on legal cases involving transfer pricing, which
has been issued over the years in the form of directives (A directive is an indication
of how the tax authorities will interpret and apply legal decisions.).

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Legal cases
Several cases over the years have established important principles for dealing with
transfer pricing issues. These are summarised below:

Parent-subsidiary relations: expenses invoiced by a foreign

parent company
SA Borsumij Whery France, CAA (Cour Administrative d’Appel) Paris 11
February 1998
The administration considered that the reimbursement of such a charge represented
a transfer of profits abroad “insofar as the French company has not substantiated
the reality of the services, invoiced in a vague manner for services which the French
company could perform itself”. The submission of “incomplete documents of a general
nature” was deemed to be insufficient. This analysis was then confirmed by the French
supreme tax court.

Parent-subsidiary relations: partnership

SA Cogedac, CE 23 November 2001
A parent company and its subsidiary incorporated a partnership in which the
subsidiary contributed its purchasing platform. Ninety percent of the benefits were
attributed to the parent company. The CE ruled that the administration is entitled to
reincorporate to the tax base of a French subsidiary the revenue allocated to the parent
company. The important contribution of the subsidiary and its absence of interest are
considered by the French Supreme Court as an abnormal act of management (acte
anormal de gestion).

Reality of services
SA Bossard Consultants, CAA Paris 17 March 1998
A subsidiary company, which paid royalties for a licence of a trademark to its parent
company, could not deduct part of the sums paid as a temporary increase of the
royalties by one point because it could not justify the reality of the public relations
and promotion activities in respect of the trademark that the temporary increase was
purported to cover.

Date to use when appraising a transfer pricing transaction

CE Ford France and CAA Paris 4 October 1994
The transaction must be appraised on the basis of facts known (or facts that could have
reasonably been known in the circumstances) at the time the contract was made. The
use of hindsight is not permitted.

Comparable searches
Pharma Industrie, CAA Paris 12 July 1994; CE Galerie Vercel 28 September 1998; SARL
Solodet, CE, 21 February 1990; Reynolds Tobacco, CAA Paris, 20 November 1990;
SARL les fermiers de l’Aisne, CE, 12 February 1993; Lindt et Sprungli CE, 4 December
2002; Novartis Groupe France SA, CAA Paris, 25 June 2008; Man Camions et Bus, CAA
Versailles, 5 May 2009

The Pharma Industrie case illustrates the type of comparison that the courts require
from the FTA and taxpayers. The tax authorities used five products of similar
commercial reputation, distributed by three companies operating in the same
pharmaceutical sector with comparable turnovers, as comparable evidence in a
transfer pricing dispute.

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The CE is very careful when examining comparable situations. For example, the CE,
on 28 September 1998, refused to consider that situations were comparable when the
FTA was relying on isolated French-based transactions when the situation under audit
involved a long-lasting relationship between a French entity and its US subsidiary.

In Solodet, the comparison was rejected because the comparable products were sold
in Germany rather than in France. It was judged that both the prevailing market
conditions and the end use of the products in Germany were different, and that
therefore the companies identified by the tax authorities were, in fact, comparable to
the French company under review.
F
In Reynolds Tobacco, the 2%–3% commission received by the French entity was
deemed by the courts to be an arm’s-length amount, even though competitors were
receiving about 8% for providing similar services. This was decided on the basis
that the services provided by the French company were sufficiently, if only slightly,
different, and this justified the lower rate charged.

The Tax Administrative Court of Paris decision in 1990, referred to above, is in line
with the courts’ approach to comparables. The tax court decided not to accept the
position of the FTA because the data provided to support its approach was too vague.
In particular, the transfer of ownership did not take place in the same manner in the
various comparable situations as it did in the taxpayer’s situation.

In Lindt & Sprungli, the CE approved the position taken by the FTA, even though the
FTA did not support its position by reference to independent comparable data, but
rather through facts and circumstances of the case at stake.

In the Novartis Groupe France SA case, the court stated that if the FTA intends to use
prices existing between other companies or a profit split approach by considering the
global margin realised on one product at group level to reassess the French entity, it
must demonstrate that the price invoiced to the French entity by a related company
does not comply with the arm’s-length principle with a relevant and exhaustive
economical analysis.

In Man Camions et Bus, the Court of Appeals stated that a comparability study
performed by the FTA has to be based on independent comparables acting in similar
conditions and markets. In this case, the FTA did not establish that foreign European
markets were similar to the French market and therefore rejected the pan-European
comparable study performed by the FTA. The fact that the French entity has been loss-
making for years is not, in isolation, sufficient to prove the existence of a transfer of
benefit out of France.

Concept of group interest

n° 2372, CE, 24 February 1978; Sovifram, CE 3 June 1992; Société Nord Eclair, CAA
Nancy, 6 March 1996; CAA Lyon 24 February 1998; SA Rocadis, CE 26 September 2001

The French courts consistently have supported the tax authorities in refusing to accept
the idea of the interests of the group as a whole serving as sufficient justification for a
particular intragroup transfer pricing policy. However, charges at cost were accepted by
the courts when the charges were invoiced by a parent entity to a subsidiary, according
to the 24 April 1978 CE decision.

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The CE accepted the same approach on 26 June 1996, where the charges were
invoiced by a subsidiary to a parent company. In a 6 March 1996 decision, the Nancy
appeal court expressly accepted an invoicing of charges at cost between two sister
entities. This conclusion may derive from the fact that the FTA was challenging the
flow of invoices and suggested that the invoicing should have gone through the parent
company, so that the loss was incurred by the parent entity rather than one of the sister
entities.

In a decision in 1992, the CE mentioned that an offset could also be a valid justification
for a loss made by the subsidiary when selling products acquired from its parent entity.

In a recent decision, the Lyon Appeal Court denied the group concept approach
because the tax administration was able to demonstrate that margins were significantly
higher on third-party transactions than on transactions entered into with the parent
company, despite both groups of transactions being of similar size. The subsidiary was
unable to provide evidence of services that had been provided by the parent company,
which may have allowed the subsidiary to justify this difference in margins.

In the Rocadis decision in 2001, the CE accepted the concept of group of interest
between the members of a distribution network. The CE did not adhere to the general
group concept approach, but the French court reckoned with the specificity of
functioning of this specific distribution network.

Economic or commercial benefit

Boutique 2 M, CE 27 July 1988
In a number of cases over the years, the courts have accepted taxpayers’ arguments
that their transfer prices did not satisfy the arm’s-length principle because they
resulted in some economic or commercial benefit. For example, their prices increased
market share.

In all instances where this argument is put forward, the deemed benefit must be
specific and reasonable in relation to the loss or reduced revenue recognised by the
French company. Where the taxpayer has been able to prove only a potential benefit,
the transfer pricing policy has been adjusted.

In such cases the burden of proof lies with the taxpayer. Various court decisions have
established that this applies whether the tax authorities are attempting to enforce
Section 57 of the tax code or the concept of acte anormal de gestion.

Legal protection of the intangible licensed as royalty payment

Bentone Sud, CAA Paris 15 June 1999
Despite the fact that the patents were no longer protected and there was a lack of
actual transfer of know-how, the Appeal Court of Paris accepted the deductibility of a
licence fee covering patents and know-how, in addition to a trademark and a regular
supply of equipment. The court judged that the access to the trademark and the right
to access products made by the licensor were a valid justification for the payment of
royalty. This decision is unique.

Decisions such as Outinord, or the above-mentioned Lindt & Sprungli court decisions,
confirm that the lack of legal protection is a critical factor for the courts in appraising
the arm’s-length nature of a royalty flow.

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Existence of a written agreement
Electrolux, CE 21 October1991; Barassi, CAA Lyon 11 February 1995
The court ruled in Electrolux that the lack of a written agreement signed prior to
transactions taking place was not relevant to the transfer pricing policy under dispute
because the ongoing trade between the related companies under review supported
the transfer price as described to the tax authorities. This decision was based on the
provisions of the “Code de Commerce”, which recognises oral trade agreements as
valid and binding.

Once an agreement has been signed, the parties must abide by it. If circumstances
change and the terms no longer apply, it must be amended.
F
Despite the above court decision, a contemporaneous written agreement is advisable in
all instances.

Sale of assets
N°17055, CE 21 November 1980; Berri Ponthieu, CE 21 June 1995
In Berri Ponthieu, the court decided that the sale of shares in a listed entity at book
value, which was lower than the prevailing market value, was a non-arm’s-length
transaction, even though the sale was a group reorganisation.

Similarly, the acquisition of shares at a price exceeding the market value is also a non-
arm’s-length transaction, unless there are special circumstances.

Sale of goods or services

SARL Rougier Hornitex, CE 26 June 1996; SNAT, CE 31 July 1992 Rouleau, CAA
Bordeaux 27 December 2001; Etablissements Georges Legros, CAA Lyon, 29
October 2010
The sale of products or services to related parties at a price below prevailing domestic
or international prices is not considered an arm’s-length transaction.

In Rougier Hornitex, the court decided that a sale at a loss of services and goods
invoiced by a subsidiary to a parent company during the subsidiary’s first two financial
years was not an acte anormal de gestion. The price of the goods and services, even
though generating operating losses, was not below the market price and therefore was
considered an arm’s-length transaction.

In the Rouleau case, the court ruled that the tax authorities did not establish an acte
anormal de gestion by only referencing that the sales of goods and services were below
the market price.

In the Etablissements Georges Legros case, the Court of Appeals decided that setting
an intragroup currency conversion rate different from the market rate can constitute
a transfer of profits as defined by the Section 57 of the French Tax Code if it results
in a price increase. In this case, such an increase in the prices was not justified by
economic reasons.

Commission
Vansthal France, CAA 11 March 1993
A number of court decisions address situations where companies used related
intermediaries whose activities did not justify the level of commission or remuneration
paid to them. For example, the decision of the Court of Appeal in Nancy on 11 March

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1993 disallowed a transfer pricing policy under which a 20%–40% mark-up was added
to payments to a Swiss entity because in its capacity as a billing centre it bore no risk.

However, where taxpayers have been able to justify the nature and value of the services
provided, the courts have invariably accepted the commission paid. For example, a 5%
commission was found to be acceptable between A and B, where B was assisting A with
promoting its exports to Italy (CE 26 June 1985).

Royalties
Caterpillar, CE 25 October 1989
In Caterpillar, a 5% royalty was judged to be an arm’s-length rate for the
manufacturing and assembling operations. In this case, the court refused to accept that
there should be different rates for the two different activities.

Cap Gemini, CE 7 November 2005

In Cap Gemini, the French tax Supreme Court stated that the FTA did not demonstrate
the indirect transfer of benefit in the absence of a comparability study. The criticised
transaction consisted of a royalty-free licence of the Cap Gemini trademark and logo.
The court considered that the fact that French subsidiaries were charged with a 4%
royalty, whereas European and American subsidiaries were charged no or lower
royalty, was not relevant. The court considered that the value of a trademark and logo
may differ depending on each situation and market. Different situations may request
different royalty rates. In its ruling, the Conseil d’Etat reaffirmed that a transfer pricing
reassessment must be based on solid evidence.

Commissionaire and permanent establishment (dependent agent)

Zimmer Limited, CAA Paris 2 February 2007, CE 31 March 2010
In Zimmer Limited, the Administrative Court of Paris stated that a commissionaire
of a UK principal company constituted a permanent establishment of that company
in France. The French company, Zimmer SAS, distributes in France the products for
Zimmer Limited and was converted into a commissionaire (acting in its own name but
on behalf of Zimmer Ltd.) in 1995. The FTA considered that Zimmer SAS constituted
a permanent establishment of Zimmer Limited in France because the French entity
had the power to bind its UK principal in commercial transactions related to its own
activities. Zimmer Limited should, therefore, be taxed on the profits generated in
France according to Section 209 of the FTC and Article 4 of the double-tax convention
between France and the United Kingdom.

The court concluded that Zimmer SAS constituted a permanent establishment

of Zimmer Limited in France and that, accordingly, the taxation in France of the
profits attributed to such permanent establishment for the years under audit was
fully justified.

Following the conclusions of the “Rapporteur public”, Ms. Julie Burguburu, the
High Court (CE 31 March 2010) nullified the earlier decision of the Paris Court
and agreed with the taxpayer. The High Court reconfirmed that a company has a
permanent establishment in a state if it employs a person who has the authority
to bind the company in a business relationship and that person is not independent
vis-à-vis the company. Two criteria, therefore, need to be met in order to be qualified
as a permanent establishment. The two criteria are dependence and the authority
to engage:

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• The High Court does not address the issue of dependence, which was not debated
in this case because the dependency was already established.
• Concerning the authority to engage, the High Court quotes article 94 of the
Commerce Code included in article L-132-1 of the new code and notes that the
commissionaire acts in its own name and cannot conclude contracts in the name
of its principal. It underlines that the commissionaire does not legally bind its
principal because of the nature of the contract. The High Court concludes that a
commissionaire cannot constitute a permanent establishment of the principal.
However, the High Court also sets certain limits by stating that when it derives from
either the terms and conditions of the commissionaire’s contract or any element
identified during the examination of the case that the principal is personally bound
F
by the contract agreement concluded by the commissionaire with third parties, and
the commissionaire then constitutes a permanent establishment of the principal.

Financial charges and revenue

Interest charges
N° 75420 and n° 77533, CE, 16 November 1988; Société Arthur Loyd, CAA Paris 1
February 1994; Montlaur Sakakini, CAA Lyon, 25 October 1995; SNC Immobilière
GSE, CE, 7 September 2009; France Immobilier Groupe, CAA Paris, 29 September
2009; Société d’acquisitions immobilières, CE, 22 January 2010.
The interest rate charged to a subsidiary by a French entity must be comparable with
the interest rate the French entity would receive from a French bank for an investment
similar in terms and risk. The interest rate used by the courts as a reference in Montlaur
Sakakini is the Banque de France’s loan rate.

In the France Immobilier Group decision, the Court of Appeal considered that the
level of the interest rate should not be assessed by reference to the debts obtained by
the lender, but should be based on the financing conditions that the borrower could
have obtained from a third-party bank. This case illustrates the recognition of the
“standalone basis” approach.

In the SNC Immobilière GSE case, the High Court ruled that foreign rules had to be
taken into account when examining whether or not a French company committed an
abnormal act of management. If foreign rules prohibit serving interests on certain
“sums” contributed to a foreign subsidiary, then the French parent cannot be viewed as
having unduly renounced to some remuneration in the benefit of its foreign subsidiary.
In this case, the Portuguese law expressly characterised the payments as shareholders
equity and thus prohibited interest payment.

In the Société d’acquisitions immobilières decision, the High Court decided that the
cash advance granted by a sub-subsidiary to its “grandmother” in difficulty with
which it had no business relations, even accompanied by the payment of interest,
could constitute an abnormal act of management if the amount lent is clearly
disproportionate to the creditworthiness of the borrowing company.

Deferral of payments
Baker International, CAA Bordeaux 6 April 1994
If interest is not charged on outstanding loans to a related company, it is considered
either an acte anormal de gestion or is subject to Section 57 of the tax code.

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Absence of charges for guarantees

Soladi, CAA Nancy 30 April 1998; Carrefour, CE, 17 February 1992
It is deemed to be an abnormal act of management to provide a financial guarantee
free of charge, unless direct actual benefit for the entity providing this support can be
justified. In a decision of 17 February 1992, the French Supreme Court suggested a rate
of 0.25% for this service, while the FTA was seeking 1%. The remuneration asked for
this service should be commensurate with the risk incurred as well as with the market
value of this service, irrespective of the actual cost.

Debt waivers
SA Les Editions JC; CE 11 February 1994; Télécoise, CE, 16 May 2003; Guerlain,
CE, 23 April 2008; Beauté Créateurs SAS, CAA Paris, 12 May 2010; Société
Générale, CAA Versailles, 29 June 2010; Delpeyrat Chevalier, CAA Bordeaux, 15
March 2011
The arm’s-length principle also applies to debt waivers. France-based entities may
waive all or part of outstanding loans to related foreign entities to the extent that they
can justify some economic or commercial benefit as a result of this financial assistance.

In Télécoise, the High Tax Court determined that a French company is allowed to
deduct a provision for bad debt in relation to its foreign branch whenever the debt is
related to its foreign business operations carried out through the branch. However, the
French company must establish that the operation has a direct commercial benefit on
the business activities carried out in France.

In the Guerlain decision, a French company waived its receivables towards two foreign
branches in Australia and Singapore of its Hong Kong subsidiary. The judge made
a reference to the consolidated results of the subsidiary (including those of the two
branches), which were positive despite the financial difficulties of the branches; this
was one of the arguments put forward by the judge to reject the deductibility of the
waiver of the receivables in France.

In the Beauté Créateurs SAS case, the Court of Appeals applied the principle settled in
the Télécoise and Guerlain cases. In this case, the court permitted the deduction of the
debt waiver granted to its foreign branch by the headquarters in France because the
branch provided services for the benefit of the French headquarters which increased
the sales in France and thus developed the business in France.

In the Delpeyrat Chevalier case, in order to refuse the deductibility of the debt waiver,
the Court of Appeals took into account the turnover generated by the operations
conducted with the foreign branch. In this case, it represented only 1.24% of the
total turnover.

In the Société Générale case, the parent company granted an advance to a foreign
subsidiary to face its financial difficulties and to meet the capital ratio requirements
demanded by the local authority. The parent company granted a debt waiver to
its subsidiary. The court ruled that such a debt waiver of a financial nature did not
constitute an abnormal act of management if it allowed the parent company to avoid
suffering a negative impact on its reputation from the bankruptcy of its subsidiary,
even where the subsidiary in question is a small one.

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Choice of the financing mode of a company’s operations
SA Andritz, CE 30 December 2003, n° 23-3894; Banca Di Roma, CAA Paris, 16
December 2010
The terms of Article 57 of the French Tax Code (FTC) do not have the purpose, nor
the effect, of allowing the administration to assess the “normal” nature of the choice
made by a foreign company to finance through a loan, rather than equity, the activity
of an owned or controlled French company, and to deduce, if the need arises, tax
consequences (cf. Article 212 of the FTC – thin capitalisation).

In the Banca di Roma case, the Court of Appeals reiterated that the FTA is not allowed
to decide whether a business is to be financed through debt or equity.
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Management charges
Allocation of charges
N° 2372, CE 24 February 1978
Management charges must be shared among all of the group entities benefiting
from the corresponding services. Not allocating charges among all receiving group
companies is considered to be an acte anormal de gestion. Management charges should
generally be allocated on the basis of a detailed analysis, taking into account which
of the services the company received. However, when such a breakdown would be a
cumbersome exercise unlikely to result in an accurate allocation, the charges may be
allocated on the basis of a less detailed calculation, such as turnover.

Justifying the services

Gibert-Marine, CAA Bordeaux 12 December 1995; n° 26241 CE 22 June 1983; SA Mat
transport, CAA Nancy 5 July 2001

The basis of fees paid for management services will be examined in a tax audit. The
taxpayer will have to provide evidence about the nature, content, and value of the
services rendered by the supplier to justify the fees paid and to receive a tax deduction
for them. In this context, an invoice alone is not sufficient proof.

Payments for seconded executives

Oudot, CE, 30 March 1987; Ministerial commentary, 7 September 1987
In Oudot case law, it was considered that the costs of an executive seconded from a
French company to a Swiss subsidiary should be charged to the Swiss company, unless
the French entity could demonstrate a commercial or economic benefit from not
doing so.

Burden of proof
As a rule, the burden of proof lies with the tax authorities, unless the transfer of profits
concerns a tax haven, in which case the burden of proof is transferred to the taxpayer.

However, there is now a legal requirement for taxpayers to provide documentation

supporting their transfer pricing policies. Although in theory the burden of proof lies
with the tax administration, in practical terms, the burden of proof has always fallen on
the taxpayer where the tax authorities have deemed a profit shift to have taken place or
inappropriate transfer pricing to exist.

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Tax audit procedures

Selection of companies for audit
Generally speaking, transfer prices are audited as part of a formal tax audit on all
issues. There are no rules as to which companies come under investigation. Major
companies are audited every three to four years, unless in a loss-making situation in
which the statute bar limitation rules for corporate income tax are less crucial to the
tax administration. Nowadays, almost all sectors are audited, including French wholly
owned entities and subsidiaries of non-France-based groups.

The audit procedure

Tax audits are generally carried out through the following procedure:

• Written notice is sent to the taxpayer informing of the date of the auditor’s first
visit and the particular taxes and years under investigation. The taxpayer may use a
professional advisor to assist during the investigation.
• The auditor’s site visits take place at the taxpayer’s main premises, either the
registered offices or the main place of operations. The auditor’s on-site presence
can last from a few days to several months, depending on the size of the taxpayer’s
business and the number and complexity of issues under review. There is no
maximum limit to the time the auditor may spend on-site. The auditor may be
assisted by information systems or specialists taken from a dedicated group within
the tax administration, as well as by FTA transfer pricing experts.
• Throughout the auditor’s visit(s), regular dialogue takes place between the
taxpayer and the tax inspector.
• On-site investigations by the tax inspector cease when the inspector is satisfied that
all outstanding questions have been answered. At this point, written notice of any
underpayment is sent to the taxpayer.
• The taxpayer must provide a written response to the notice within 30 days of
receipt. In the response, the taxpayer must either accept or reject the proposed
adjustment. If s/he chooses to contest the reassessment, the taxpayer must set
out detailed and convincing arguments to support his/her case. At this point, the
taxpayer may ask to meet the tax inspector’s superior. Such a request is generally
not denied. After this meeting the taxpayer may then also request a meeting with
the local head of the tax audit division (i.e. the appeals officer or Interlocuteur
départemental).
• After considering the written arguments of the taxpayer (and generally only after
the meetings described above have taken place), the tax authorities either reaffirms
or amends their initial position in a letter. There is no time limit within which the
tax authorities must provide their response.
• In their final response, the tax authorities are obliged to offer the taxpayer the
opportunity to take his/her case to the Commission Départmentale. This body
consists of representatives of the taxpayer and the tax authorities and is responsible
for reviewing technical, as opposed to legal, tax issues. Both parties are entitled to
submit reports to the commission, which hears both arguments before issuing a
decision. The decision, however, is not binding on the FTA.
• The tax authorities are allowed to raise an assessment to collect the tax only once
the Commission has reached its final decision, at the latest within three years from
the date of the assessment notice (unless an application for MAP has been filed –
see mutual agreement procedure paragraph below).

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Revised assessments and the appeals procedure
If the taxpayer still wants to appeal against the revised assessment, then s/he
may submit a réclamation pré-contentieuse, a claim prior to court action, to the tax
authorities. If there is no response from the tax authorities within six months of the
claim submittal, then the taxpayer may elect to take the case to court. Otherwise, s/he
can wait for the tax authorities to release their decision, after which the taxpayer has
two months from that date to take the case to court.

The first court in which the case may be heard is the Tribunal Administratif (TA).
Arguments are submitted in writing, although either or both parties may be called
to the actual court hearing. Like the Cour Administrative d’Appel (CAA), the TA may
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appoint an independent expert to review the facts presented by both parties before
giving its judgment.

Either party may appeal the TA’s decision; this appeal would be heard by the CAA. The
plaintiff has two months from the announcement of the TA’s decision in which to make
an application to the CAA.

In very limited circumstances, either party may ask the CE to hear the case. The CE
is the supreme corporate and income-tax court, and once it has heard the case it will
either issue its own final ruling or instruct the CAA to review the initial ruling decision
reached by the TA.

Depending on the provisions of the tax treaty that applies, a taxpayer may at any time
decide to pursue a competent authority claim instead of litigation. It is also possible to
pursue both routes at the same time.

Additional tax and penalties

Interest at the rate of 0.40% per month, or 4.8% per year, is charged for late payment
or underpayment of corporate income tax. These amounts are not deductible for the
corporate income-tax basis.

If the good faith of the entity is challenged, which tends to be frequent when transfer
pricing issues are scrutinised, a penalty of 40% or even 80% of the tax avoided is levied
(pénalités pour manquement délibéré). This extra charge is obviously not deductible
from the corporate income-tax basis.

In addition, a transfer pricing adjustment may lead to VAT and taxe profesionnelle,
or local tax on business activity, as well as a deemed dividend issue, depending on
treaty provisions.

Resources available to the tax authorities

The resources available to the tax authorities to devote to transfer pricing
investigations are increasing. Major multinational entities are audited by the Direction
des Vérifications Nationales et Internationales (DVNI or National and International
Audit Administration).

The DVNI is responsible for auditing all companies with a turnover in excess of
EUR 152.4 million for industrial companies or in excess of EUR 76.2 million for
service companies.

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With 30 auditing teams divided by sectors, the DVNI’s level of industry-specific

knowledge is high. General tax auditors may be assisted by tax inspectors specialised
in transfer pricing (30ème Brigade). They can also use dedicated teams in charge of
computer-assisted audit or audit of tax credits for research and development expenses.

Use and availability of comparable information

Various databases are available that contain the financial accounts of most of the
companies, whether or not listed on the stock exchange. These include InfoGreffe,
Diane and Amadeus databases.

The FTA has extensive access to Diane and Amadeus. The inspectors specialised in
transfer pricing commonly use these tools to check taxpayer’s benchmarks or produce
their own alternative comparable studies. The DVNI is increasingly inclined to accept
or even perform pan-European benchmarks.

Risk transactions or industries

Conversion schemes with a transfer pricing element are currently scrutinised in
audit situations.

The legal cases listed above illustrate that other sectors, such as retail, may also
occasionally be investigated. In addition, it is worth noting that the DVNI’s transfer
pricing and financial inspectors recently have been put together on the same team to
enhance efficiency in transfer pricing audits involving valuation issues.

Limitation of double taxation and competent

authority proceedings
The FTA does not publish data on competent authority proceedings.

Advance pricing agreements (APA)

French tax regulations provide for official APA procedures. Between 1999 and 2004,
only bilateral APAs were accepted. The rectifying Finance Bill of 2004 (Article 20)
codifies the legal basis for APAs and extends their scope to unilateral APAs. The APA
procedure is now included in the tax procedures code (see Article L. 80 B 7° of the Livre
des procédures fiscales). Previously, the only domestic authorisation was through a 1999
FTA regulation. In addition, an APA procedure requesting limited documentation and
simplified monitoring is now available to small- and medium-size enterprises.

Bilateral APAs
In a regulation issued on 7 September 1999, the tax administration defines the
conditions under which it would be willing to grant a bilateral APA. This may be
initiated only with states that have signed a treaty with France containing a section
equivalent to Section 25.3 of the OECD model treaty. This regulation is a fundamental
change from prior opinion expressed by the central tax administration, where they
saw an APA procedure as a breach of the principle of equality. Under this regulation,
the application process can be initiated in France or in the other state. The application
may cover all transactions or only certain transactions, covering all or part of the
companies’ operations (product, function, type of transaction or line of business).
Through preliminary meetings with the FTA, the exact scope of the information (tax,
financial, legal, industrial, commercial, etc.) to be provided is defined. A formal request
may then be addressed to the FTA. Within two months of this application, the same

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application must be submitted to the other tax administration. An indicative list of
information to be provided is included in this regulation, but the basic idea behind this
list is to establish constant debate and exchange of information with the FTA as part of
the review of the application. Once the review is completed, a draft ruling is issued for
final approval by the taxpayer.

The ruling defines the parties, transactions, transfer pricing method(s) elected,
assumptions used, revision formula, date of application of the ruling and its duration
(three to five years), and contents of the annual report to be issued by the taxpayer.
The ruling may not have a retroactive effect, except within the limit of the financial
year during which the application is made.
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Unilateral APAs
Unilateral APAs, which until the rectifying Finance Bill of 2004 were not authorised in
France, may now be accepted by the French administration. However, in a regulation
issued on 24 June 2005, the FTA made it clear that it would still favour the conclusion
of bilateral APAs. Unilateral APAs could be granted in cases such as:

• If the bilateral tax treaty does not provide for a MAP;

• If, despite the MAP provided in the bilateral tax treaty, the foreign competent
authority refuses to conclude an APA; and
• For simple issues such as management fees and allocation key issues.

Small-and medium-size (SME) enterprises: simplified APA procedure

As the standard APA procedure can be burdensome, a simplified APA procedure for
SMEs is available as from 28 November 2006. The simplified procedure proposed by
the FTA includes the following:

• Less transfer pricing documentation is required for the APA request. The
documentation is limited to a legal chart of the group, the list of transactions and
prices between related parties, functional analysis, description and justification of
the transfer pricing method, and the financial statements of the foreign companies
involved in the transactions.
• The FTA assists in the preparation of the functional analysis and in the choice of the
appropriate transfer pricing method.
• An economic analysis is also requested. During an experimental period, the FTA
may perform the benchmarking analysis at the request of the SME.
• Simplified content of the annual compliance report requested in the follow-up years
of the APA (e.g. details of the computation of the remuneration and a statement on
the substantial changes to the activity conditions described in the APA request, such
as activities, functions performed, risks borne, legal/de facto dependence, assets
used, accounting methods).

Only SMEs that meet the following two criteria are eligible for the simplified
APA procedure:

• SMEs with (1) fewer than 250 employees, and (2) a net turnover of less than EUR
50 million or with assets that do not exceed EUR 43 million; and
• 25% or more of the capital or voting rights are not owned by one enterprise,
or jointly by several enterprises that do not meet the conditions of the
previous paragraph.

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To determine whether the criteria are met, reference should be made to the financial
year preceding that in which the request to initiate the procedure is submitted.

Mutual agreement procedure (MAP)

The rectifying Finance Bill of 2004 (Article 21) suspends the collection of taxes when,
following a notice of reassessment, a competent authority procedure is undertaken by
the taxpayer to eliminate double taxation (see Article L. 189 A of the Tax Procedures
Code, Livre des procédures fiscales). Prior to this amendment, after issuing a notice of
reassessment the FTA had three years to issue a notice of collection, notwithstanding
the taxpayer’s undertaking of a competent authority procedure. In this situation, given
the average length of a competent authority procedure in France (three years and
seven months), the FTA had to collect the taxes before the outcome of the competent
authority procedure. After receipt of the notice of collection, the taxpayer could, and
still may, request to benefit from deferral of payment of taxes if appealing to domestic
remedies. However, under the deferral of payment procedure, the taxpayer incurs
interest for late payment from the date stated in the notice of collection.

Under the new tax collection regime, the three-year statute of limitation (relating
to issuance of the notice of collection) is suspended starting from the opening date
of the competent authority procedure. The suspension holds until the end of the
third month following the date of the notice given to the taxpayer that states the
outcome of the competent authority procedure. Suspension of tax collection applies to
competent authority procedures pursuant to the relevant tax treaty and the European
Arbitration Convention.

The suspension of tax collection is applicable to competent authority procedures

opened as from 1 January 2005.

In February 2006, the French revenue issued a new regulation regarding MAP.
This detailed regulation provides guidance pertaining to the scope, conditions and
implementation of the MAP in France. It also aims to apply the recommendations
encapsulated in the code of conduct elaborated by the EU Joint Transfer Pricing Forum
with respect to the implementation on the EU Arbitration Convention.

Binding PE ruling
The rectifying Finance Bill for 2004 (Article 19) extends the tax ruling procedure
to permanent establishments (PE) (Article L. 80 B 6° of the Tax Procedures Code,
Livre des procédures fiscales). Under the extended procedure, foreign companies
may request a ruling from the FTA stating whether their business activity in France
constitutes a PE or a “fixed place of business”, according to the bilateral tax treaty
between France and the parent company’s country of residence. Not only may the
ruling apply to subsidiaries, but also it can relate to agents, regardless of whether they
are independent (see Article 5 §6 OECD Model Convention), or branches, regardless
of whether their only purpose is to hold and deliver the parent company’s goods (see
Article 5 §4 OECD Model Convention). When a request for a ruling is sent, the FTA has
three months to reply. If the FTA does not reply within that time period, the request is
automatically approved. The French subsidiary of the foreign company is, therefore,
not deemed a PE in France, and the group is not liable for corporate income tax in
France, consequently avoiding double taxation.

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The approval binds the FTA, which may not issue tax reassessments for periods prior
to the ruling. This new procedure is, however, limited exclusively to taxpayers acting in
good faith (contribuables de bonne foi), that is, taxpayers having provided all the useful
elements to decide whether a business constitutes a PE and has not provided wrong
or incomplete information. The tax authorities may change their decision regarding
periods after the ruling, as long as the taxpayer is informed of that change. This
procedure is applicable as from 1 January 2005 (see Decree of 8 September 2005).

Liaison with customs authorities

The tax authorities have the authority to use information gathered by the customs
authorities when challenging a transfer pricing policy. F

OECD issues
The French tax authorities have not published a formal interpretation of transfer
pricing guidelines issued by the OECD. Indeed, there has not yet been any commentary
on the guidelines issued in July 1995. At various times, however, such as at public
seminars, the tax authorities have indicated that they do refer to the OECD principles
during audits and settlement procedures.

An explicit reference to the OECD principles was made for the first time in the
regulation of 23 July 1998. Reference to these principles is also made in the APA and
transfer pricing documentation regulations referred to above.

The courts tend to use the OECD’s principles as guidelines (TA de Lyon, 25 April
1990, Fisons).

Joint investigations
There is little information about joint investigations, although it is generally thought
that the tax authorities participate more in these now than in the past. In particular,
the French authorities tend to join forces with their counterparts in the United States,
Germany, Belgium and the United Kingdom.

Thin capitalisation
To counter thin capitalisation situations more efficiently, the French 2006 Finance
Bill adopted a new system, applicable from January 2007. The scope of the old thin
capitalisation rule had been limited by two major decisions of the French Supreme
Court on December 2003 (Conseil d’Etat, Andritz SA and Correal Gestion) and by a
regulation dated 12 January 2005.

The new provisions provide for the repeal of the existing thin capitalisation legislation
and replacement by an entirely new set of rules, which cover the interest rate charged
and thin capitalisation. These new thin capitalisation rules apply to all types of
financing granted to a French entity by any French or foreign-related party.

Interest rate limitations

Under the revised Article 212 of the CGI, the tax deduction of interest paid to related
parties is limited to the higher of (1) the average annual interest rate charged by
lending institutions to companies for medium-term (two years or more) variable-
rate loans, or (2) the interest that the indebted company could have obtained from
independent banks under similar circumstances.

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The arm’s-length criterion mentioned in (2) is a new feature for France. This provision
is likely to shift the burden of proof to the taxpayer, as the French tax authorities, in
practice, likely will seek to apply the average annual interest rate. Once companies
have passed this interest rate test, French indebted companies must pass a second test,
namely the debt ratio.

Debt ratio
In addition, the new thin capitalisation rules provide that a portion of interest paid to
related parties, which is deductible under the interest rate test, may be disqualified
as a deduction if it exceeds all of the three following limitations during the same
financial year:

• Interest relating to financing of any kind granted by related parties within the limit
of 1.5 times the net equity of the borrower;
• 25% of the adjusted net income before tax (résultat courant avant impôt’, defined
as operating income increased by financial income), before related party interest,
amortisation and certain specific lease payments; and
• Interest income received from related parties (there is no limitation on thin
capitalisation grounds when the enterprise is in a net lending position vis-à-vis
related entities).

The portion of interest that exceeds the above three limits may not be deducted in the
accounting period, unless it amounts to less than EUR 150,000.

For these purposes, “related parties” are defined as (1) a parent company and a
subsidiary whose capital is held more than 50%, directly or indirectly, by the parent
company, or which is de facto controlled by the parent company, or (2) two companies
which are controlled, directly or indirectly, by a common parent company.

The 2010 Finance Bill brought all financings (including bank loans) secured by a
“related party” within the scope of the thin capitalisation limitations. Thus, any
financing in respect of which a related party grants a guarantee or security is treated as
related party debt.

Carry-forward of excess interests

That portion of the interest expense that is not immediately deductible by the French
enterprise in the accounting period in which it is incurred may be carried forward
without a time limit for relief in subsequent years, provided that there is excess
capacity in the subsequent years, based on the second limitation mentioned above.
However, the excess amount is reduced by 5% each year, from the second accounting
period following that in which the interest expense was incurred.

Exceptions
The new provisions provide for several exceptions.

These new rules do not apply to interest payable by banks and lending institutions, or
to certain specific situations (e.g. interest in connection with intragroup cash pools or
in connection with certain leasing transactions).

In addition, the thin capitalisation rules do not apply if the French indebted company
can demonstrate that the debt-to-equity ratio of the worldwide group to which it
belongs exceeds its own debt-to-equity ratio.

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Also, deductibility of interest is facilitated within a French tax-consolidated group. The
new thin capitalisation rules apply to each enterprise member of the group taken on a
standalone basis.

However, any excess interest incurred by such an enterprise may not be carried
forward by that enterprise. Instead, it is appropriated at the group level. Subject
to certain limitations, the consolidating company may deduct extra “disqualified”
interest. Any remaining excess interest may be carried forward for possible deduction
at the group level in future accounting periods, less the 5% rebate.

The FTA issued an administrative regulation regarding these new complex rules on
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31 December 2007 (Administrative regulation: 4 H-8-07). The guidelines provide the
French tax authorities’ interpretation of Section 212 of the French tax code relating
to thin capitalisation rules. They clarify the legal provisions and provide practical
guidance on the computation of the three tests.

In particular, the guidelines state that Section 212 is applicable to permanent

establishment of foreign companies. It provides clarification on how the debt-to-equity
ratio would be applied in the case of permanent establishments where the entities do
not have a share capital, per se.

The guidelines also detail the exclusion of “treasury centre” and “leasing agreements”
from the scope of the thin capitalisation rules, and they describe the specific conditions
under which the thin capitalisation rules would allow deduction at a tax group level
(Section 223B of the French tax code) for those interests that have failed the three tests
at the level of a subsidiary on a standalone basis.

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