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04 November 2005
France is now vying for recognition as an attractive jurisdiction for holding companies. In addition to the participation exemption for dividend distributions, companies seeking to set up a foreign holding company in France to own subsidiaries will also benefit from a capital gains exemption regime, no capital duty on the creation of the company and the opportunity to deduct in full interest incurred from loan capital. Moreover, France has entered into a large number of tax treaties providing for the avoidance of double taxation (ie, 109 tax treaties on income).
A holding company eligible for the participation exemption regime is exempt from corporation tax on received dividends to a level of 95%. The tax is levied on a 5% lump sum of received dividends, representing non-deductible business expenses. This 5% lump sum is recaptured into the ordinary taxable income subject to corporate tax at the normal rate of 33.33%. Thus, the effective corporation tax rate for dividends is 1.66%.
However, this tax regime - which is similar to those in Belgium, Germany
and Italy - must be put into perspective, since the 5% lump sum in question
cannot exceed the amount of actual expenditure undertaken by the holding company.
When the actual amount of expenditure undertaken is less than 5% of the received
dividends, the taxation will be under 1.66%. Furthermore, where the distributing
subsidiary is held for 95% and is part of the holding company group for fiscal
unity purposes, the 5% recaptured lump sum will be cancelled and no corporation
tax will be levied on these dividends.
The participation exemption regime is granted to companies holding at least 5% of the shares in a subsidiary, which is significantly lower than the participation threshold of 20% required by the parent-subsidiary affiliation exemption provided by the EU Parent-Subsidiary Directive (2003/123/EC). On the other hand, the minimum holding period is two years, which is the same as that suggested by the directive. However, although other EU member states do not require any holding period (eg, Cyprus, Germany, the Netherlands, Sweden - for unquoted shares - and the United Kingdom) or require a holding period of one year (eg, Belgium, Denmark, Luxembourg and Sweden, for quoted shares), the two-year holding period requirement is not as constrictive as it appears, as it need not be fulfilled at the time the dividends are paid to the holding company. The participation exemption regime is granted to companies which undertake a two-year commitment to keep shares.
The revised Finance Act 2004 established a preferential capital gains tax system to promote French competitiveness in the EU market. France has not opted for full exemption in the capital gains participation exemption regime - which will become effective as of the fiscal year beginning January 1 2007 - since a lump sum of 5% of the net gains representing non-deductible business expenses will be added back to the taxable income and taxed at the standard corporate income tax rate. Shareholdings whose capital gains benefit from the participation exemption fulfil the conditions for the dividend exemption regime. Shares must therefore have been held for two years and represent at least 5% of the subsidiary's capital. Other EU countries require a shareholding threshold at least equivalent (ie, Ireland, the Netherlands and Spain) or higher (eg, Luxembourg and the United Kingdom).
The 5% lump sum - which also gives rise to corporation tax at a rate of 1.66% of the net capital gain - will be based on the capital gains minus the capital losses made in the same year that are eligible for the preferential regime, but does not take into account the related provisions. Capital losses on shares qualifying for the preferential regime may be offset only against capital gains derived from other qualifying shares made in the same year. Any excess of these capital losses will be lost. The tax authorities have not yet specified whether the lump sum can be capped at the amount of actual expenditure undertaken by the holding company, as is the case for the participation exemption for dividend distributions purposes.
The ability to deduct interest is important when the holding company has trading operations of its own and borrows funds to acquire holdings in subsidiaries. Certain jurisdictions cap the deductibility of interest paid on loans according either to constrictive debt-equity ratios (eg, Germany, Hungary, Italy and Spain, for interest paid to non-EU shareholders) or to a percentage of the borrower's adjusted income (eg, the United States). In contrast, France allows companies to deduct interest payments in their entirety, unless the tax authorities can prove that such interest constitutes expenses unrelated to normal acts of management or deemed not to have been incurred for the benefit of the enterprise.
Existing thin capitalization provisions (Articles 212 and 39(1)(3) of the Tax Code) target only loans granted by direct shareholders. Interest payments made to a direct shareholder on a loan to the company are deductible within the limit of the mean interest rate practised by French credit establishments on short-term, variable-rate business loans (eg, this rate was 4.5825% for the 2004 calendar year). However, there is a limitation on the permitted deduction of interest relating to loans that exceed a thinly capitalized company's capital by 1.5 times. Only interest relating to the part of the loan falling within the limit is deductible. Nevertheless, the debt-equity ratio applies only to loans from shareholders which legally or actually manage the thinly capitalized company, or directly own more that 50% of the rights to dividends or voting rights. Furthermore, the ratio is set aside for parent companies eligible for the participation exemption regime. This exception also applies when the parent company is headquartered in another EU member state(1) or in a non-member European jurisdiction, as long as that jurisdiction has signed a tax treaty with France incorporating a non-discrimination clause capable of overriding national thin capitalization rules.(2)
Legislation has been drafted with the aim of applying a combined threshold of 1.5 times the equity and 25% of the ordinary income before taxes (but including the amount of the interest). Interest expenses in excess of either of these limits would not be deductible (not exceeding €150,000). The non-deductible interest could be carried over with a 5% discount for each financial year as of the second year of carrying over. This thin capitalization provision draft, which could be overcome in certain situations, is likely to come into force for the financial year beginning January 1 2007.
As in Germany, Denmark, Sweden, the United Kingdom and, soon, the Netherlands, setting up a French company gives rise to no taxation. This is not the case in many other EU jurisdictions, where a flat-rate capital duty based on the contribution of capital is triggered (eg, 1% in Ireland, Luxembourg and Spain).
Therefore, the various advantages sought by those contemplating setting up a holding company are now to be found in France, even if new thin capitalization provisions are reportedly in the pipeline.
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