Global Tax Alert | 3 December 2013

French Government proposes anti-hybrid provision

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Executive summary

In light of the current discussions raised by the Organisation for Economic Co-operation and Development associated with the Base Erosion and Profit Shifting report, the French Government, within the draft 2014 Finance Bill, has proposed adding a new restriction on interest deductions aimed at hybrid instruments (the anti-hybrid provision).

Detailed discussion

Description of the anti-hybrid provision

As per the anti-hybrid provision, interest paid out by a French enterprise to a related French enterprise or a nonresident enterprise will no longer be tax deductible for French Corporate Income Tax (CIT) purposes if the interest paid out is not subject to tax at the level of the beneficiary company at a rate of at least 25% of the French CIT that would have been due under the standard French rules.

In the case where the lender is domiciled or established outside France, the French CIT is determined as if the lender were established or domiciled in France.

The French MPs (members of Parliament) have already mentioned that “the French CIT that would have been due under the standard French rules” corresponds to the standard French CIT rate of 33.33% so that interest received by the related lender must be subject to tax at a rate of at least 8.33% (i.e., 25% of 33.33%).

In the current state where the anti-hybrid provision stands, two different interpretations of the anti-hybrid provision coexist in the case where the lender is a nonresident enterprise:

(i) A strict interpretation which is based on the literal wording of the provision where the nominal CIT rate applicable at the level of the nonresident lender to the sole interest income is compared to the effective CIT rate that would have been applicable in France if the nonresident enterprise were taxable in France on the same interest income (in light of both the French basis and rate rules but limited to the interest income).

In this scenario, to the extent that interest received by the related lender is theoretically taxable at a nominal rate of at least 8.33%, it should not fall within the scope of the new anti-hybrid provision irrespective of specific tax incentives granted when computing the tax charge owed by the nonresident enterprise.

This interpretation is partially supported by the Parliamentary debates where a member of the French Finance government confirms that the taxation of the related lender should be appraised with respect to the sole interest flows received and not by reference to its global taxation.

This strict interpretation seems shared by the major part of the tax community. It is also in line with an informal interpretation (non-enforceable) obtained from the French Tax Authorities.

(ii) A broader interpretation which is asserted by a number of tax lawyers who consider the wording of the second paragraph of the current anti-hybrid provision relating to lenders established outside France in light of the French Controlled Foreign Companies’ rules. These rules require a computation of the actual taxation applicable at the level of the foreign entity and in this case of the related lender.

Therefore, under this broader interpretation, the foreign actual CIT owed upon interest received by the related lender should be compared to the effective CIT that would have been applicable in France if the nonresident enterprise were taxable in France (in light of both the French basis and rate rules but expanded to the entire P&L of the lender).

In this scenario, the anti-hybrid provision would take into account specific tax incentives granted to the nonresident enterprise (e.g., notional interest deduction, absence of thin-capitalization rules, and tax credits among others).

No further guidelines have been issued either by the French MPs or the French Tax Authorities in order to clarify the above issue.

The National Assembly has also added to the initial provision that in the case where the lender is a transparent entity related to the French debtor, the minimum CIT rate of 8.33% should be appraised at the level of the transparent entity’s shareholder(s).

Implementation of the anti-hybrid provision

Upon request of the French tax authorities, French taxpayers must provide documentation supporting that the foreign CIT theoretically owed by the lender upon interest paid out and deducted is at least equal to 8.33%.

This new provision will apply to fiscal years ending on or after 25 September 2013 encompassing therefore interest paid during the course of any fiscal year ending on or after 25 September 2013.

It is worth noting that the French National Assembly rejected a number of amendments aiming either to introduce a safe harbor clause for lenders established within the European Union or postpone the entry into force of the anti-hybrid provision.

Current state of Parliamentary proceedings

The draft 2014 Finance Bill encompassing, inter alia, the anti-hybrid provision has been voted by the National Assembly on 19 November 2013 and sent to the Senate on 21 November 2013.

The anti-hybrid provision was approved on 25 November 2013 by the Senate with the exact same wording as the National Assembly version.

However, the whole 2014 Finance Bill has been rejected by the Senate on 27 November so that it should be discussed by a Joint Commission.

In the case where a disagreement persists between the National Assembly and the Senate, the National Assembly will have the power to definitively vote the draft 2014 Finance Bill.

However, as the National Assembly and the Senate agreed on the exact same wording for the anti-hybrid provision, further modifications appear unlikely.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Société d’Avocats, Paris
  • Philippe Paul-Boncour
    +33 1 55 61 10 20
    philippe.paul-boncour@ey-avocats.com
Ernst & Young LLP, French Tax Desk, New York
  • Frédéric Vallat
    +1 212 773 5889
    frederic.vallat@ey.com

EYG no. CM4009