On 13 July 2021, the French Administrative Supreme Court (Conseil d’Etat) handed down three important tax decisions which shed new light on the conditions under which the French tax authorities may tax as salaries gains arising from “management packages” (warrants in the Financière Derby and G7 cases and share options granted outside the French legal stock options regime in the LBO France case).

In summary, the French Administrative Supreme Court – which clearly intended to highlight these decisions in particular by posting them on its website – held that the gains arising from a financial instrument shall be taxed as salaries when the source of these gains “can essentially be found in the exercise, by the taxpayer, of a salaried or management position” (LBO France case) or when, “in light of the conditions under which they were realised, the gains on the disposal of the financial securities at stake shall be regarded as the consideration for the manager’ or employee’s position rather than a gain realised by the seller in his capacity as investor” (Financière Derby and G7 cases).

The French Administrative Supreme Court applied the criteria of the “link” between the gain and the salaried or management position of the taxpayer very broadly, as it does not take into consideration the fact that the taxpayer has borne a financial risk or – although this point should be further clarified – that the instrument has been acquired or subscribed for at fair market value. For the record, the existence of both a financial risk and a subscription at fair market value were, until now, the central criteria used to demonstrate that a gain was considered a capital gain.

In the Financière Derby case, this “link” has been recognized in light of the following body of evidence:

• the non-legal documentation referred to the taxpayer as a “manager”, benefiting from a management incentive plan “to be further refined pursuant to the usual formulas”;
• the shareholders’ agreement provided that the financial investors were investing “in order to participate in the fulfillment of the development project” and the manager had to comply with a number of contractual obligations (loyalty, exclusivity, non-compete, lock-up of the instruments held), while the breach of these commitments was sanctioned by the exercise of a €1 call option on the manager’s securities (also applicable upon the departure or death of the manager); and
• the warrants had been exclusively granted to the manager and were exercisable based on IRR and multiple criteria over the duration of the investment in order to grant the “retrocession” of an “additional capital gain” to the manager.

The opinion of the rapporteur public (advocate general) confirms this approach: in light of the circumstances described above, the holder of these warrant is not seen “as an investor managing his assets and deciding when and how to sell” but as “a manager whose gains on the sale of his warrants will be the consideration of the services he provided as a manager”.

The LBO France and G7 cases have respectively been referred back to the Administrative Court of Appeal of Versailles and Paris. These Courts will have to determine whether the relevant instruments were granted and exercisable in consideration of the salaried or management position of the taxpayer. On the contrary, the Financière Derby case has not been referred back to the appeal court and is therefore final.

Although it is not easy to draw definitive conclusions at this stage, the decisions and the opinion of the rapporteur public (i) invite reconsideration, for the future, of leavers mechanisms and certain provisions of the shareholders agreements imposing contractual obligations on the taxpayer in their capacity as a manager (exclusivity, non-compete) rather than in their capacity as a shareholder and (ii) support the idea that legal mechanisms, such as “free shares” plans, shall be preferred over ad hoc instruments, especially when they benefit only the managers (such as ratchet shares).