As part of the French Amended Finance Bill for 2021, the French Parliament amended the French capital gains tax applicable to non-French residents on transfers of significant shareholdings (Section 244 bis B of the FTC, applicable subject to double tax treaties), found to be, in certain circumstances, inconsistent with EU principles. Although this amendment provides for a welcome legal security to foreign investors, it might however not be sufficient to ensure a full consistency to such principles.

The inconsistency

The non-resident French capital gains tax generally creates discrimination inconsistent with EU principles when imposed in circumstances where a French tax resident transferor would have been subject to a lower level of tax in similar circumstances (e.g., pursuant to the French participation exemption regime, providing for an effective corporate tax charge of c. 3% - to be compared with the c. 27% rate applicable to a non-French resident corporate transferor for FY 2021). In order to avoid such discrimination, the official guidelines issued by the French tax authorities have, since 2006, included for EU (and certain EEA) corporate investors, a “safe harbor” that, under certain conditions, caps the non-resident French capital gains tax at the amount of French corporate income tax that would have been payable had the non-French resident been resident in France.

In a decision dated 14 October 2020 (no 421524 – covered in a previous post), the French Administrative Supreme Court (Conseil d’Etat) confirmed this inconsistency but considered however that it could only be fixed by the law and not by the above mentioned official guidelines. This decision was therefore leaving – for eligible non-residents – the non-French resident capital gains tax totally inapplicable, even for the fraction not exceeding the amount of French corporate income tax that would have been payable had the non-French resident been resident in France.

In a non-definitive decision dated 20 October 2020 (no 18VE03012 – also covered in a previous post), the Administrative Court of Appeal of Versailles considered that this inconsistency could also be claimed by non-EU corporate investors as it could not be covered by the “standstill clause” provided for by Article 64 of the Treaty on the Functioning of the European Union (which allows the application to third countries of any restrictions existing on 31 December 1993 (and remaining in force continuously since that date) insofar as “direct investments” are involved). The Court considered that, as far as non-resident “capital companies” are concerned, the restriction existed only from 2 January 1994.

The legislative fix

In addition to an exemption granted to eligible non-resident collective investment vehicles, the law now provides for a refund mechanism allowing, for transfers occurring from 30 June 2021, eligible non-French resident corporate investors to claim a refund of the non-resident French capital gains tax for the fraction exceeding the amount of the French corporate income tax they would have borne had their registered seat been in France, which leads in practice to the same solution as the “safe harbor” referred to above (but with a refund rather than a cap mechanism). 

This refund mechanism will be available to:

• non-French corporate investors having their registered seat in the EU or in an eligible EEA State; and
• non-French corporate investors having their registered seat in a country having concluded with France a tax treaty containing an administrative assistance clause for the purpose of exchanging information and combating tax fraud and tax evasion and which is not a “non-cooperative state” (as defined under French tax law), but only if these investors do not effectively participate in the management or control of the target company.

This means that an eligible non-French resident corporate investor which would have been eligible for the French participation exemption regime had it been established in France would be entitled to claim for a refund equal to the difference between the standard rate and c. 3%.

An imperfect fix?

This welcome fix is however disappointing in two respects.

Firstly, it regrettably introduces an ex post refund mechanism which requires the non-French resident taxpayer to pay the non-resident capital gains tax at the standard rate and then apply for a refund, which is likely to create a cash-flow disadvantage and an additional administrative burden as compared to a French resident company which can apply the participation exemption regime from the outset.

In light of ECJ case law, these disadvantages may raise the question of the consistency of this new regime with EU non-discrimination principles (see notably ECJ, 3 October 2006, 290/04, FKP Scorpio Konzertproduktionen GmbH pt. 46 and seq.; ECJ, 22 November 2018, 575/17, Sofina, pt. 29 and seq.). As it was the case for the “safe harbor” referred to above, we would expect the FTA to allow the non-French resident to apply directly the tax regime which would have been applied had it been established in France with an ex post audit by the FTA.

In light of the recent case law of the French Administrative Supreme Court referred to above, one could however wonder whether this potential inconsistency can validly be fixed by the FTA and not by the law itself.

Secondly, as far as non-EU corporate investors are concerned, the refund mechanism does not apply to investors who “effectively participate in the management or the control of the target company”, which is in our view very close to the definition of “direct investments” within the meaning of the “standstill clause” (see notably ECJ, 12 December 2006, 446/04, Test Claimants in the FII Group Litigation, pt. 182).

If it is confirmed that this new provision intends to exclude from the refund mechanism investments falling within the scope of the "standstill clause" (which effectively only applies to “direct investments”) and not only the investments falling within the scope of the EU freedom of establishment, it would in our view disregard the second cumulative temporal condition pursuant to which a restriction may be covered by the “standstill clause” only if it existed on 31 December 1993 (and exists continuously since that date).

The new regime could therefore be viewed as not taking into account the above mentioned solution adopted by the Administrative Court of Appeal of Versailles which set aside the “standstill clause” not because the investment at issue was not a “direct investment”, but because the temporal condition was not met. We will now have to wait the outcome of the appeal lodged against this decision to confirm whether taxpayers may have grounds to challenge the new regime on this point.