In a decision dated 25 April 2022, the French Administrative Supreme Court has provided useful clarifications on the French CFC regime (art. 209 B of the FTC) in a non-EU context. Although it relates to the French CFC regime in its version applicable in 2010, this decision should be relevant for the current version of the text.
The fact pattern
In 2007, Rubis Energie, a French company, purchased several companies, including Vitogaz Bulgaria, a Bulgarian company. In order to avoid any link with it during an observation period, the shares of this company were purchased and held by a Dutch foundation.
In 2010, the latter sold these shares to a Mauritian subsidiary of Rubis Energie, which in turn sold them a few months later to a third party, realizing a capital gain of €3.1 million. Considering that the Mauritian subsidiary was benefiting from a preferential tax regime, the French tax authorities applied the French CFC regime to tax this capital gain in France at the level of Rubis Energie.
In order to challenge this tax reassessment, the taxpayer was notably arguing that the French CFC regime did not comply with the EU freedom of movement of capital, as this regime was not restricted, outside the EU, to “wholly artificial arrangements” exclusively motivated by tax reasons, but might apply to operations which were principally tax motivated.
The French Administrative Supreme Court has however not tackled this question as, applying the principles set forth by the ECJ to determine the respective scope of the EU freedom of establishment and the EU freedom of movement of capital, it has considered that the EU freedom of movement of capital is not applicable to challenge a potential inconsistency of the French CFC regime with EU principles.
This decision also provides useful details on the way the non-EU safeguard clause shall apply and gives the opportunity to discuss how it may benefit a French taxpayer who inherited from the foreign company, for example in the context of an external growth operation.
Finally, and although this point was not discussed, the opinion of the rapporteure publique (equivalent to an advocate general) under this decision invites consideration of the question of the compatibility of the French CFC regime with double tax treaties.
The French CFC regime is outside the scope of the EU freedom of movement of capital
When it comes to assess whether a domestic provision complies with the EU freedom of movement of capital, it is first necessary to determine whether this freedom is applicable.
Pursuant to the ECJ case law, when a relation with a non-EU jurisdiction is concerned, the freedom of movement of capital is applicable when the provision does not apply exclusively to shareholdings allowing the exercise of a decisive influence over the foreign entity, irrespective of the factual circumstances of the case (C-35/11, Test Claimants in the FII Group Litigation, pt. 99).
According to the taxpayer, this was precisely the case of the French CFC regime, as the threshold triggering its application is set at more than 50% of the “shares, financial rights or voting rights” of the foreign entity and may therefore apply to shareholdings that do not necessarily confer control over the foreign entity.
To dismiss this argument, the French Administrative Supreme Court has considered that, in light of the purpose of the French CFC regime and its provisions, including its safeguard clauses, this regime was intended to apply only to shareholdings allowing the exercise of control over the foreign entity and that, consequently, the freedom of movement of capital was not applicable.
This solution should be transposable to the current version of the text since the purpose of the French CFC regime has not changed.
Conditions of application of the non-EU safeguard clause
In the version applicable to the case at hand, the non-EU safeguard clause required the taxpayer to demonstrate that the “operations of the foreign entity” had mainly a non-tax “effect”. In its decision, the French Administrative Supreme Court considers that the taxpayer could not benefit from this provision and made the following three points on its implementation:
- first, notwithstanding the letter of the law, the Court considers that the non-EU safeguard clause required the characterisation of a main non-tax “purpose” (instead of an “effect”) – although the provision applicable today has been amended to mention both the “purpose” and the “effect”, this solution should a priori be still relevant today;
- second, the Court considers that the main non-tax purpose shall be assessed by focusing only on the transaction at stake (here the acquisition and the subsequent sale by the Mauritian company generating the capital gain) without taking into account the activities of this foreign entity taken as a whole. As a result, the fact that the setting-up of the entity was mainly justified by non-tax reasons would not be decisive if its involvement in the transaction is not consistent with the rationale of its creation;
- third, this decision shows that the demonstration required from the taxpayer in a non-EU context must be supported by a strong and detailed body of evidence. In the case at hand, the taxpayer was notably arguing that the interposition of the Mauritian company was motivated by the will to be insulated from the risks linked to the level of corruption in Bulgaria in the 2000s. The French Administrative Supreme Court dismissed this argument, considering that it was “poorly justified” and that this objective may arguably justify the interposition of the Dutch foundation, but not the interposition of the Mauritian entity just before the unwinding of the structure.
Finally, this decision gives the opportunity to discuss the implementation of the safeguard clause when a taxpayer inherits from a foreign entity, for instance in the context of an external growth operation. In this case, the French CFC regime may generally be disregarded for the year of acquisition, as the acquiring group did not play any role in the creation of the structure. But this regime may likely be implemented for the subsequent years, unless the decision to maintain the foreign structure is justified mainly by non-tax reasons or this situation is strictly limited to the time required to liquidate the entity.
Compatibility of the French CFC with double tax treaties
Pursuant to the French CFC regime, the profits of the foreign entity are taxable in France as “deemed dividends”. France considers that, thanks to this qualification, most of the double tax treaties do not prevent the implementation of this regime. This highly questionable analysis has been upheld by the administrative tribunal of Montreuil (TA Montreuil, 21 May 2019, n° 1801760), but remains however to be confirmed by the French Administrative Supreme Court.
Indeed, although the French Administrative Supreme Court considers that the domestic qualification of an income is relevant to determine the applicable treaty provision, the legislator shall exercise this power of qualification in compliance with the principle of the binding force of treaties. In other words, the qualification on which taxation is based in domestic law may only lead, for the State exercising its power of qualification, to limit the right to tax attributed to it by the applicable treaty, and never to extend it beyond the treaty provisions.
Interestingly, the rapporteure publique considers that the French CFC regime is not intended to tax dividend distributions, but the profits and income realized by the foreign entity which, by effect of a “legal fiction”, are deemed to constitute a dividend received by the French entity. This presumption therefore does not alter the intrinsic nature of the foreign entity’s income, which remain either “business profits” within the meaning of Article 7 or “capital gains” within the meaning of Article 13, the right to tax in those cases being generally attributed to the State of residence of the foreign entity. One may therefore wonder whether the use of this “legal fiction” by the French legislator is actually in line with the provisions of double tax treaties.