There are multiple purpose tests across different parts of the French corporate income tax legislation pursuant to which the French tax authority can challenge, recharacterise or disregard transactions or series of transactions. These range from general anti-abuse rules to regime-specific purpose tests, for instance in respect of safe harbours in the French controlled foreign companies or tax neutral merger regimes. The tests generally require a subjective condition (looking at the purpose of the transaction) to be met; a number require that an objective condition (looking at the purpose of the relevant law) is also fulfilled.

The subjective condition looks at the purpose of transactions. In most cases, the subjective condition is fulfilled where the main purpose, or one of the main purposes of a transaction is to obtain a tax advantage. The historic abuse of law procedure (with an automatic penalty equal to 80% of the tax at stake), however, would require an exclusive purpose to this effect.

In assessing the subjective condition, one has to compare the relative significance of the tax advantage purpose with the other non-tax purposes of the transaction (such as business, financial or patrimonial purposes). The French tax authority considers that a main purpose would be equivalent to an essential aim. The French Supreme Court decided that an “exclusive” tax advantage purpose exists where the non-tax impacts/ purposes are minimal or negligible as compared to the tax advantage.

Where applicable, the objective condition looks at whether the intended tax treatment of the transaction is compatible with the object/ purpose of the relevant legislative provisions. In practice, French tax courts tend to take the view that this condition is automatically met where the transaction constitutes a “wholly artificial arrangement”, an approach which is not easy to reconcile with the letter of the law as it effectively neutralizes this condition.

Enforcement trends

There are a number of areas where taxpayers need to be particularly mindful of potential challenges under the relevant purpose tests.

Where funds are returned to shareholders in the form of a proportionate share buy-back rather than by way of a dividend where the latter would have resulted in a less favourable tax treatment for the shareholders, the French tax authority may challenge the buyback unless it can be shown that there are sufficient non-tax reasons to justify the choice of a share buy-back instead of a dividend distribution. The French tax courts have yet to confirm the position.

The French Supreme Court recently upheld the French tax authority’s challenge to the interposition of a foreign holding company, even though the holding company had substance and carried out a genuine commercial activity, because there was no good reason for its interposition in the particular transaction. It can be expected that the French tax authority will maintain or even increase its enquiries in this area.