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TAX PLANNING INTERNATIONAL EUROPEAN TAX SERVICE International Information for International Business >>>>>>>>>>>>>>>>>>>>>>>>>>>>> VOLUME 17, NUMBER 3 >>> MARCH 2015 www.bna.com EU Financial Transaction Tax Back from the Dead? France: Taxation of Dividends Received by Parent Company Extension of U.K. Capital Gains Tax to Non Residents Hybrid Loans: Recent OECD Measures, EU Actions Tax Highlights of 2015 South African Budget

TaxTreatmentof DividendsReceived byfrenchparent CompanyinViewof Parent-Subsidiary Directive Bertrand Hermant Taylor Wessing, France Recent decisions of the French courts have provided some guidance on the taxation of dividends received by parent companies in France. A number of conditions have been set out which need to be met before dividends will be considered tax exempt. Bertrand Hermant is Senior Associate at Taylor Wessing, Paris I. Introduction The EU Directive 90/435/EEC, known as the Parent-Subsidiary Directive, set out some rules in order to abolish the potential double taxation on dividends distributed by a subsidiary to its parent located in different member states. Two different sets of rules were implemented. First, at the level of the subsidiary, there would not be any withholding tax in cases where certain conditions were met(in particular, where the parent had held at least 25% of the subsidiary s shares for at least 2 years). The second rule applied at the level of the parent: dividends received from its foreign subsidiary should be either (a) exempted from taxes or (b) the taxes paid by the subsidiary should give rise to a tax credit. These rules have been modified several times within the last two decades. France introduced into its domestic legislation a provision under which dividends distributed by a subsidiarytoitseuparentcompanywouldnotbesubject to any withholding tax. At the time the Parent- Subsidiary Directive was passed, France already had in its legislation a tax regime which provided that dividends received by a French parent company benefited from a tax exemption. Accordingly, the French Parliament decided that it was not necessary to modify French legislation. Indeed, the French Tax Code provides that dividends received by a company owning at least 5% of the share capital of the distributing company will be tax exempt save for a lump sum amount equal to 5% of the dividends ( the participation exemption regime ). The following discussion looks to set out the conditionswhichhavetobemetinordertobenefitfromthe participation exemption regime in France. We will 03/15 Tax Planning International European Tax Service Bloomberg BNA ISSN 1754-1646 7 03/15 Tax Planning International European Tax Service Bloomberg BNA ISSN 1754-1646 7

first consider the shares which are eligible for the regime. The section following will examine the tax regime applicable to proceeds deriving from such shares. II. Shares Eligible for Parent-Subsidiary Regime Articles 145 and 216 of the French Tax Code provide that dividends distributed by a French or foreign company to its parent are exempt from corporate income tax at the parent s level (save for a lump sum amount of 5% of the dividends) provided that certain requirements in terms of shareholding interest are met. The regime is applicable to a parent company owning directly at least 5% of the share capital of its subsidiary for at least 2 years (A). There are nonetheless certain exceptions applicable to these rules in order to circumvent certain tax driven schemes (B). A. Conditions with Respect to the Shares (i) Parent Must Own 5% of Share Capital of Subsidiary Article 145 of the French Tax Code provides that the participation exemption regime is applicable where a French parent company owns 5% of the share capital of the subsidiary. In order to treat a French parent company eligible to the participation exemption regime similarly to an EU parent company receiving dividends from its French subsidiary, the French tax authorities decided to extend the withholding tax exemption to EU companies holding shares eligible to the participation exemption regime. This means that the conditions which have to be met with respect to theshareholdingarethesameinthecaseoftheapplication of the participation exemption regime by a French parent company or the application of the withholding tax exemption in the case of distribution to an EU parent company. In a recent decision of the French Administrative Supreme Court (Conseil d Etat), 1 a Belgium parent companyheldmorethan5%ofthesharecapitalofits subsidiary but less than 5% in terms of voting rights, due to the double voting rights for certain classes of shares. Although Article 145 of the French Tax Code only refers to the share capital, the French tax authorities considered that the parent had to own at least 5% of both the share capital and voting rights of the company. 2 TheiranalysiswasbasedonthefactthattheFrench Tax Code mentions that those shares have to be qualified as participating shares (titres de participation) as defined under French GAAP, which provide that such shares are deemed useful for the company s business, notably because they gave an influence or permit to control the issuing s entity. 3 Therefore, this control or influence requires that the parent owns a minimum level of voting rights. 8 03/15 Copyright 2015 by The Bureau of National Affairs, Inc. TPETS ISSN 1754-1646

In addition, the French tax authorities argued that the participation exemption regime was not applicable to proceeds deriving from shares with no voting rights. 4 According to the authorities, all these elements imply that the participation exemption regime requirestheparenttoown5%ofthevotingandfinancial rights. The French Administrative Supreme Court ruled that the 5% threshold only refers to the share capital as clearly stated in the French Tax Code and does not require owning 5% of the voting rights. In other words, the participation exemption regime is applicable irrespective of the voting rights attached to the minimum 5% shareholding. Based on this recent ruling, one should in fact distinguish two steps when assessing whether dividends received from a subsidiary are eligible to the participation exemption regime. First, the regime is open to French parent companies owning at least 5% of the share capital of the company. Second, the proceeds which may benefit from the participation exemption regime are those related to shares with voting rights unless the parent owns at least 5% of the voting and financial rights of the subsidiary. In that case, all dividends received by the parent company are eligible to the participation exemption regime even for shares with financial rights only, such as preferred shares. (ii) Parent Must Own its Shareholding Directly Parent companies may own the subsidiaries shares indirectly through another entity such as a partnership. This was the case in another recent decision rendered by the French Administrative Supreme Court 5. In the case at hand, a French company, Artemis SA, owned 98.32% of Artemis America, a U.S. general partnership, which in turn owned more than 10% of a U.S. company, Roland. The question that arose was whether the participation exemption regime was applicable. The parent company considered that dividends received in respect of the U.S. company were eligible to the participation exemption regime, for three reasons. First, the company took the view that the U.S. partnership was a transparent entity pursuant to U.S. tax rules. As a result, the parent company should be deemed to have received the dividends directly. That position was not followed by the Supreme Court as the existing position of the French courts when dealing with a transaction involving a foreign legal person is to view which French legal person the entity most closely resembles, based on its legal characteristics and its operating rules. Foreign tax rules are irrelevant. The Supreme Court ruled that the U.S. general partnership in the particular case was similar to a French partnership (société de personnes), a semitransparent entity for French tax purposes. The court s reasoning was that (a) the company was not a corporation and (b) it had a legal personality distinct from its shareholders. As a result, the French parent company could not be viewed as owning the subsidiary s shares directly, since the partner of a French partnership is not deemed to own directly the partnership s underlying assets. Therefore, the participation exemption regime was not applicable. The parent company s alternative contention took into consideration the specific tax regime applicable to French partnership. The French tax result of a partnership is determined at its level but taxed in the hands of its partners. Based on these rules, the parent company took the view that dividends distributed through the U.S. partnership should be eligible to the participation exemption regime given that the dividends are included in the partnership tax result. However, the French Administrative Supreme Court held thattheparentcompanywasonlysubjecttotaxonits share of profits of the U.S. partnership but could not be considered as receiving dividends directly. The French parent company s final contention was that the France-US income tax treaty dated August 31, 1994 provides specific provisions dealing with U.S. partnerships whereby the partner will be deemed to have realized the entity s profits directly. Nonetheless, the French Administrative Supreme Court considered that rule only aims at allocating the taxing rights on profits realized by a U.S. partnership. Indeed, Article 7 of the France-US income tax treaty provides that dividends received by a U.S. partnership having a French partner will be subject to tax in France up to the share of this partner. This rule does not mean that the French partner is deemed to own the shares directly. Accordingly, it is clear now that the participation exemption regime is only applicable in case of direct ownership of the subsidiary s shares. However, it is interesting to note that the French Finance Bill for 2015 has recently modified the tax treatment of shares held through a fiducie (which could be compared to a trust in some respects). Indeed, it is unclear whether the participation exemption regime remains applicable in such a case. Effective immediately, these shares are deemed to be owned by the settlor, it being noted that the participation exemption regime remains applicable provided that the settlor retains the voting rights or the trustee (fiduciaire) exercises these rights based on the settlor s instructions. In other words, in case of ownership of shares through a fiducie, in contrast with the situation where the shares are held directly, the settlor has to keep at least 5% of the voting and financial rights in order to benefit from the participation exemption regime. (iii) Parent Must Own Minimum 5% Shareholding for a Minimum 2 Years The participation exemption regime is applicable if the parent has held the shares for a minimum of 2 years. At first glance, this means that dividends received in respect of the shares benefit from the participation exemption regime where all these shares have been held for at least 2 years. However, an alternative interpretation is that the holding period will only be satisfiedforatleast5%ofthesharecapitalofthesubsidiary. This means that a parent company may benefit from the participation exemption regime on shares which have been held for less than 2 years. In 03/15 Tax Planning International European Tax Service Bloomberg BNA ISSN 1754-1646 9

light of the EU Directive, the French Administrative Supreme Court considered that this 2-year holding period should be complied with for at least 5% of the subsidiary s share capital. 6 In other words, a French parent company is entitled to benefit from the participation exemption regime on proceeds deriving from shares held for less than 2 years provided that the parentcompanyhasheldatleast5%ofthecompany s share capital for at least 2 years. These rulings now clearly indicate the cases in which the participation exemption regime will be applicable. B. Anti-Avoidance Rule and Participation Exemption Regime The participation exemption regime is not applicable in certain situations even if the conditions set forth above are met. We will specifically focus on two specific exceptions which have recently been into the spotlight. (i) Dividend Distributed by a Company Located in an NCCT In 2009, France prepared a list of non-cooperative countries or territories ( NCCT ) updated every year which includes all states failing to provide both fiscal transparency and administrative cooperation with France. Transactions with NCCT entities are subject to a detrimental tax regime. Indeed, dividends distributed by the NCCT companies do not benefit from the participation exemption regime, which means that they will be subject to corporate income tax at the standard rate. More importantly, in contrast with most of the French anti-avoidance rules, there is no safeguard provision, which means that a French company cannot benefit from the participation exemption regimeeveniftheownershipofancctentityisjustified for business reasons. Some taxpayers have recently raised the fact that this provision does not comply with the French Constitution. In a ruling dated January 20, 2015, the FrenchConstitutionalCourt 7 statedthattheprovision complies with the French Constitution, provided that the taxpayer should be able to rebut that presumption. This means that French entities having bona fide activities in these countries will now be able to benefit from the participation exemption regime on the dividends received from their shares. This could be of interest for certain French companies having activities in these countries, as the profits realized by such entities might be repatriated tax-free. (ii) Dividend Distributed by a Company Shall Not Be Deducted From Distributing Entity Result: The Fight Against Hybrid Instruments The Finance Bill for 2015 also included a provision disallowing the application of the participation exemption regime in case the proceeds distributed by the subsidiary (a) are deducted from the distributing entity or (b) relate to an activity which is not subject to corporate income tax(or a similar foreign tax). This would have meant that dividends paid by a subsidiary which is not subject to corporate income tax (or similar foreign tax) would no longer benefit from the participation exemption regime. However, the latest provision was struck down by the French Constitutional Court 8 because of its lack of clarity. Indeed, it was difficult to understand how this provision would be applicable in case of multiple tiers of companies. There is nonetheless a tendency to limit the application of the participation exemption regime. The European Council has recently passed an amended EU Directive which includes a general anti-avoidance rule with respect to the EU parent-subsidiary regime. The rule, which is an amendment to the current anti-abuse rule, must be implemented by December 31, 2015 and aims at limiting the benefits of the EU parentsubsidiary regime to genuine arrangements. That is, arrangements which are not mainly tax driven without any economic reality. The rule is seen as a minimum requirement and does not prevent member states from implementing tougher provisions. Tax regime applicable to dividends distributed by subsidiaries. III. Tax Regime Applicable to Dividends Distributed By Subsidiaries If a parent company meets the conditions set out above, dividends received from its subsidiary will be tax exempt. This exemption will not be total though, as the French participation exemption regime limits the taxable basis at the level of the recipient company to 5% of the dividend, leading to an effective tax rate between 1.66% and 1.9% depending on the company s turnover. The tax 9 regime is even more tax efficient where the parentandthesubsidiaryarememberofthesametax group, which requires, most notably, that the parent company and its subsidiary are established in France. In that case, dividends will be tax exempted as the lump sum amount will be neutralized for the determination of the tax group result except for dividends receivedfromasubsidiaryduringitsfirstfiscalyearasa member of the tax group. In other words, the tax 10 regime applicable to dividends received in respect of French shares could be more favorable than the one applicable to foreign shares as a foreign company cannot join a French tax group. This difference could be viewed as an incentive to invest into French companies (which may join a French tax group) rather than foreign companies. Such a difference could also be viewed, however, as a restriction on the EU freedom of establishment which is not justified by any overriding reasons in the public interest. A taxpayer recently raised that argument before the Administrative Court of Appeal. 11 The court decided torequestarulingfromthecourtofjusticeoftheeuropean Union, though that decision has been challenged by the French tax authorities before the French Administrative Supreme Court. It is interesting to note that the CJEU has already considered that the Dutch tax group regime (which is similar to the French tax group regime) cannot be viewed as an infringement of the EU law 12 even if a foreign company 10 03/15 Copyright 2015 by The Bureau of National Affairs, Inc. TPETS ISSN 1754-1646

isunabletojointhetaxgroup.however,inthefrench case, the situation is somewhat different as the issue is not whether to allow the foreign company to join the tax group, but for the parent company to be taxed under the same conditions irrespective of the location of its subsidiaries. The decision of the Supreme Court and later the CJEU is expected in the coming months and may once again substantially alter the participation exemption regime. IV. Conclusion The recent decisions have given companies a roadmap for the application of the participation exemption regime in France but also for the application of the EU withholding tax exemption set forth under the French tax guidance. These recent cases have shown some opportunities to recover corporate income tax unduly paid on dividends received in respect of certain shareholdings. On this point, one should note thatataxpayerhasnormallyuntildecember31ofthe second year following the one during which the tax was paid to file a claim. This means that a French company with a financial year closing on December 31 is able to file such claims in 2015 for dividends received for the financial year 2012 onwards. BertrandHermantisSeniorTaxAssociateatTaylorWessing, Parisandmaybecontactedbyemailat b.hermant@taylorwessing.com. Theviewsinthisarticlearethoseoftheauthoranddonot necessarilyrepresenttheviewsoftaylorwessing. Notes 1 French Administrative Supreme Court, November 5, 2014, No. 370650, société Sofina. 2 French Tax Guidance 4 H-3-07; French tax guidance BOI-IS-BASE- 10-10-10-20 No.70, July 18, 2013. 3 French General Accounting Plan dated 1982 (PCG), p.i.42. 4Article145oftheFrenchtaxCodewaslatermodifiedin2006inorder to provide that dividends resulting from shares giving right to financial rights are eligible to the participation exemption regime provided that the parent company owns at least 5% of the voting and financial rights of the company. 5 French Administrative Supreme Court, November 24, 2014, No. 363556, Artémis SA. 6 French Administrative Supreme Court, December 15, 2014, No. 380942, société Technicolor. 7 French Constitutional Court, January 20, 2015, No. 2014-437 QPC. 8 French Constitutional Court, No. 2014-708-DC. 9 The standard corporate tax in France amounts to 33.33%. In case only 5% of the dividend is taxed, the effective tax rate amounts to 33.33% X 5% = 1.66%. Additional taxes may also be applicable depending on the company s turnover. 10 Article 223 B of the French Tax Code. 11 Versailles Administrative Court of Appeal, July 29, 2014, No.12VE03691; Groupe Steria SCA v. Ministry of Finance and Public Accounts (Case C-386/14). 12 X Holding BV, February 25, 2010, Case C-337/08. 03/15 Tax Planning International European Tax Service Bloomberg BNA ISSN 1754-1646 11