France’s new proposals to limit financial expense deductions

February 11, 2013

France’s recent Finance the Bill for 2013 firmly cemented the country as one of a set of European nations putting in place stringent austerity measures in a bid to stave off further deterioration of their deficit which, projected at 4.6% of total GDP in 2012 is far beyond a 3% target.

This article was first published in the Ernst & Young Global Tax Policy and Controversy Briefing, Issue 11, December 2012 (pdf, 4.25 MB)

Much news has circulated about the drastic step that François Hollande, the president of France, has taken in increasing the top marginal rate of personal income tax for the highest earners to 75%.

Perhaps receiving less media coverage but of arguably more importance to corporate tax professionals are the proposals to limit financial expense deductions to 85% of interest for fiscal years ending on or after 31 December 2012, further reducing the deduction by 10% to 75% for years 2014 and beyond, aligning France even more to the widespread global trend in this area.

The immediate effect of the Bill would mean:

  • The interest limitation would not apply if the net financial interest expenses of the financial year do not exceed €3 million.
  • With regard to the acquisition of qualifying participants, an acquiring company will face a limitation to the deduction of interest if:
    • The company is established in France controlling the latter or it effectively makes decisions related to those shares
    • When it has control or influence over the shares of a company that is held or established in France
    • Corporate income tax (CIT) would be applicable to 10% of the total gross capital gains without subtracting potential losses from the same fiscal year
    • A reduced cap of net operating loss (NOL) carryforwards to €1 million plus 50% (a 10% reduction from previous years) of the taxable income of the fiscal year exceeding €1 million.
    • An easing of conditions under which a company can request a tax ruling in order to secure the benefit of research and development (R&D) where the eligible company has already begun research
    • Improved R&D tax credit for small- and mid-sized firms as defined by EU law
    • Fourth installment of CIT extended for firms that have an estimated annual revenue exceeding €250M (reduced from €500M) for the current fiscal as well as an increase of the installment amount
    • French firms with non-EU subsidiaries will only be eligible for the safe harbor clause and benefit from a tax favorable gain only if they can prove the absence of tax purpose or effect resulting in such an establishment (inversion of the burden of proof)
    • Financial debt waivers would no longer be tax deductible

Additionally, companies are subject to a 3% additional surtax based on the dividends paid as of 4 July 2012 and as announced some time ago, the 2012 and 2013 CIT rate will include a 5% surtax on total corporate taxes due, which increases the effective corporate tax rate to 36.1%. However, this rate will decrease by a little less than 1.6% to 34.43 in the year 2014 and remain the same through 2015.

Policy context

While these changes have come to a fore within this single Bill, all have been under debate for some time. Considering the projected budget deficit of 4.6% of GDP and taking into account the overall European and global economic weakness, France has been under tremendous pressure from the European Commission as well as the financial markets to take action.

Prior to Mr. Hollande’s election, the previous government had already started putting in place measures to reduce the deficit in 2011. Previously anticipated to reach 5.6% of GDP, the deficit was in fact reduced to 5.2% by the end of 2011.

Now, France is trying to speed up the process to further reduce the deficit to 3% of the GDP and to meet that goal by the end of 2013. All in all, these drastic changes indicate difficult and somewhat tough times ahead for both taxpayers as well as France in the years to come.

Future predictions

France finds itself in a difficult predicament where, with a high corporate tax rate in place (although, to be fair, a smaller tax base than many European neighbors), it is most likely to have increased the tax burden of individuals over that of large multinational companies, as evidenced by the significant increase to the top rate of personal income — although that increase in fact impacts a relatively small number of taxpayers.

What will be of greater interest — to the taxpaying public, at least — is whether the government takes advantage of the fact that it has only just been elected to play the “long game” by increasing the tax burden on the middle classes before reducing it in advance of the next election.

As in many other countries, tax is now taking the stage as a core component of the political landscape in France. It is anticipated that the main provisions of the Bill will pass in parliament with few amendments. Whether or not this challenges the overall tax competitiveness of France remains to be seen.

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