Published in Revue Européenne et internationale du Droit Fiscal n° 2012/3
Day: January 19, 2023
Do zero-interest cash-flow agreements constitute an abnormal act of management?
STARTING SITUATION
SAP France is indirectly owned by the German company SAP AG. Under a contract signed in 2009, SAP France entered into a centralized cash management agreement with its parent company, under which it deposited its cash surpluses with the German company, which were remunerated on the basis of an interest rate equal to the EONIA interbank reference rate less 0.15 points. In 2012 and 2013, the application of this formula resulted in a negative interest rate, due to changes in the EONIA, and the parties to the cash management agreement agreed to set this rate at 0%.
ADMINISTRATIVE CONTROL
Following an audit of SAP France's accounts for the 2012 and 2013 financial years, the tax authorities questioned the normal nature of this nil remuneration, considering that the absence of interest on this cash flow agreement constituted a benefit in its own right. It therefore corrected the company's taxable income, and considered this benefit as income deemed distributed to the German company, subject to withholding tax.
DECISION OF THE CAA DE VERSAILLES
In ruling that SAP France had granted SAP AG a liberality by waiving the right to remuneration in return for depositing its cash surpluses with the latter, the Administrative Court of Appeal based its decision on the fact that this zero remuneration was unrelated to that to which the company would have been entitled if it had deposited its cash surpluses with a financial institution over the same period, without this absence of remuneration being offset by the possibility of financing cash requirements, which were non-existent for the years in question.
DECISION BY THE CONSEIL D'ÉTAT
The Conseil d'Etat annulled the CAA's decision and referred the parties back to the CAA. According to the tax judge, the CAA erred in law when it ruled of its own motion that the application of a zero rate constituted a liberality, on the sole grounds that it was lower than what a financial institution could have granted to SAP France. In the CE's view, the Court should have examined whether the modification by the parties of the initial terms of the contract, which led to the application of a negative rate, and the substitution of a rate which was then zero (and therefore more advantageous for SAP France), still represented an abnormal act of management for the company.
OUR ANALYSIS
IS A NEGATIVE RATE POSSIBLE UNDER A TREASURY AGREEMENT?
The case concerns the replacement of the contractual rate, which in view of market trends led to the application of a negative rate, by a 0% rate. Applying a negative rate would have led SAP France, which was in a credit position, to pay interest on the investment of its funds. The mechanics may seem abstruse, even though they reflect a market situation. In our view, the question of the applicability of negative interest rates to cash management agreements poses two major problems: (i) firstly, cash management agreements are specific to corporate groups, so there is no external comparable reflecting market conditions (at arm's length); (ii) secondly, the subject also brings into conflict two opposing visions: fiscal on the one hand, and economic on the other. Indeed, there is an economic current that recognizes the possibility of the financial market applying negative interbank rates. Earlier decisions also suggested that, in the absence of a specific clause implementing a floor rate, it could not exist implicitly (see e.g. TGI Strasbourg, January 5, 2016; CA Colmar, March 8, 2017). However, we believe that a holistic legal approach should lead us to consider that negative rates do not reflect normal management. Firstly, loans governed by the Monetary and Financial Code imply that the lender is acting for consideration (art. L 313-1 Code mon. et fin.). The lending activity must generate an economic benefit. Moreover, the commercial status of the companies involved in the transaction theoretically requires them to pursue a profit-making objective. We therefore believe that, irrespective of the state of the market, the application of a negative interest rate constitutes an abnormal act of management, unless the parties renegotiate the terms of their agreement.
WHICH REFERENCES TO USE?
It is interesting to note that to assess the deemed arm's length rate, the CAA had validated the reference used by the department to the average rate of remuneration on sight deposits calculated by the Banque de France. No reference was made to the rate referred to in article 39-1-3 of the CGI, which is the rate to which the application of article 212-I of the same code leads. In our view, the reason for this is that the rectifications were made under the sole authority of article 57 of the CGI, and not 212-I. Nonetheless, in our view, this ruling allows us to derogate from the systematic application of the Article 39-1-3 rate, insofar as a cash flow agreement is, by its very nature, necessarily liquid and short-term. Nevertheless, we believe that a more appropriate benchmark would be the yield on money-market mutual funds (Sicav monétaires) or units in money-market mutual funds (fonds communs de placement monétaires), which are used to invest cash surpluses or highly liquid capital.
PAY ATTENTION TO OPERATION QUALIFICATION!
The ruling concerns a treasury agreement, which remains a special financing tool, specific to groups of companies, and theoretically liquid and available. However, groups must ensure that the repetition of flows over time, and in a single direction, does not lead to the reclassification of all transactions as longer-term loans with successive drawdowns. Such reclassification would necessarily lead to the application of a different rate, as this would be correlated to the specific factors of the transaction (duration, currency, borrower's credit rating, etc.), all parameters which have been largely defined by recent case law (see for example CE, 29/12/21, 441357, Apex Tool).
Reversing the burden of proof in financial matters: is the pendulum swinging back?
STARTING SITUATION
SAS Willink issued two ten-year bonds convertible into shares at an interest rate of 8% per annum, subscribed by two French venture capital funds and a UK company.
ADMINISTRATIVE CONTROL
The tax authorities questioned the deductibility of the financial charges incurred by this transaction, insofar as the fraction of interest paid to the funds and the British company exceeded the rate stipulated in article 39-I-3° of the CGI. In addition, the tax authorities considered that the interest due on the differential constituted a gift to the British company.
To justify its position, the company subsequently produced a rate study using Riskcalc software. This study is based on a model calculating the probability of default in the short and long term, and then associates implicit scoring. A search for comparable transactions on the open market was then carried out using the SetP Capital IQ database.
DECISION OF THE CAA DE PARIS
In rejecting the company's argument, the CAA dismissed the results obtained from the Riskcalc scoring tool, finding that it was a statistical model based on historical quantitative data from companies that were not representative of the market, since defaulting companies were over-represented; that it only took into account a dozen or so financial data items supplied by the company itself; and that there was no evidence that the risk rating obtained using this tool would adequately take into account all factors recognized as predictive, and in particular the specific characteristics of the business sector concerned.
DECISION BY THE CONSEIL D'ÉTAT
The Conseil d'Etat considered that the Court, which had followed the tax authorities, had erred in law by rejecting the probative value of the Riskcalc tool used, and by giving preference to the rating agencies. In rejecting the probative value of the risk estimate obtained from the Riskcalc scoring tool, without investigating whether elements relating to the use of this tool in the case in question or derived from other elements of comparison led to calling it into question, the Court vitiated its ruling with an error of law.
OUR ANALYSIS
IMPOSSIBLE PROOF" PUT TO THE TEST BY CASE LAW
Article 212-I, which leads to the application of the reference rate referred to in article 39-1-3 of the CGI, has already undergone a clear shift under the impetus of the tax judge. For the record, when a loan is granted by an affiliated company, interest is deductible up to the limit of that calculated on the basis of a rate defined in article 39-1-3° of the CGI. However, the borrowing company benefits from a mechanism of proof to the contrary: it may deduct interest calculated on the basis of a higher rate if it demonstrates that the latter corresponds to the rate it could have obtained from independent financial institutions or organizations under similar conditions (article 212-I-a of the CGI). The administration's strict reading of the texts had led to a mechanism of "impossible proof" according to practitioners. However, the tax judge has tempered the rigidity induced by administrative practice by validating the fact that (i) alternative searches for comparables may not be contemporaneous with the financial transactions (e.g.: TA Paris, June 7, 2018, Paul Ka); the credit rating systems employed are deemed to sufficiently reflect the intrinsic elements of the economic markets concerned (e.g.: CE, Dec. 29, 2021, Apex Tool); or (iii) the rate may be determined by reference to the bond market (CE opinion, Jul. 10, 2019, SAS Wheelabrator Group).
HOW IS CREDIT RATING DEFINED?
Determining the borrower's credit rating is the first step in the analysis, insofar as this indicator reveals the company's overall solvency. On this point, the Conseil d'Etat formally acknowledges that ratings obtained using "RiskCalc" type tools are admittedly more approximate than a credit rating that might be carried out by a rating agency. However, it pragmatically admits that "the use of such a rating is not necessarily appropriate, given its cost, in an intra-group transaction". On the other hand, contrary to what the Paris CAA ruled, this tool does take into account the company's sector of activity, which must be entered by the user. In fact, the resulting ratings are based on data taken from the company's accounts, without the latter being able to modify the parameters used by the application. In this case, the Minister did not dispute the overall robustness of the application. The reference to such a tool can therefore be considered sufficiently reliable to justify a company's risk profile. Taxpayers therefore have two ways of establishing their credit rating: using a specialized computer tool (e.g. RiskCalc), or referring directly to a rating agency. It should be noted that the use of the RiskCalc tool has already been validated in the Studialis ruling (CAA Paris, Oct. 22, 2020).
REBALANCING THE BURDEN OF PROOF
The burden of proof under article 212-1 of the CGI does indeed shift to the taxpayer. However, the tax judge has gradually repositioned the administration in the system of proof, making it responsible for demonstrating the inaccuracy of the taxpayer's analysis. In so doing, the Conseil d'Etat laid the foundations for a 3-step waltz:
If the rate referred to in article 39-1-3 is not applied, the taxpayer bears the full burden of proof.
The latter can nevertheless carry out alternative economic analyses using specialized statistical and digital tools.
These alternative analyses are deemed reliable, unless the administration can demonstrate that the approach is flawed. For example, the tax authorities may provide detailed criticism of the use made of the RiskCalc tool in the case in point, or evidence that the resulting valuation was flawed in the particular case. It can also demonstrate that reference to the bond market does not constitute a viable reference when such loans constitute, in each case under consideration, an unrealistic alternative to a traditional intra-group loan.
Should the CIR be neutralized for intra-group invoicing?
STARTING SITUATION
STMicroelectronics carries out R&D in the field of
semiconductor technologies, for which it receives a research tax credit. It has signed a framework agreement with its parent company, STMicroelectronics NV, under which STMicroelectronics carries out R&D operations on behalf of STMicroelectronics NV. STMicroelectronics NV defines the research program and owns the resulting intellectual property rights. STMicroelectronics NV pays STMicroelectronics NV a fee calculated by applying a mark-up of 7% to the costs of R&D operations incurred by STMicroelectronics NV (Net Cost Plus), less the amount of research tax credits and public subsidies linked to research operations received by STMicroelectronics NV.
ADMINISTRATIVE CONTROL
Following an audit of STMicroelectronics' accounts for the years ended 2012 and 2013, the French tax authorities considered that the deduction of research tax credits and public subsidies from the basis of costs re-invoiced by the company led to an indirect transfer of profits abroad, within the meaning of Article 57 of the French General Tax Code. It increased the income recorded by the company by the amount of the subsidies and the research tax credit added back to the cost price used to determine the sale price, and notified the company of the increases in its corporate income tax assessment bases. Drawing the consequences, for the determination of the controlled company's added value, of the rectification of the income booked, the tax authorities notified STMicroelectronics of reminders of the company's added value contribution, its additional taxes and management fees for the years ended 2012 and 2013.
ADMINISTRATIVE COURT DECISION
In judgment no. 1907583 of December 17, 2020, the Montreuil Administrative Court discharged the company from paying the additional corporate income tax, social security contributions and exceptional corporate income tax, as well as the corresponding penalties. However, the company considers that this ruling is vitiated by a clerical error, and is seeking discharge from the additional corporate income tax, social security contribution and exceptional contribution and from the corresponding penalties.
DECISION BY THE ADMINISTRATIVE COURT OF APPEAL
On August 16, 2022, the Court of Appeal overturned the ruling and discharged the tax.
In the opinion of the tax judge, the deduction of the CIR by a French company to determine the sale price of the product to be invoiced to a foreign company with which it has a contractual relationship, cannot in itself be considered to give rise to a presumption of the existence of a transfer of profits abroad, within the meaning of Article 57 of the French General Tax Code.
OUR ANALYSIS
BENEFITS BY NATURE VS BENEFITS BY COMPARISON
In this case, the Court reiterates one of the foundations of the dialectic of evidence in transfer pricing matters, which consists in apprehending in a different way what the Commissaire du Gouvernement Emmanuel Glaser described as advantages "by nature", as opposed to advantages "by comparison". The former are easy to perceive, as they are not offset by any direct consideration, such as interest-free loans. The latter are more tenuous, as they require an economic analysis (a benchmark) aimed at identifying third-party references that are necessarily independent and placed in conditions similar to those surrounding the intra-group transaction that is the subject of the rectifications. This distinction has given rise to a recital almost systematically taken up by judges in transfer pricing matters, inviting the tax authorities, in order to provide a presumption of indirect transfer of profits abroad, according to which "in the absence of having carried out such a comparison, the service is not, on the other hand, is not entitled to invoke the presumption of profit transfer thus established, but must, in order to demonstrate that a company has granted a liberality by invoicing services at an insufficient price, establish the existence of an unjustified difference between the agreed price and the market value of the asset transferred or the service rendered".
It is interesting to note here that the Court considers that the advantage criticized by the administration is an advantage by comparison, which therefore required the department to demonstrate, by means of a search for comparables, that third-party and independent references would (or would not) have deducted the amounts of the CIR and other subsidies from their cost base on which the margin is based.
WHAT DEDUCTION?
In this case, the ruling highlights the fact that the company had deducted the CIR amounts from its cost base, thus reducing the base on which the 7% margin is based. In doing so, the company applied the transactional net margin method, coupled with a "Net Cost Plus" profit indicator. An alternative would have been to deduct the CIR not from the cost base, but from the total amount comprising this 7% Net Cost Plus. The decision might then have been different, since the CIR compensates for the costs incurred. The company's approach thus respects the very nature of the CIR, by considering that its impact is on costs, and not on the company's total profitability.
ONE MORE STONE
The Paris CAA's decision adds another stone to the solution provided by the Versailles CAA's decision of October 11, 2016, Sté Philips France (n°14VE02651). In this former case, the judge had rejected the administration's claims on the grounds that the comparables produced were not independent. The evidence was therefore inherently flawed. Before the Conseil d'Etat, the Minister was again dismissed on the grounds that no more well-founded economic analysis had been provided (CE, September 19, 2018, n°405779). However, it was already clear that the advantage deemed to exist was an advantage by comparison, and not by nature.
BEWARE OF CONTRACTS!
In the Conseil d'Etat's 2018 ruling, the tax judge considered "that even though the agreement between the two companies did not expressly stipulate that the cost price taken as the basis for calculating the sale price would be the cost actually incurred, net of the amount of subsidies, the Minister is not entitled to argue that the administrative court of appeal erred in law". At the time, only the comparative analysis counted. It seems to us that this approach could now be called into question, not least because of the decision SAP France Holding (CAA Marseille, July 08, 2021, n°20MA00804). This decision reminds us of the imperative need to specify, in the contract, the exact components of the cost base on which the margin is based. In the SAP case, the contract stipulated that all costs had to be rebilled. Inspired by this, the department deduced that the CVAE, which is deducted from the company's income, should therefore be included in the costs re-invoiced to the foreign partner.
Interest deduction on intra-group loans: the end of the saga?
STARTING SITUATION
WB Ambassador has taken out two loans with its parent company and another group company, bearing interest at an annual rate of 7%.
The tax authorities considered this rate to be excessive in the light of Articles 212-I and 39-1-3 of the General Tax Code, and consequently proposed a correction, reinstating a fraction of the interest incurred.
JULY 07, 2017: ADMINISTRATIVE COURT DECISION
In a ruling dated July 07, 2017, n°16007683, the Paris Administrative Court rejected WB Ambassador's request for a discharge of the additional corporate income tax assessments and reinstatement of the carry-forward of the deficit recognized on January 1, 2020.
The judges made a strict assessment of the provisions of Article 212-1 and the evidence that taxpayers could provide. The three studies provided by the company were rejected for lack of precision and detail. However, they confirmed that the taxpayer's supporting analysis need not be contemporaneous with the loan offer.
DECEMBER 31, 2018 : DECISION BY THE ADMINISTRATIVE COURT OF APPEAL
On December 31, 2018, in ruling no. 17PA0318, the Paris CAA upheld the administrative court's decision and dismissed the appeal lodged by the company.
According to the judges, the comparison used by the company was not relevant, as it was based "on rate comparables from bond financial markets" and agreed with the tax authorities' position that only a bank offer or references to the debt market were acceptable within the meaning of article 212-I of the CGI.
DECEMBER 10, 2020 : DECISION BY THE CONSEIL D'ÉTAT
In a ruling dated December 10, 2020, no. 428522, the Conseil d'Etat, seized of a power of attorney brought by the company, overturned the ruling of the Administrative Court of Appeal.
According to the Conseil d'Etat, the court erred in law by excluding the possibility for the company to justify the rates by using the yield of bond issues granted by companies in comparable conditions.
The Conseil d'Etat continues, and its 2019 "Wheelabrator" opinion, and the trend started by the "Studialis" decision, and validates the use of bond issues as comparable.
JUNE 29, 2022: DECISION BY THE ADMINISTRATIVE COURT OF APPEAL
On June 29, the 2nd chamber of the Paris Court of Appeal, on a referral from the Conseil d'Etat, overturned the decision of the Paris Administrative Court and reinstated the losses incurred by AB Ambassador.
OUR ANALYSIS: Problem posed by the ruling
THE TAXPAYER'S FREEDOM OF PROOF IS ENSHRINED
The Court of Appeal has endorsed the December 10, 2020 ruling by the Conseil d'Etat, which had adopted a position favorable to taxpayers. Indeed, this ruling confirms the opinion issued a year earlier (CE July 10, 2019, n°429426, SAS Wheelabrator), by reaffirming the principle of freedom of proof in determining the interest rate on loans concluded between companies belonging to the same group.
From now on, tax authorities and judges must genuinely debate the evidence provided by the taxpayer to justify the normal and arm's length nature of an intra-group interest rate.
It is in the context of this debate that the Administrative Court of Appeal assesses the evidence provided by AB Ambassador and confirms that the interest rates charged on bond loans can constitute proof of the arm's length nature of the rate on an intra-group loan, provided that it is proven that these loans constitute a realistic alternative to an intra-group loan (i.e. a reference to the debt market).
In this case, the evidence provided by the company was sufficiently elaborate to justify the rates applied to the intra-group loans.
THE FINAL EPISODE IN THE WB AMBASSADOR SAGA, BUT WHAT ABOUT THE SEQUEL?
The ruling handed down on June 29, 2022 brings to a close the WB Ambassador saga, which has given rise to a number of issues and questions that have fuelled a strong movement in case law on intra-group loans, as well as debate on the link between transfer pricing and Article 212-1 of the French General Tax Code.
The Administrative Court of Appeal has clarified the nature and mechanics of proving the normality of the interest rate applied in the case of an intra-group loan. This decision is in line with the analysis inspired by the Bercy guidelines on intra-group financial transactions, and by the body of case law comprising the Studialis, Wheelabrator, Appex Tool and BSA decisions.
Nevertheless, while this decision clarifies intra-group loan situations, many uncertainties remain as to how to demonstrate the arm's length rate attached to other financial vehicles, notably the Cash Pool. The decision also leaves minority shareholders still subject to the compartmentalization of Article 212-I and the strict application of the Article 39-1-3 rate, as the Trocadéro decision recently reminded us.
Finally, although the taxpayer can now refer to the bond market, he still needs to be able to demonstrate that such a reference constituted a realistic alternative given his situation. While the burden of proof on the taxpayer has been eased (somewhat), justifying a borrowing rate different from that referred to in article 39-1-3 of the CGI still remains a challenge for taxpayers. The judges have not yet given us all the keys to transfer pricing applied to financial flows.