Cara Avocats

Day: June 20, 2023

Intra-group reorganizations: social interest must be assessed over time

Posted on by admin1708

THE FACTS

Howmet SAS is part of a group headquartered in Luxembourg. Together with its French subsidiary, it forms a tax consolidation group. With a view to completely overhauling its financial organization, the group undertook a succession of restructuring operations in a very short space of time, aimed at bringing a Belgian subsidiary, previously held by the Luxembourg parent company, back under the French subsidiary of Howmet SAS. To achieve this, the Luxembourg holding company first sold the shares to Howmet SAS, which in turn sold the shares to its subsidiary on the same day as the transaction. The following day, the French subsidiary, which now held the shares in the Belgian company, took out a loan with a Group entity in Switzerland, and contributed the corresponding amount to its subsidiary, which then changed its articles of association to include a financial activity. From then on, the Belgian company made loans, thereby collecting financial interest.

ADMINISTRATIVE CONTROL

The tax authorities challenged the succession of transactions under article L64 of the LFP, considering that these restructurings constituted an abuse of rights aimed at creating an artificial arrangement, the objective of which is to seek the benefit of a literal application of articles 38, 39 and 209 of the CGI. More specifically, the French tax authorities ruled out the deductibility of interest borne by the French subsidiary that had taken out a loan within the group, and instead reintegrated the interest received by the Belgian subsidiary under the guise of a capital increase into the overall result.

DECISION BY THE MONTREUIL TA

In judgment no. 1709196, 1801203 of November 19, 2020, the Montreuil Administrative Court ruled that SAS Howmet should be discharged from the additional taxes, duties and penalties incurred as a result of the reconsideration of the deduction of loan interest, on the basis of article L. 64 of the French tax code, in respect of the 2011 and 2012 financial years, and dismissed the remainder of its claims.

DECISION OF THE CAA DE PARIS

The Court upheld the Minister's request, re-establishing the characterization of abuse of rights and annulling the decision of the Montreuil Administrative Court. Firstly, it noted that the financial impact of this transaction on the French integrated companies was in fact neutral, especially when compared with the increase in the Belgian subsidiary's net assets. In addition, the CAA noted that the Belgian company acted merely as an intermediary, lacking the necessary substance to assume the role it was now supposed to play.

OUR ANALYSIS

COMPANY INTERESTS AT THE HEART OF CONSIDERATIONS

Since the transactions were accompanied by financial interest charges on the earnings of both the French company (which pays interest) and its Belgian subsidiary (which now receives interest), the question of corporate interest within the meaning of Articles 209.1 and 39.1 arose. The Group argued that the concomitant borrowings and capital increases by the Belgian subsidiary were motivated by shareholder demand for higher dividend payouts, and to this end made it possible to mobilize the capital available to the French subsidiaries, thereby helping to strengthen their weight within the Group. This argument was dismissed by the Court, on the dual grounds that, on the one hand, the shareholders' interest was not the same as that of the company; and, on the other, that the immediate effect was to impose additional costs on the French company, while at the same time housing interests abroad.

THE TIMING IS PROMODIAL

After all, the concomitance of the transactions is hardly denounced in the judgment. However, it is an essential element in assessing the fictitious nature of the overall scheme, as it blurs the economic and financial perception of the transactions. The recovery period gives the tax authorities plenty of time to assess, with hindsight, the succession of transactions and their relevance in terms of the effects generated within the group and for the French taxpayer taken individually. In the case in point, the group concentrated its transactions over a very short period of time, just a few days, without being motivated by the imminent end of the financial year, or the occurrence of an event requiring a rapid reaction. In retrospect, it was therefore easy for the administration to question the relevance of transactions on a calendar scale. In economic terms, projects are often built up progressively over time, in the same way as business plans and investments, which traditionally require a later return. In fact, economic cyclicality does not correspond to the independence of financial years, which remains a strictly accounting and tax concept. It seems to us, therefore, that in the case of intra-group reorganizations, the non-tax objective is more easily demonstrated once the operations have been quietly staggered over time.

THE LOOK IN CARA'S EYES

Corporate reorganizations generate variations in taxpayers' accounts, which are systematically detected by tax authorities' tools. On this point, it should be remembered that the interest of the group does not exist in French tax law, and that all measures to combat tax evasion echo the praetorian concept of an abnormal act of management. This ruling sheds additional light on the concept, adding a temporal dimension to the debate. An abnormal act of management is more easily recognized when the transactions impacting a company's accounts take place over a very short period of time. As economic cyclicality is traditionally a long-term process, the concentration of transactions over a period of just a few days raises doubts as to the real aim of the parties involved. In addition, it is crucial to prepare documentation in support of the transaction, and at the same time as it takes place, so as to explain years later, when control is exercised, what effects were intended by the parties, taking into account the parameters and realistic options available at the time. Otherwise, the authorities will have ample opportunity to rewrite history on the basis of the inevitably more numerous elements available.

Comparables and transfer pricing: when the authorities fight the wrong battle

Posted on by admin1708

THE FACTS

SAS Weg France trades in industrial electric motors and electrical equipment.
Following a tax audit of the 2011 and 2012 financial years, the tax authorities noted that the company paid its suppliers, who were members of the group, within a maximum of 30 days of shipment of the goods, whereas delivery times averaged two months. At the same time, its customers paid within 45 to 90 days of invoicing. In practice, therefore, this mechanism led SAS Weg France to bear a high cash flow risk, resulting in recourse to borrowing from its parent company in Spain and from various banking establishments in order to honor its debts to related suppliers.

ADMINISTRATIVE CONTROL

In view of the financial charges it incurred, the French tax authorities took the view that SAS Weg France was providing a service to Group companies by granting cash facilities that it did not invoice. Consequently, this failure to bill for the service rendered constituted a transfer of profit within the meaning of article 57 of the CGI. It then compared the company's adjusted net margin with the median of a range derived from a search for comparables.
In addition, the tax authorities pointed out that, despite a formal notice sent to the company, it had failed to produce the transfer pricing documentation referred to in article L 13 AA of the LPF, even though it fell within its scope. Naturally, the tax authorities then applied the penalties provided for in article 1735 ter of the CGI, which in this case amounted to 81,733 euros.

DECISION BY THE TA OF GRENOBLE

In judgment no. 1902236 of September 16, 2021, the Grenoble Administrative Court rejected SAS Weg France's claims, adopting the now classic approach to transfer pricing by comparing the company's net margin with the median of a panel of database comparables.

DECISION OF THE CAA DE LYON

The Court overturned the Grenoble Administrative Court's ruling and reinstated the company's losses, on the grounds that of the panel of comparables produced by the tax authorities, only five could be considered functionally comparable. However, these companies showed net margins consistent with SAS Weg France's margin adjusted for financial charges over the period under review. In so doing, the Lyon CAA ruled that the tax authorities had failed to demonstrate an indirect transfer of profits under Article 57 of the General Tax Code. It therefore follows that, in the absence of income deemed to have been distributed, the tax authorities cannot uphold the ancillary reassessments in respect of withholding tax and the 10% penalty for late declaration.

OUR ANALYSIS

A FINE EFFORT DENIED BY THE COURT

First of all, the orthodoxy with which the administration has apparently attempted to extract comparable references is to be commended. Practitioners are well aware of the difficulty of this exercise and, above all, of the subjectivity to which it often leads.
In this case, the authorities have probably used the Diane® database, which lists only French companies. This makes it possible to capture references subject to economic conditions close to or similar to those of the party being tested, which is an essential comparability criterion according to the OECD, as well as having been highlighted by a landmark Man Camions et Bus ruling (CAA Versailles, May 5, 2009 n° 08VE02411). Going even further, the French tax authorities had applied a sales filter, as well as a ratio of sales of goods to sales, precisely to capture companies primarily engaged in distribution activities.
However, the CAA rejected certain references. We understand that retail distributors were excluded, since SAS Weg France acts as a wholesaler. This difference has already been considered material enough to pollute the economic analysis by previous rulings (e.g. CE,March 16, 2016, n° 372372 Amycel). Similarly, the rejection of companies distributing their goods to individuals, where SAS Weg France operates in a B-2-B environment, seems logical, given that the difference in clientele leads to differences in functions and risks that blur comparability.
However, we may be surprised at the zeal with which the CAA analyzed the ruling, given that we know that the method used (net margin method) and the use of an interval make it possible to smooth out certain functional differences. In this respect, the ruling is unique and suggests a more orthodox approach to the search for comparables.

THE WRONG FIGHT

It seems to us that, in trying to do the right thing, the tax authorities engaged in a demonstration that ultimately backfired. It seems to us that the administration had correctly identified the presumption of abnormality linked to the financial charges borne by the company in respect of the loan it took out with the group, to finance the cash flow conditions linked to the time lag between the payment of suppliers (members of the group) and the payment of its customers. Insofar as the very purpose of this loan was to finance intra-group flows of goods, the tax authorities considered that the resulting expenses were operating expenses. This approach is also taken in other situations, such as when the taxpayer incurs high interest charges because of the interest it pays to suppliers within the same group. It therefore adjusted the company's net (operating) margin, and in so doing, necessarily placed itself on the ground of "comparative advantage", seeking to quantify the abnormality by using a panel of comparables. This approach is notoriously complex, and case law abounds, opening the door to easy criticism of the degree of comparability of the references used. In fact, there has been no shortage of such criticism.
On the contrary, it seems to us that the administration would have been more successful if it had focused on two areas. Firstly, it would have been easier to question the very purpose of the loan, and therefore the deductibility of the resulting charges. Secondly, it could have used Article 212-I of the General Tax Code, already applicable to the years in question, to attack the interest rate applied. Finally, it should be noted that the tax authorities considered that SAS Weg France was providing a service to Group companies by granting cash facilities that it did not charge for. We were therefore dealing with a non-remunerated service, and therefore with a liberality constituting a "benefit in kind", which is therefore exempt from any search for comparables. The tax authorities could easily have claimed remuneration for this service, without the tax judge disallowing it.

EXPENSIVE DOCUMENTATION

Finally, we note that despite a formal notice, the company failed to produce transfer pricing documentation, even though it fell within the scope of Article L 13 AA. As a result, it incurred penalties of over €81,733, which are obviously non-deductible. Surprisingly, the company did not take advantage of the 30-day formal notice period to prepare such a document, given that such formal notices are often issued several weeks after the start of the audit. This serves as a reminder of the importance of such documentation, especially in view of the penalties that may be claimed.