Cara Avocats

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Is summer in Brazil a good time for tax reflection?

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Meeting for the third time in Rio on July 25 and 26, the G20 reaffirmed its strong commitment to fair global tax reform.

The G20 continues to play a crucial role in reshaping the international tax system to meet the challenges posed by economic globalization and digitization. By supporting the OECD's BEPS initiative, the G20 is focusing on two key pillars:

  • - Reallocation of taxation rights: Digital companies will now be taxed where their consumers are located, even if they have no physical presence in those countries. A major step towards fairer taxation!
  • - Global minimum tax rate: A minimum tax rate is introduced to prevent companies from taking advantage of tax havens. A key measure to put an end to the race to the bottom.
  •  
  • These reforms aim to ensure that all companies pay their fair share of taxes, wherever they operate, while strengthening international cooperation to combat tax evasion. In this way, the G20 is leading the way towards a fairer, more transparent global tax system.

CARA'porteur public: what are the effects of settlement periods in transfer pricing analysis?

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The Administrative Court of Appeal has ruled in favor of the Clarins group in a dispute with the French tax authorities. The case, which concerned transfer pricing and payment deadlines between subsidiaries, could have major repercussions for international groups operating in France.

The background to the case

The case dates back to the 2005 and 2006 tax years, when the tax authorities carried out an audit of Clarins SA's accounts. The tax authorities criticized Clarins for granting its foreign subsidiaries abnormally long payment terms, without interest, while incurring factoring costs for these receivables. The tax authorities saw this as an indirect transfer of profits abroad, a practice sanctioned by article 57 of the CGI.

Judicial reversal

After an initial rejection of its request by the Montreuil Administrative Court, Clarins appealed the decision. The CAA not only annulled the court's decision on grounds of insufficient reasoning, but also ruled in Clarins' favor on the merits of the case.

The decisive arguments

The court noted that the comparisons provided by the tax authorities, which were intended to prove the abnormal nature of the payment delays, were deemed irrelevant. The Court considered that these comparisons did not take into account the specificities of Clarins' business sector and the particular nature of its transactions.

The implications of the decision

This decision is a landmark in the field of transfer pricing tax audits. It underlines the importance for tax authorities of providing precise and relevant comparative data when seeking to demonstrate the existence of an advantage granted between related companies.

For international groups, this ruling is a reminder of the importance of carefully documenting their transfer pricing and payment terms policies, taking into account the specific features of their business sector.

Transfer pricing: the importance of a substantiated functional analysis (CAA Paris, Engie)

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An adequate and well-founded functional analysis, enabling a precise assessment of the nature of the functions, risks and assets of the parties to an intra-group transaction, and their intensity in the group's value chain and business, is and always will be the cornerstone of any transfer pricing demonstration.

The resulting functional classification determines the selection of the most appropriate transfer pricing method, and hence the allocation of large value pools between the parties and their respective capacity to withstand market volatility and losses over the longer or shorter term.

The obvious, which is now almost a truism, was once again pointed out by the tax judge in the Engie case.

In this case, the French tax authorities challenged the cost-plus method applied within the group to "single voice" contracts, which grouped together various services rendered to subsidiaries in the United States and Luxembourg. Taking the view that the French company was not merely a service provider (or "broker" in the ruling), but had a "strategic function", holding "intangible assets of unique value", the tax authorities substituted the profit split method. This substitution mechanically shifted the profitability hitherto captured by the subsidiaries to the French company, which was then remunerated on the basis of the overall contract and no longer its incurred costs.

Following a detailed analysis of the parties' roles and their importance, the Paris CAA rejected the administration's characterization and overturned the lower court's decision.

The functional analysis revealed that the French company did not mobilize any strategic functions, and that the subsidiaries remained the final decision-makers for all transactions.

The ruling reiterates the imperative need for a precise description of the parties' roles in the light of the value chain in which they are involved, and the importance of materializing these roles through the resources deployed internally (substance enabling the functions to be performed and the inherent risks to be controlled).
CAA Paris June 27, 2024 n°21PA01277

Enforceability of transfer pricing documentation. Yes, but from when?

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The Finance Act for 2024 has enacted the tightening already observable in the field with regard to transfer pricing, by reinforcing the documentary system weighing on companies. In addition to lowering the thresholds for transfer pricing, documentation is now formally enforceable against companies. In order to make companies more accountable for the documentation they produce, and to reinforce the effectiveness of tax audits, Article 116 of the 2024 Finance Act has supplemented Article 57 and made transfer pricing documentation enforceable for financial years commencing on or after January 1, 2024.

But are we to understand, then, that documentation covering financial years beginning on or after January 1, 2024 will henceforth be enforceable; or that all documentation produced from that date onwards, irrespective of the financial year it covers, will be enforceable?

While the law does not settle the matter, it seems fairly certain to us that the event to be taken into account is not the fiscal year, but the duty to communicate. As a result, any documentation, even relating to a past or even an old financial year, will now be enforceable against the company, as long as it is produced to the tax authorities after January 1. Thus, in the context of an accounting audit, in the event of a discrepancy between the pricing policy declared by the company and the one it actually applies, the difference between the result recorded and the amount it would have reached if the documentation had been respected is now presumed to constitute an indirect transfer of profits, which the tax authorities can reintegrate even for the past.

In support of this position, it should be noted that this measure does not create a new obligation for the taxpayer, but rather clarifies its scope. It is therefore not subject to the non-retroactivity rules of tax law. Above all, the tax judge had already settled the question, relying on the content of the documentation produced during the audit operations to assess the validity of the rectifications made by the administration. In two recent cases before the Cour administrative d'appel, the judge referred to passages in the taxpayer's transfer pricing documentation to assess the correct application of the remuneration method used. In the Sumitomo case, for example, the Lyon CAA noted that the net margin method, although included in the documentation, had not in fact been applied (no. 21LY02821). In the Itron ruling, the Paris CAA relied on the explanation provided in the documentary report for transfer pricing adjustments to discredit the interpretation made by the tax authorities (no. 21PA04452). In these two cases, therefore, it was the content of the documentation that steered the debates and gave rise to an obligation on the part of the taxpayer. Even before opposability was conferred by the Finance Act, it had already been established in practice.

Deductibility of intra-group interest : The proof is clearer and more flexible!

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THE FACTS

Following an audit of GEII Rivoli Holding's accounts for the 2013 and 2014 financial years, the tax authorities questioned the deductibility of the difference between the 5.08% rate applied and the 2.79% corresponding to the value mentioned in 3° of 1 of Article 39 of the CGI.
During the litigation phase, the company produced an initial analysis based on the RiskCalc tool developed by Moody's, identifying the risk rating that could have been assigned to it, as well as a rate range established by reference to those obtained by fifteen non-financial companies, belonging to heterogeneous business sectors.
A second corroborative analysis was submitted to the Paris CAA, based on the calculation of two financial ratios, one of which, known as the "loan-to-value" (LTV) ratio, was based on bond market data taken from the Standard & Poor's Capital IQ financial database.

THE RULE

A trend in case law built up around the 2020s has redrawn the contours of proof with regard to the deductibility of rates charged to majority shareholders.
Specifically, the borrowing company may rely on the rates of bank loans granted, under arm's length conditions, to companies in the same non-financial sector, which have obtained credit ratings close to that which can be determined for it, even though these other companies may belong to heterogeneous business sectors.
The borrowing company may also take into account the yield on bonds issued by companies in comparable economic conditions, where such bonds represent a realistic alternative to an intra-group loan.

THE JUDGES

The TAA de Paris in 2021, then the CAA de Paris in 2022, rejected the company's claims and confirmed the rectifications made.
Firstly, the judges noted that, in order to justify the 5.08% rate applied to its parent company, GEII Rivoli Holding had produced a report using the RiskCalc tool developed by Moody's, which identified the risk rating that could have been awarded to the company, i.e. Baa1. However, this risk rating had been obtained without entering the applicant's business sector in the RiskCalc tool. Thus, the CAA was able to dismiss this method as inconclusive on this ground, without committing an error of law, since such a circumstance meant that the company's particular economic situation was not taken into account.
Secondly, in rejecting the corroborative method proposed by the company, the CAA considered that the company did not justify that a bond issue would have constituted a realistic alternative to an intra-group loan.
Finally, the CAA considered that the company had not been provided with any precisely identified comparables whose relevance it would have been able to assess.

THE CONSEIL D'ÉTAT'S SOLUTION

The EC accepted the first argument of the lower courts, rightly considering that the company's sector of activity is an important parameter to be taken into account when calculating the credit rating on the RiskCalc tool.
However, it rejected the rest of the arguments, thus validating the company's economic and statistical demonstration. More specifically, the EC emphasized:
- "The size of a company is not in itself such as to hinder access to this market, and that the realistic nature, for a company having recourse to an intra-group loan, of the alternative hypothesis of a bond issue can only be assessed in the light of the specific characteristics of this company and of the transaction, the rates observed on this market having to be adjusted if necessary".
- The arm's length rate put forward by the company as corresponding to its level of risk was based on the use of rate curves established on the basis of all the transactions recorded, for loans of the same duration contracted by companies with the same risk profile, and it was not argued that the recording of transactions in this database was unreliable".

OUR ANALYSIS

THE RISKCALC TOOL IS USEFUL, BUT NOT ALL-POWERFUL

Developed by Moody's, the RiskCalc tool has gained legitimacy among tax judges since the Studialis ruling by the Paris CAA in 2020 (no. 18PA01026).
This tool can be used to determine a borrower's risk rating, which is the first essential step in demonstrating the arm's length nature of a rate charged to majority shareholders. However, this tool requires a detailed analysis of the borrower's intrinsic parameters, both quantitative and qualitative, including in particular its business sector.
This latter indicator has a major influence on the past and future prospects for growth, profitability and therefore risk, of the players making up a given market. If this essential criterion was not included, the analysis produced initially could not be relevant or complete, as it necessarily misunderstood the company's economic situation.
It is interesting to note, however, that neither the contemporaneity of the analysis nor the relevance of the tools cited were discussed, thus validating, and no doubt definitively, the praetorian trend initiated by the aforementioned Studialis, BSA de la CAA de Versailles (n°20VE03249), and Willink du Conseil d'Etat (n° 446669) rulings.
Above all, it should be noted that the demonstration that finally won over the Conseil d'Etat was based on an alternative financial ratio known as "loan to value" (LTV), which relates the level of indebtedness to the value of the company's real estate assets. In this case, this indicator led to an estimate, based on a comparison with the ratios of listed French and European property companies, that the financial rating it could have obtained would not have exceeded BBB, i.e. a level close to that initially proposed by RiskCalc.
In this case, the LTV ratio had been calculated taking into account a financial debt corresponding exclusively to the loan whose rate had to be assessed. One might have thought that the calculation was flawed because it was circular. However, by focusing on the principal loan (the purpose and amount of which were not in dispute), without taking into account the interest (the rate of which was at the heart of the debates), the ratio was indeed relevant and valid.

THE CONSECRATION OF THE BOND MARKET

In its July 2019 Wheelabrator opinion, the Conseil d'etat paved the way for a pragmatic approach, in line with OECD practice, to the taxpayer's demonstration of the "arm's length" nature of an interest rate charged in the context of intra-group financing, allowing in particular the use of bond benchmarks.
However, this opinion, as well as subsequent rulings, seemed to contain a reservation, by making reference to the bond market conditional on demonstration that "these loans constitute, in the hypothesis under consideration, a realistic alternative to an intra-group loan". In other words, the taxpayer appeared to have to prove that issuing bonds was a realistic alternative to taking out a conventional loan with a bank or credit institution.
In recital 10, however, the CE seems to reinforce the burden of proof on the tax authorities. The judge considers that "the realistic nature, for a company having recourse to an intra-group loan, of the alternative hypothesis of a bond issue can only be assessed in the light of the specific characteristics of the company and the transaction, with the rates observed on this market having to be adjusted, where necessary, to take account of the specific features of the company in question". In order to disregard the reference to the bond market, it would seem that the tax authorities would have to demonstrate that, given its specific and intrinsic parameters, this option would have no purpose, or would be inappropriate.
In our view, such proof is impossible.

BENCHMARKS FOR ALL?

While the two-step economic analysis now seems to be well recognized by the tax judge, both in its credit risk calculation component and in its search for comparables on bond markets, it should be remembered that this approach is only valid if the lender is a majority shareholder within the meaning of Article 212-I. Minority shareholders cannot use this analysis to justify a different rate from that referred to in article 39-1-3 of the CGI (see CAA Versailles, Sté Financière Lilas, n°19VE00546). This trend further reinforces the difference in treatment between taxpayers.

France v/s. SAS Itron France January 2024

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Facts, Procedures, and the Decision

STATEMENT OF FACTS

SAS Itron France ("Taxpayer") (a manufacturer and distributor of water, electricity and gas meters) was the subject of a tax audit for the financial years 2012 and 2013, which resulted in an assessment. The tax authorities ("TA") considered that the transfer pricing applied by the group had resulted in an understatement of taxable income in France and a transfer of profits to a Hong Kong-based distributor of the group. An appeal was filed by SAS Itron France and in a ruling handed down on December 2, 2021, the Administrative Court annulled the assessment. The TA filed an appeal against this ruling. The Administrative Court of Appeal dismissed the appeal and decided in favor of SAS Itron France. The TA concluded that the Taxpayer had granted an unfair advantage to its related party distributor within the meaning of Article 57 of the French Tax procedure Code.

ARGUMENTS OF THE TAX ADMINISTRATION

The Taxpayer is a manufacturer as well as a distributor of water, electricity, and gas, therefore it is in a situation of mutual dependence with its Group entities. The TA tested the Taxpayer's relations as a producer with group distributors and followed a "profit-sharing" method. It further functionally analyzed the Taxpayer and then attributed the following distribution margin between the manufacturer and the distributors:
(i) 53% and 47% for "gas" product line respectively;
and
(ii) 51% and 49% for water and electricity respectively.
The TA stated that the Taxpayer's profit as a manufacturer was insufficient in relation to the overall margins determined by the TA (i.e., 53% and 51%).

THE DECISION

The Court rejected the adjustment sought by the TA in terms of the group's transfer pricing policy as such adjustment can only be warranted in the event of a significant differences between the transfer price resulting from this method and the economic reality, such adjustments are provided for only in exceptional circumstances and under a procedure that derogates from the "cost-plus" method. The Court observed that the TA failed to demonstrate whether any special circumstances arose during the period of assessment (FY2012 and FY2013) which could justify the adjustment. The Court ultimately stated that the TA had failed to interpret tax law as they could not establish any consistency to their allegations. The case was therefore dismissed in the final appeal.

CARA ANALYSIS

BREAK DOWN OF THE DECISION

On one hand, the Court gave consideration to the Taxpayer's claim that in order to reconstitute the transfer prices between SAS Itron France as a manufacturer and its related party distributors, the TA used the margin of the distributing entities after deducting the sale price of SAS Itron France's products, without taking into account the distributor's own operating expenses (such as cost of discounting ; commissions paid to agents; rebates and discounts; product shipping costs; insurance costs incurred in transporting products; customs duties; product packaging costs), even though these expenses contribute to the distributors' share of the Group's net margin to which they should be entitled.
On the other hand, the TA deducted their direct expenses from the margin of the manufacturing entities, including SAS Itron France, to which the gross margin rates mentioned in the previous point apply under the cost-plus method.
Without calling into question the parameters used by SAS Itron France to determine its transfer prices as a producer (costs used and margin rates mentioned) determined within an arm's length interval), the TA had carried out a comparison of heterogeneous margins, gross for the distributing entities and net for the producing entities. Moreover, for an adjustment to be applied, three conditions must be met:

  • existence of new markets or invitations to tender;
  • existence of a turnover exceeding 10% of the distributor's revenue;
  • existence of a variation in the distributor's turnover of at least 500,000
    euros.

The Court observed that the TA failed to demonstrate the existence of the above elements.

THE CONCLUSION

At CARA we always stress on the importance of really understanding the functions and risks undertaken by the parties to a given controlled transaction, as it is extremely crucial not only in determining the range but also in applying the correct methods and profit level indicators (PLIs) to derive the range. This decision of the Court is a case in point for the same.
Different methods and PLIs test different functions of the tested party, especially when the tested party has dual profiles. Therefore, one must be sure to test the correct profile (for e.g., distributor or manufacturer) and the risks associated with that profile, as demonstrated by this case law.
Moreover, experience has shown us that the application of most methods will be imperfect, even, for example, by applying the CUP method which bases itself on very precise internal and/or external comparables. The reason for the same is that
(i) comparable data available for testing such method may certainly not take into account the various risks undertaken by the parties; or
(ii) it may not reflect the economic reality at a given period of time.

However, we may conclude that clear and cogent functional and risk characterization is key in determining a relevant interquartile range, and is therefore, THE antidote to tax assessments.

Should the 10% penalty for late SAR reporting be automatic?

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CAA Lyon, 5th ch. 21/12/2023; n°21LY02821; Sumitomo
Chemicals Europe

THE FACTS

Following an audit of the accounts of Sumitomo Chemicals Europe (SCAE), the tax authorities considered that the intra-group transactions in which the company was involved did not comply with the arm's length principle. The advantages thus granted were classically qualified as "deemed distributed income", which, in view of the applicable tax treaties, gives rise to a withholding tax. Insofar as the company obviously failed to declare this withholding tax, the existence of which only came to light following the rectification, the penalty provided for in article 1728 of the CGI.

THE RULE

As a reminder, when the tax authorities make an adjustment under Article 57 of the CGI, they consider that an indirect profit transfer has taken place, which must then be treated in the same way as dividend distributions. A withholding tax is then levied, in addition to corporate income tax, the rate of which is calculated by reference to the tax treaty applicable to the case in question. This is a collateral consequence of transfer pricing rectifications, which has been validated on numerous occasions by the tax judge, and which we will not discuss here.
The penalty referred to in article 1728 of the CGI penalizes failure to file within the prescribed time limit a declaration or document indicating the elements to be retained for the assessment or liquidation of tax. This penalty, expressed as a percentage of the amount of duty payable by the taxpayer or resulting from the late filing of the return or deed, is equal to 10% in the absence of formal notice, which is the case following an adjustment highlighting income deemed to have been distributed.

THE JUDGES' POSITION

In 2021, the Lyon TAA ruled in recital 20 that "By merely pointing out the non-voluntary nature of this omission and its right to make a mistake, the applicant company is not contesting the validity of the penalties imposed on it on the basis of the aforementioned provisions". In many cases, however, the taxpayer is not claiming good faith or the right to make a mistake, nor is he asking for the penalties to be reduced, which the tax judge has always refused to do. On the contrary, it is a question of the relevance of an automatic penalty, linked to an offence whose existence and quantum the taxpayer cannot know prior to the rectifications.
The CAA persists, however, and considers that "the aforementioned provisions proportion the increase to the taxpayer's actions by providing that its amount is set as a percentage of the duties evaded. Moreover, it is clear from the provisions of article 1728 that the rates of increase applied vary according to whether the failure to declare within the time limit was noted without formal notice to the interested party or after one or two unsuccessful formal notices, so that the law itself has thus ensured, to a certain extent, the modulation of penalties according to the seriousness of the penalized behaviors. It follows that the argument based on the automatic nature of the application of a 10% surcharge can only be rejected".

OUR ANALYSIS

A PENALTY IMPOSSIBLE TO PREDICT IN PRINCIPLE...

Insofar as the penalty under article 1728 of the CGI is applied automatically, in a situation where the taxpayer is unable to comply with it, it exceeds in our view the objective that this article is supposed to pursue, and therefore creates an error in the assessment of the legal basis.
It seems to us that the tax merits of an automatic penalty should be reconsidered, since it sanctions behavior that is not only involuntary on the part of the taxpayer, but above all unavoidable, given that the taxpayer can be unaware of either the existence or the amount of the withholding tax to be declared.
In fact, this penalty affects the withholding tax, which is itself a collateral consequence of a main corporate tax adjustment, and whose existence and quantum are only known at the end of the
audit procedure:
On the temporal aspect on the one hand: this withholding tax arising from the indirect transfer of profit can logically only be known to the taxpayer at the end of the tax audit, i.e. after the administration has considered that an indirect transfer of profit has taken place. It is therefore materially impossible for the taxpayer to produce the withholding tax within the time allotted to him, since the event giving rise to the withholding tax is then unknown to him. In the case in point, the French tax authorities brought to light the existence of the withholding tax in its proposed rectification of August 4, 2014, i.e. for the 2010 tax year, 44 months after the deemed taxable event; and 32 months after the taxable event for the 2011 tax year. In order to comply with article 1728 of the CGI, the taxpayer should theoretically have declared the transfer of profits before the fifteenth day following the month of the transfer, i.e. before January 15, 2011 for 2010 and before January 15, 2012 for 2011.

NOR IN ITS QUANTUM!

Secondly, in terms of quantum: the penalty is expressed as a percentage of the withholding tax, itself calculated by reference to transfer pricing adjustments.
More precisely, this withholding tax is applied to the basic adjustment made under article 57 of the CGI, which is then qualified as deemed distributed income. However, transfer pricing is a subjective discipline, the limits of which are not clearly defined. Whether we are talking about transactions falling within the scope of transfer pricing, or the calibration of deemed profit transfers, the taxpayer cannot rationally know in advance the exact amount of an indirect profit transfer, and hence the theoretical amount of withholding tax he should have declared.

BENCHMARKS FOR ALL?

Finally, we would like to remind you that tax penalties, which are synonymous with sanctions, are intended to punish the taxpayer's behavior. This is the very essence of the difference with interest on arrears, which is intended to compensate for financial loss. The case law of the Conseil d'Etat is clear on this point, underlining a contrario the intrinsic link between tax penalties and the taxpayer's behavior. However, in our case, the taxpayer's behavior can in no way be voluntary, nor can it be modifiable or anticipated. In this respect, we believe that article 1728 of the CGI cannot be applied in such cases, as its provisions should be limited to cases where the taxpayer is aware of the obligations incumbent upon him.
Maintaining the sanctions of article 1728 would mean removing their status as tax penalties, and turning them into real taxes. In effect, these penalties would be dissociated from conduct, which constitutes the intrinsic element for falling within the scope of tax penalties, but would in reality automatically apply a rate (in this case 10%) to a base (the deemed transfer of profit), just like a tax.

Will the limit on the deductibility of financial expenses set out in article 39-1-3 withstand international law for long?

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In recent years, article 39-1-3 of the French General Tax Code has become one of the best-known tax provisions. Like a kind of code, a digital password reserved for a community apart. We no longer speak of the deductible interest rate. We say "the 39-1-3 rate". Take the test and you'll be able to spot the tax experts in the audience.

As a reminder, this text, as incongruous and anti-economic as it may be, specifies that "interest paid to partners on sums they leave or make available to the company, in addition to their share of the capital, whatever the form of the company, [is deductible] up to the limit of that calculated at a rate equal to the annual average of the average effective rates charged by credit institutions and finance companies for variable-rate loans to companies, with an initial term of more than two years".

Incongruous, because it is a French speciality, a secret of Bercy's, and adds to an already long list of measures designed to restrict companies' financial burdens.

Anti-economic, as it forces companies to limit the tax deductibility of the interest they pay to minority (or even very minority) shareholders, whereas an exception is made for shareholders holding more than a majority of the debtor's share capital, thanks to the alternative provided for in Article 212-I. In practice, this can lead to companies having taken out a loan, or having issued bonds to third-party banking institutions, and which, as is often the case, acquire a stake in the said company in order to follow its development. Consider the paradox: the BPI, which contributes to the growth of our economy, very often holds minority shares in the capital of the companies it supports. These same companies will therefore not be able to deduct all the financial interest they pay it, since the interest rates charged to them when they are starting up, or for the bonds they issue, are statistically well above the rate of the famous article 39-1-3.

But if these minority shareholders are located in a country other than France, can the provisions of Article 39-1-3 of the CGI withstand the arm's length principle referred to in Article 9 of the OECD Model Tax Convention? The arm's length principle may in fact offer a radically different rate, since it reflects market conditions and what independent companies in a similar situation would have negotiated with each other.

If we consider for a moment, the limitation provided for in this article 39-1-3 contradicts article 9 of the model, which is found in all the treaties signed by France, and which allows an alternative rate to be applied. The principles of subsidiarity and the primacy of treaties would then have to play their role, dear to the minds of tax law theorists, and thus give precedence to the possibility for related parties to demonstrate the correctness of the rate they have actually applied.

In many conventions, Article 9§1 refers to the case of "an enterprise of a Contracting State [which] participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State". However, direct or indirect participation in the management or capital does not require a majority shareholding. If we leave it at that, the arm's length principle could therefore be applied to any partner who, by nature, "participates in the capital". But since every good tax expert is a potential paranoid, let's go a step further and take a moment to consider the notion of "control", which seems more ambiguous. It has to be said that the OECD's definition of this notion is as grey as the concrete of the château de la Muette that houses its services.

The OECD comments state that "Two enterprises are associated if one of them fulfils the conditions set out in Article 9 paragraphs 1a) or 1b) of the OECD Model Tax Convention in relation to the other enterprise".

The comments on Article 9 of the Model Convention state that "the Committee has devoted considerable time and effort (and continues to do so) to studying the conditions of application of this article, the consequences of such application, and the methodologies applicable for the adjustment of profits when transactions have been concluded under conditions other than at arm's length. The conclusions of this study are described in the report entitled "Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations", which is periodically updated to take account of developments in the Committee's work on this issue. This report represents internationally accepted principles and provides guidelines for applying the arm's length principle, of which Article 9 is the authoritative statement".

So let's continue the treasure hunt and refer to the OECD guidelines, which reproduce the same definition as the comments under the model convention.

It therefore appears that the notion of control, which is key to the applicability of the arm's length principle, is not explicitly or formally defined by international law standards. As nature abhors a vacuum, it is best to refer to the domestic law of each State.

In our case, Article 39-12 of the French General Tax Code stipulates that "two companies are deemed to be dependent on each other when: (a) one of them directly or through an intermediary holds the majority of the share capital of the other, or in fact exercises decision-making power over it; (b) both of them are placed, under the conditions defined in (a), under the control of the same third party". From the point of view of French positive law, therefore, control seems to be assessed from the angle of majority (of capital or of decision-making power).
Would this have led to a dead end, leaving the taxpayer to face the cold injustice of article 39-1-3? Well, perhaps not for long. On September 12, 2023, the European Commission unveiled two draft Directives, on the "BEFIT" initiative and on the harmonization of transfer pricing rules within the EU. The second draft directive aims to simplify the applicable rules and reduce the risk of double taxation, by incorporating the arm's length principle into EU law. One of the ways in which tax certainty could be strengthened is by harmonizing the main transfer pricing rules, creating the possibility for the Commission to establish common rules on specific subjects within the Union.

In order to define an associated undertaking, Article 5 of the draft Directive proposes a minimum threshold of 25% of an entity's voting rights, capital or profits, in order to establish a relationship of dependence. Transposition of the Directive as it stands would therefore automatically and necessarily lead to minority shareholders being able to rely on the arm's length principle, and thus defeat the provisions of Article 39-1-3 of the CGI, which, by freezing an interest rate, contradicts the alternative offered by international law, and more specifically Article 9 of the Model Tax Convention. The constraints currently imposed on minority shareholders by the provisions of article 39-1-3 of the CGI would therefore be lifted for certain shareholders only, who on the one hand hold at least 25% of the share capital, either directly or indirectly, or who are placed under a common entity exceeding this threshold; and on the other hand, who are resident in a country other than France.

However, our positive law would create a double discrimination, by keeping under the yoke of Article 39-1-3 ultra-minority partners, holding less than 25% of the debtor company's capital, and partners established in France. For the latter, reverse discrimination has already accustomed us to treating purely domestic operations less favourably.

For foreign partners holding less than 25%, the taxman will tell you: you always need someone smaller than you.

Transfer pricing: tax judge insists on automatic reference to median of comparable panels.

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In a case brought before the Lyon CAA by our firm, the tax judge reiterated his commitment to the median of an arm's length interval for assessing an indirect profit transfer. In this case, the company's margin fell below the first quartile of an interval made up of some thirty references. This was all it took for the tax authorities to consider that a transfer pricing anomaly was affecting the company's profitability, and consequently to adjust its net margin to the median of the panel.
The Lyon Administrative Court endorsed this approach, repeating almost verbatim the operative part of the GE Medical system ruling and considering that "in the circumstances of the case, the median [...], which makes it possible to limit the margins of approximation in relation to a point situated at one or other of the extreme limits of this interval, must be regarded as the point of the interval which best reflects the facts and circumstances of the transactions concerned" (Lyon Administrative Court, June 22, 2021, N°1909917 and 1910206).

This recital continues to leave us stunned, as these two decisions are conspicuous by their failure to explain the "facts and circumstances" apparently so exceptional as to justify the administration's automatic assumption that the taxpayer must necessarily generate a higher margin than half of the companies deemed comparable. We therefore expressly asked the Lyon CAA to take a firm and explicit stance on this issue, both in our writings and at the hearing, in order to provide the clarity needed to ensure legal and tax certainty for taxpayers. However, the Lyon CAA noted that "the investigation revealed that the net margins generated on business flows with companies X and Y were not only lower than the lowest of the data in the arm's length interval, but also lower than the "extreme" minima of the sample observed. For its part, the claimant merely points out that the margins making up the first quartiles already place it above six companies in the two panels for 2010 and 2011, and that it is not clear from the investigation that the administration applied the median of the interquartile range automatically and without any assessment of the circumstances of the transactions concerned. The claimant, for its part, does not justify any specific circumstances making it possible to establish that the administration, in view of the transactions in dispute, should have deviated from this median margin".

  • We deduce the following from this decision:

    The French tax authorities are confirmed in their automatic reference to the median of arm's length panels, whenever the taxpayer's remuneration deviates from this median.
  • It is up to the taxpayer to provide any factual, statistical, economic or other evidence to show that the tax authorities should have deviated from this median, given the transactions in dispute. In practice, this reverses the burden of proof onto the taxpayer, forcing him to produce a highly subjective analysis.

The Court's recital does, however, seem to contain a positive clue: if the taxpayer's margin already falls within the arm's length (interquartile) range, the system could be reversed, as the famous "facts and circumstances" would be different. Indeed, it was because the margin fell outside the range that the Court had to retain a target.

Yes, the "IP Box" tax regime also applies to individuals.

Posted on by admin1708

Introduction

Since the major overhaul introduced by the 2019 Finance Act, the so-called "IP Box" scheme has become a considerable asset working to boost business growth and competitiveness. Indeed, the renewal of this scheme and the extension of its scope to software has brought a breath of fresh air to the intellectual innovation scene. By investing in the research and development of new intangible assets, companies can now benefit from substantial tax advantages. In addition to the well-known Research Tax Credit (Crédit d'Impôt Recherche - CIR), companies subject to corporate income tax can also opt for separate taxation at a reduced rate of 10% on income derived from the granting, sub-granting or sale of certain intangible assets, provided certain conditions are met.
However, the IP Box regime is not just the prerogative of legal entities. Even if the provisions of Article 238 CGI do not apply to individual inventors, they can still benefit from this tax incentive under Article 93 quater of the CGI.
I of this article stipulates that: "the long-term capital gains or losses regime provided for in article 39 quindecies is applicable to income received by an individual inventor and his assigns from the sale or licensing of copyrighted software, a patentable invention or an intangible asset that satisfies the conditions mentioned in 1°, 2° or 4° of I of article 238. By way of derogation from the first paragraph of I of article 39 quindecies, the rate applicable to the transactions mentioned in this paragraph is 10%".
Thus, income derived from the exploitation of these intangible assets by individual inventors, their heirs or private individuals who have acquired them free of charge or for valuable consideration falls into the "non-commercial profits" category. They are, however, taxed under the long-term capital gains regime, at a reduced rate of 10%. In addition to the tax, social security contributions are levied at a rate of 17.20%, giving a total tax take of 27.20%.
However, for an individual to benefit from the "IP Box", he or she must first meet certain conditions (I) which, once met, will enable this preferential tax arrangement to be implemented (II).
Conditions for application of the IP Box to individuals
In order to benefit from the IP Box, two cumulative conditions must be met by the taxpayer. The intangible asset concerned must be eligible (A), and the transaction giving rise to the taxable profits must fall within the scope of the scheme (B).

Eligible assets

According to article 93 quater of the French General Tax Code, the following are eligible for the IP Box scheme:
Software licenses protected by copyright, i.e. works that emanate from the mind, are sufficiently elaborate and have an original character.

Patents and patentable inventions or improvements thereto. Patents are industrial property titles which grant the holder exclusive rights to exploit the patented invention by commercial means for a limited period, generally 20 years from the date of filing of the application. Patentable inventions, on the other hand, correspond to creations of the mind which meet the conditions of patentability necessary for a patent to be granted by a Receiving Office, i.e. inventions which are not expressly excluded by law and which provide an answer to a technical solution, while being new, innovative and having industrial applications. However, it is important to point out that the legislator does not require the taxpayer to present a patentability certificate when filing his application with the tax authorities. Indeed, taxpayers can always obtain approval if they can demonstrate the patentability of their invention. In practice, however, such proof is very difficult to establish, and has been since the repeal of the documentary opinion by the Finance Act 2023. Indeed, this document enabled the INPI to certify the patentability of an invention even before obtaining a final patent. That said, the individual inventor still has other options. In fact, according to some authors, in addition to filing his application with the tax authorities, he can also file a patentability application with a Receiving Office. In this case, as the examination of the patent application progresses, he will provide the tax authorities with any evidence enabling him to establish the patentability of his invention, including the search report and the preliminary opinion on patentability. However, even if these documents are of benefit to the inventor, they are merely the beginnings of proof, devoid of any definitive or binding character. They cannot therefore be relied upon by the tax authorities, especially as neither case law nor administrative doctrine has yet ruled on the subject.
Intangible assets satisfying the conditions mentioned in 1°, 2° and 4° of I of article 238 CGI. These include utility certificates, supplementary protection certificates attached to a patent, plant variety certificates and industrial manufacturing processes. However, specifically for processes, the legislator requires that they be the result of research operations, that they constitute the essential accessory to the exploitation of a patented invention, a utility certificate or a supplementary protection certificate attached to a patent, and that they are the subject of a single operating license with the invention.
Thus, as soon as the intangible asset targeted by the individual belongs to one of the above-mentioned categories, it will be considered eligible for the IP Box. However, this eligibility alone is not sufficient. In addition to this first condition, the transaction giving rise to the taxable income must also fall within the scope of this preferential tax regime.

Operations covered by the IP Box

Articles 93 quater and 39 terdecies of the French General Tax Code (CGI) stipulate that the long-term capital gains or losses regime applies to income received by individual inventors and their beneficiaries from the sale or grant of licenses to exploit the aforementioned intangible assets.
The term "assignment" refers to any transaction involving the removal of the items in question from the assets of the assignor, in return for financial consideration (in cash or in kind).
Concessions cover any leasing contract by which the owner of the intangible asset (the "licensor") grants the right to exploit all or part of his asset to a third party (the "licensee"), in return for payment of a royalty. The license may take several forms:
It may be exclusive or non-exclusive;
It may be concluded for the whole of the territory or territories for which the invention enjoys legal protection, or for part of it only;
It may relate to all the rights or to certain elements only (for example, the license may concern only certain applications of a patent).
In addition, a license to exploit refers to any contract granting the licensee the right to use the invention both for internal purposes, for its own needs, and with a view to producing and marketing goods and services.
However, the tax authorities specify that when the contract covers both items that fall within the scope of Article 39 terdecies 1 of the General Tax Code and items that do not, the regime provided for in Article 39 terdecies 1 of the General Tax Code applies only to those items that meet the conditions set out in the text. Thus, in the case of global contracts covering a set of elements, whether patentable or not, and technical assistance services, a distinction should be made between two situations:
Either the contract makes it possible to isolate the price of each element and each service covered by the contract. In this case, this price should be taken into account when calculating the proceeds from the transaction of only those elements of industrial property that fall within the scope of the scheme, i.e. the eligible intangible assets mentioned in the previous paragraph.

Or the contract stipulates a global price. In this case, since the long-term capital gains regime applies to only part of the items covered by the terms of the contract, it is necessary to break down the overall price. Consequently, it is up to the taxpayer to determine the part of the price corresponding to the remuneration of these assets according to the most appropriate method, and to be able to trace this method in the documentation made available to the tax authorities in the event of an audit. In this respect, the breakdown of the overall price must be based on objective factors. It can be based either on comparisons with transactions carried out on similar dates and relating to eligible items whose characteristics are similar to those covered by the contract, or on one or more allocation keys based on accounting data such as: the intrinsic value of the rights transferred, the value retained for the acquisition of the rights, the cost price of the various items and services covered by the contract, etc. In this case, the valuation criteria used must be based on the same criteria as those used for the contract. In this case, the valuation criteria used for each element of the contract must be consistent.

IP Box implementation

In order to implement the IP Box, it is first necessary to identify the income generated by the operation that is likely to fall within the scope of the scheme (A). Once identified, this income will serve as the basis for determining the final amount of tax due by the individual inventor or his successors (B).

Identifying taxable products

The last paragraph of Article 39 terdecies 1 of the French General Tax Code states that, in principle, the long-term capital gains regime does not apply to patents, patentable inventions or industrial manufacturing processes that do not qualify as fixed assets or were acquired for valuable consideration less than two years ago.
This principle is tempered, however, by the fact that industrial property rights held by individuals, either as independent inventors or after having acquired them for valuable consideration or free of charge, do not constitute a means of exploitation. In fact, these inventions are considered to be the very product of the inventor's creative activities. Unlike those held by industrial and commercial companies, they do not therefore have the nature of assets allocated to the exercise of a non-commercial profession.
Consequently, it is accepted that this circumstance is not such as to deprive the interested parties of the application of the long-term capital gains regime for the taxation of proceeds from the sale or licensing of these intangible assets.
Accordingly, the preferential tax regime set out in article 93 quater of the French General Tax Code applies to net income from the sale and licensing of patents or patentable inventions received by individual inventors, their heirs or private individuals who have acquired these rights, including where there is a relationship of dependence between the licensor and licensee.
Furthermore, in the case of natural persons, the tax authorities specify that there is no need to take into account the date on which the industrial property rights were acquired by the inventor, provided that they were discovered or developed by the inventor or were transferred to him free of charge. On the other hand, where industrial property rights have been acquired for valuable consideration, income derived from the sale or licensing of these rights is not eligible for the long-term capital gains regime until two years after the date of acquisition. Income received before the expiry of this period is subject to the progressive scale of income tax.
However, the determination of taxable income differs between sale and grant transactions:
Indeed, the value of the consideration received by the transferor is considered as income from a sale, i.e., the sum acquired by the seller in the case of a sale, the actual value of the goods received in the case of an exchange, and the actual value of the securities received as remuneration in the case of a contribution. These proceeds are taxable in the year in which they are received. However, individual inventors taxed as non-commercial profits who contribute a patent, a patentable invention or an industrial manufacturing process to a company responsible for exploiting it, may request deferral of taxation of the capital gain realized on this occasion.

On the other hand, the income from a concession corresponds to the results of the management of the concession, i.e. the contractual royalties received during the tax year.
Furthermore, in the case of sale or concession contracts relating to a set of items, only some of which are eligible assets, only the net results directly derived from the exploitation of these assets will qualify as taxable income.
Once the income subject to the IP Box regime has been identified, a calculation must be made to determine the amount of tax due by the taxpayer.
Determining the tax due by the taxpayer
Only net amounts are subject to tax. A deduction must therefore be made from the income generated by the operation of eligible assets in order to determine the taxable amount. However, deductible expenses differ according to whether the transaction is a transfer or a concession contract:
In the case of a transfer transaction, deductions are made for costs incurred in researching and developing the patent, or expenses paid for its acquisition, less any depreciation applied where the item was included in business assets. Secondly, costs incurred in maintaining or improving the invention. However, if the sums thus deducted exceed the sale price, the corresponding loss may be offset, where applicable, against other industrial property income received by the taxpayer during the tax year or against overall income. This loss is deductible from overall income for the year in which the patent is taken and for the following nine years, if the taxpayer receives no taxable income or receives income that is less than the costs incurred. The period begins to run in the year following that in which the patent is taken out (or the application is filed if the patent is granted at a later date). However, no deduction may be made where the above-mentioned costs have already been deducted from taxable non-trading profits as and when they are paid, or where, exceptionally, the patent has been capitalized and is fully amortized at the time of sale. In such cases, the taxable proceeds will be equal to the transfer price.

In the case of concessions, research costs are deducted from the proceeds, as are costs incurred in managing the concession, i.e., those taken into account in determining the net income of the operation, i.e., costs incurred in finding licensees, negotiating and concluding contracts, managing the licenses themselves, as well as collection and litigation costs. However, patent creation costs incurred with a view to issuing a patent are excluded, provided their counterpart is the creation of a fixed asset. In addition, where the licensee is taxable as a non-commercial business, Article 93(1)(8) of the CGI expressly recognizes that royalties derived from the sale of an eligible asset are deductible expenses. However, this principle is tempered when the grantor and the licensee are dependent on each other. In this case, the amount of the royalties is deductible only for a fraction of their amount equal to the ratio existing between the long-term capital gains rate at which they were taxed by the grantor and the normal corporate tax rate.
Once the expenses have been identified, they must be subtracted from the income derived from the sale or concession transaction in order to obtain the net result.
Thus, if the value obtained is positive, it will be treated as a long-term capital gain. Depending on the taxpayer's situation, this may then be offset against long-term capital losses for the year:

or set off franc for franc against the current year's deficit, and against losses carried forward from previous years;
or set off against long-term capital losses recognized in the previous ten years, which have not yet been set off.
The balance remaining after offset will therefore be taxed at the reduced rate of 10% provided for in I of article 93 quater of the CGI, plus social security contributions at a rate of 17.20%.
However, if the taxpayer has neither a deficit nor a capital loss to carry forward, the net income generated after deduction of expenses will serve directly as the tax base.