Under its CFC legislation (Art. 209 B of the French General Tax Code (CGI)), France may, under certain conditions, tax its residents currently on the profits derived by a foreign branch or subsidiary that benefits in its country or territory of residence from a privileged tax regime. The purpose of this legislation is to prevent the localization of profits in tax havens merely for tax reasons.
The regime was overhauled from 2006 following adverse case law, and again in 2012.
Under the former regime (i.e., the rules applying until 31 December 2005), if the conditions for applying the legislation were fulfilled, the profits earned through the subsidiary or branch were taxed in France as business profits. The profits so attributed were segregated from the remaining business income profits of the controlling shareholder and could not, therefore, be used to offset French losses.
On 28 June 2002, the French Supreme Court held that the CFC rules, as they then stood, could not apply if the foreign CFC is covered by a tax treaty based on the OECD Model. The Supreme Court reasoned that the attribution of the foreign business income to the French shareholder is incompatible with the rule enshrined in Art. 7(1) of the OECD Model, whereby an enterprise of one of the Contracting States may not be taxable in the other Contracting State unless it has therein a permanent establishment to which the income is attributable. Although the foreign income was technically attributed to a French resident and the tax was technically assessed on a French resident, the Supreme Court maintained that it was tantamount to taxing the income of a non-resident enterprise without a permanent establishment in France.
The French authorities attempted to surmount this decision by inserting clauses in 25 renegotiated tax treaties, notably those signed with Japan, Spain, and the United States, allowing for the full application of Art. 209 B. Even so, the renegotiation of its tax treaties by France could not prevent Art. 209 B from not being compatible with EU law.
As a result, the Finance Law 2005 overhauled the system effective 1 January 2006. Under the new rules, the attributed CFC income is classified as a deemed dividend and not as business income as under the previous rules.
The French CFC legislation applies to entities established in a country or jurisdiction where they benefit from a "privileged taxation" within the meaning of Art. 238 A of the French General Tax Code (CGI). A foreign entity is deemed to benefit from a privileged tax regime if its tax liability in the foreign jurisdiction amounts to less than 60% (increased from 50% effective 1 January 2020) of the tax liability which would have been due in France if the entity were a French resident (see Sec. 6.4.).
For the purposes of the comparison with the theoretical French tax, the foreign tax to be taken into account comprises all of the taxes on income and on capital actually borne by the foreign entity. If these taxes are levied at different levels (central state or federation, states, provinces or cantons, communes, etc.), the total of all of the taxes should be taken into consideration. In this respect, the existence of a privileged tax regime is determined at the level of the foreign entity and not by reference to the general tax environment in the foreign country or territory. Therefore, the foreign entity may be deemed to benefit from a privileged tax regime as a result of a specific measure (applicable, for example, to certain types of companies such as holding or service companies) even if its country of residence, considered as a whole, is a "normal" tax jurisdiction. Conversely, the theoretical French tax should be determined under ordinary French rules and by application of the normal corporate tax rate(s) and, where applicable, surtaxes.
The CFC legislation may apply in an EU context but only to purely artificial structures.
The French CFC legislation only applies to corporate shareholders, including the French PE of a non-resident entity. It does not apply to partnerships (unless they elect for corporate income tax treatment where possible) or to individual shareholders (but individual shareholders may fall within the PFICs rules, see Sec. 13.5.).
The CFC rules apply only if the French shareholder falls within the scope of French corporate income tax by reason of:
- its legal form (SA, SARL, SCA or SAs); or
- Its social purpose (civil companies are normally treated as partnerships but fall within the scope of corporate income tax if they have a commercial purpose); or
- The exercise of an express election, where possible, to be subject to corporate income tax (certain partnerships such as SNCs may elect to be subject to corporate income tax).
The French tax authorities considered that this condition is deemed to be met even if the French company does not actually pay corporate income tax, for example, because of the application of a special regime such as the temporary exemption regime for "new enterprises."
French branches of foreign companies also fall under this definition if the participation in the foreign CFC is recorded in the balance sheet of the branch.
The foreign entity may be any entity established abroad. Controlling interests that would fall under the CFC legislation include, inter alia, shares in stock companies, interest shares in a partnership or similar entity (e.g., EIG, joint venture), and financial rights or voting rights held in such entities. Also, entities such as foundations, anstalten or stiftungen are covered by the rules. Within the EU, the rules apply only to purely artificial arrangements designed to circumvent French tax law.
The control test is the direct or indirect ownership of more than 50% of the shares, financial rights, or voting rights in the foreign entity. French companies holding jointly with other companies more than 50% in a foreign legal entity, with the result that individually each of their stakes does not reach this ownership threshold, remain, however, within the scope of the CFC regime if they own at least 5% in the foreign CFC. This 5% reduced ownership threshold will also apply if 50% of the rights in the foreign legal entity are jointly owned by overseas companies that are under the control of, or which control, the French legal entity according to the transfer pricing provisions.
The CFC rules do not apply if the controlling French shareholder demonstrates that the operations of the company or legal entity established or incorporated outside of France do not have as a principal purpose or effect to allow the allocation of profits to a State or territory where they are subject to a preferential tax regime. This condition is deemed to be met to where the foreign CFC mainly conducts effective industrial or commercial activities in the territory of its country of establishment or incorporation.
Further, in compliance with the case law of the European Court of Justice (ECJ), the CFC rules no longer apply to legal entities located in the European Union unless the holding is considered to be an artificial arrangement designed to circumvent French tax law.
Where the CFC rules apply, the French shareholder is deemed to have received a pro rata share of the profits derived by the foreign entity. The attributed income is determined in accordance with French tax rules. It is classified as a deemed distribution but is not eligible for the participation exemption regime. The attributed CFC income is no longer segregated; instead it is added to the taxable base of the recipient. Therefore, loss carry-forwards of the recipient may be set off against the attributed CFC income subject to the standard loss-carry forward rules. In contrast, the losses of the CFC itself may not be set off against French positive income but may be carried forward against future profits of the same CFC.
A foreign CFC's income is determined under French tax rules as prescribed by the French General Tax Code (CGI) (except for certain specific provisions).
Consequently, the following rules, in particular, apply:
- If the foreign CFC receives dividends or capital gains, the participation exemption regime would normally apply. The application of the French CFC regime will then have limited adverse consequences; and
- Under the French territoriality rules, if the profits of the foreign CFC relate to a branch established outside France, these profits are not taxable in France unless the foreign branch benefits itself from a privileged tax regime, in which case the French CFC legislation would apply to the foreign subsidiary.
The taxpayer may set off any profit taxes paid by the CFC in its country of establishment against French tax on the attributed CFC income but only proportionally to the interest held by the French shareholder in the CFC. The credit is only allowed for foreign taxes which are comparable to the French corporate tax, meaning a charge levied by any level of government (central, regional, local, etc..) on a taxable base, not deductible from that taxable base, and expressed in a monetary value. As a result, taxes which cannot be credited include taxes on capital, annual lumpsum levies, taxes on turnover, subscription taxes, license fees and capital transfer duties. The credit is applied separately for each foreign CFC and for each tax period. Excess foreign tax over French corporate income tax on the relevant income may not be credited against French tax on other CFC income nor carried forward against French tax on the future income of the same CFC.
Further, where the CFC income attributed to the French shareholder includes dividends, interest and royalties received by the foreign CFC from third countries, then the withholding tax levied by the relevant third countries on the dividends, interest or royalties paid to the CFC may be proportionally credited against the French tax on the attributed CFC income on condition that (a) the third source country has a tax treaty with France, and (b) the withholding tax rate does not exceed the rate applicable under the relevant tax treaty.
Finally, withholding tax levied by the country of the CFC on actual distributions by the CFC under a tax treaty with France are creditable against French corporate income tax resulting from the CFC attribution
As indicated above, the overhaul of the system is thought to eliminate the incompatibility with tax treaties as determined by the Supreme Court with respect to the previous system. Under the new system, the French controlling shareholder is deemed to have received a dividend distribution rather than business income. In this way, it is thought the application of the CFC rules is no longer prevented by tax treaties since the deemed distribution would fall under the "other income" clause of the relevant treaty and would be taxable in France accordingly. Note, however, that the “other income” clause in a number of French tax treaties (e.g. with China, Lebanon and Thailand) is based on the UN Model and allocates to the source country the right to tax "other income" sourced therein. The application of the CFC rules in such cases will likely be controversial.
If, however, the foreign CFC is a permanent establishment, its income remains taxed in the category of business profits. Accordingly, this income can be taxable in France only if the tax treaty signed with the country in which the permanent establishment is located allows France to apply its CFC legislation.
The Freedom of capital movement is one of the fundamental freedoms under EU law. In contrast, to the other fundamental freedoms (such as the freedom of establishment) which apply only within the EU, the freedom of capital movement may, subject to conditions, also be invoked in situations involving third (non-EU) countries.
On 25 April 2022, the French Supreme Court in the Rubis case dealt with whether the application of the French CFC rules is compatible with the freedom of capital movement provided for under the EU treaty. The French Supreme Court relied on the case law established by the Court of Justice of the European Union in its 2012 Test Claimants in the FII Group Litigation (C-35/11) and held that:
- The national regulations of a Member State may be challenged under the freedom of capital movement principle only if such regulations are not restricted exclusively to situations whereby the participation in a third (non-EU) country entity affords the EU resident entity a "decisive influence" over the affairs of that third country entity. If the national regulations are not so exclusively targeted, then they may be challenged regardless of the actual holding percentage in the third country entity; and
- The French CFC rules are intended to target exclusively situations in which the French entity has a decisive influence over the third country CFC. Therefore, their application cannot be challenged by reference to the freedom of establishment principle under the EU Treaty.