Pursuant to Arts. 145 and 216 of the French General Tax Code (CGI), a corporate shareholder may, under certain conditions, benefit from a participation exemption regime whereby 95% of qualifying dividends received and 88% of qualifying capital gains are exempt from corporate tax. A separate 99% dividend received exemption applies to dividends received from members of a consolidated group, including in some instances when the distributing member is a non-resident. In contrast, the participation exemption regime is generally not available for dividends received from blacklisted non-cooperative jurisdictions (see Sec. 13.5. for the list), as well as to foreign-source dividends where the dividend was deductible to the payer.
The participation exemption regime is optional. Nevertheless, in the case of holding companies, it is, in practice, of a general application, as it is, in most cases, more favourable than the standard regime. In addition, the conditions are generally easily satisfied.
Finally, justifiable provisions and capital losses relating to the participation, whether qualifying or not, may be tax-deductible.
The parent holding company must be subject to corporate income tax in France at the standard rate on all or part of its activity. The parent company could be, in particular, an SA, SAS, SCA, or SARL that did not elect to be transparent for tax purposes. It can also be a partnership that is treated as a corporation for tax purposes (whether upon election or in specific cases). The French permanent establishment of a non-resident company can also qualify as a parent company, provided it is subject to French corporate income tax, and the relevant participation is recorded in its balance sheet. Open-ended investment companies (SICAVs) do not qualify as a parent company but are expressly exempt from corporate income tax on profits realized within their legal purpose.
The subsidiary must be a corporate income tax entity distributing income which qualifies as dividends for tax purposes. However, the dividends must not be tax-deductible in the hands of the distributing entity in order to qualify for the participation exemption. Tax transparent entities (in particular SNCs) do not qualify unless they are treated as corporate income tax entities (whether upon election or in certain specific cases). Foreign subsidiaries, whether or not resident in the EU, also qualify if the conditions are met (see below for the specific conditions regarding EU and non-EU subsidiaries). As of 1 January 2011, however, the subsidiary must not be resident in a non-cooperative jurisdiction (see Sec. 13.5. for the list) unless it can be proven that the structure is genuine and does not involve the abusive shifting of profits.
The subsidiary must be held directly by the French holding company. In this respect, the Supreme Administrative Court (Conseil d'Etat) ruled that a French company which holds a participation in a subsidiary through an Economic Interest Grouping (GIE, a transparent joint-venture vehicle) does not qualify for the participation exemption regime since the relevant participation is held by the GIE and not by its members. Equally, the GIE itself does not qualify as a parent company since it is not itself subject to corporate income tax.
The parent company should hold a participation of at least 5% in the capital of the subsidiary on the date of the payment of the dividends. The shares in the subsidiary must be held in a nominative form and either in full or in bare ownership; shares held in usufruct do not qualify. Shares without voting rights may be counted towards the minimum participation threshold. Shares lent or borrowed in the context of securities lending transactions do not qualify for the participation exemption, whether at the level of the lender or that of the borrower. The minimum 5% threshold may be reached by adding up participations held by a French entity and by its foreign permanent establishment. However, tax relief would then be available only to the portion of dividends corresponding to the interest held by the French entity. If the participation falls below the 5% threshold as a result of a capital increase in the framework of the exercise of stock options by employees, the participation exemption regime continues to apply provided the 5% test is again satisfied within 3 years of the date of the distribution of the dividends.
The shares in the subsidiary must have been either (i) subscribed by the parent company upon their issue (upon the formation of the subsidiary or a subsequent capital increase), or (ii) purchased. In both cases, the parent company must hold the shares for at least 2 years. The participation exemption applies without the need for the expiry of the minimum holding period. The breach of the 2-year holding period condition, however, results in the retroactive taxation of unduly exempted amounts and the imposition of late payment interest. In the case of certain restructuring operations, such as mergers, the company receiving shares that qualified for the participation exemption regime at the level of the former shareholder may elect to continue the minimum 2-year holding period condition.
The participation exemption applies to all types of income received by the parent company in its capacity as a shareholder. Qualifying income includes, in particular, the following:
- Dividends (including interim dividends, see below);
- Liquidation surpluses; and
- Interest paid by a subsidiary to its parent company insofar as it is not deductible for the debtor.
With respect to interim dividends, the tax administration considers that the exemption is capped at the total amount of distributable profits of the subsidiary for the tax year. Therefore, no exemption can be granted to the excess of interim dividends over the subsidiary’s distributable profits. However, this position was struck down by the Supreme Court in a decision on 12 April 2019. The Court reasoned that the position is tantamount to imposing a subject to tax condition on the subsidiary (instead of the liability to tax condition provided for under the law) and held that interim dividends qualify for the participation exemption even if they exceed the distributable profit for the year.
In contrast, income received from a qualifying subsidiary, but not related to the participation held, does not qualify for the participation exemption. This is, in particular, the case for the following:
- Directors’ fees;
- Income from bonds; and
- Advantages granted by a subsidiary to its parent company, e.g., the sale of assets at a reduced price.
The participation exemption is an optional regime, which may be elected separately in respect of each tax period. In addition, the option can be exercised for selected subsidiaries only. If the option is exercised with respect to a given subsidiary, however, the participation exemption applies to all of the dividends from that subsidiary. The French participation exemption regime is a deduction regime, i.e., qualifying dividends, which are recorded as a profit for accounting purposes, are deducted from the taxable base, and in parallel 5% of the (gross) dividends received are added back to taxable income. This implies that the deduction may generate a tax loss, which may be carried forward under the standard rules.
Since the dividends are not taxed, any attached tax credit may not be offset against corporate income tax. In certain situations, however, they may be offset against the withholding tax due on the redistribution of exempt income.
The exemption does not apply to the entire dividend received. Indeed 5% (or 1% for distributions within a consolidated group, see below) of the dividends received are deemed to correspond to the expenses incurred by the parent company in respect of the participation and are/is excluded from the exemption.
Effective 1 January 2016, the French government introduced an exemption for dividends received from qualifying domestic subsidiaries, which are a part of French tax consolidated groups (See Sec. 5.3. for qualification as a French tax consolidated group). Under these rules, dividends that qualify for the participation exemption under the domestic tax laws will be exempt for 99% of their amount where received from domestic subsidiaries which are members of the tax consolidated group.
The 99% dividends received exemption has been extended from 2019 to dividends received from an entity resident in an EU/EEA Member State provided the following tests are cumulatively met:
- The distributing entity is resident either in an EU Member State or in an EEA member country which has a treaty with France including mutual assistance clause;
- The distributing entity is subject in its EU/EEA Member State of residence to a tax on profits comparable to the French corporate income tax; and
- The receiving entity and the distributing entity meet all the conditions required to form a consolidated group in France if the distributing entity were a French resident (but naturally, the condition of liability to French corporate tax does not need to be met by the distributing EU/EEA entity).
The French tax authorities have clarified that the 99% dividend received exemption ceases to apply to distributions by UK entities as from the end of the Brexit transitional rules on 31 December 2020, since UK companies post-Brexit by definition do not meet the conditions required. As a facilitation measure, however, the French tax authorities confirmed that the 99% exemption shall continue to apply to UK dividends received during the recipient’s tax year still open on 31 December 2020, provided the standard conditions are met, and the dividend is distributed during the fiscal year, including in cases where the French company is not part of a tax group but could form a group if its EU subsidiaries were established in France. On 11 March 2021, the French tax authority published guidance (BOI-INT-DG-15-20) regarding the withdrawal of the UK from the EU, which included the guidance on the transitional provisions for the tax treatment of dividend distributions.
The participation exemption regime is generally more beneficial, although its attractiveness has been slightly limited with the taxation of a fraction of the dividends received (5% or 1% lump sum), subject to both the corporate income tax and the corporate tax surcharges. Indeed:
- If the parent company is in a profit position, the election enables it to avoid the corporate income tax except for the above-mentioned fraction of the dividends that are taxable; and
- If the parent company is in a loss position, no actual corporate income tax charges arise from the application of the standard regime, but the loss carry-forward is affected as it is reduced by the amount of the taxable dividends. Under the participation exemption regime, in contrast, the loss carry-forward remains unaffected except for the above-mentioned taxable fraction of the dividends (against which the loss carry-forward is offset and thus (partly) used).
The domestic participation exemption applies whenever the required conditions are met (and the election exercised), regardless of whether the subsidiary is French or foreign and EU or non-EU. France implemented the EU Parent-Subsidiary Directive only with respect to the abolition of withholding tax on dividends paid by a French subsidiary to a qualifying EU parent company. With respect to inbound dividends, no formal text has transposed the Directive into French law, since the legislator considered that existing French law offers (and in many respects does offer) a more advantageous treatment than that available under the Directive.
It ensues that dividends received from an EU/EEA subsidiary are exempt for 95% of their gross amount if the following conditions (as explained in detail above) are met:
- The subsidiary is liable to corporate income tax in its EU/EEA country of residence (whether or not actually subject to tax);
- The parent company holds directly 5% or more of the shares in the subsidiary; and
- The shares are held (or the parent commits to hold the shares) for at least 2 years.
Similar to the French subsidiaries, an EU subsidiary may not be a partnership not subject to corporate income tax. In addition, the participation exemption does not apply in domestic situations if the participation is held in an investment company. Whilst not expressly made clear by the law or administrative commentaries, this exclusion very probably covers foreign subsidiaries as well, so that the participation exemption would be denied if the EU subsidiary is similar to a French investment company (SICAV).
France implemented in 2016 a 99% dividend received exemption for distributions within consolidated groups. This regime has been extended from 2019 to dividends received from EU/EEA subsidiaries subject to conditions (see above).
With the expiry of the Brexit transitional arrangement on 1 January 2021, the United Kingdom formally ceased to be part of the EU. As from the same date, therefore, dividends received by French parents from their UK subsidiaries no longer qualify for the more favourable participation exemption conditions for EU/EEA sourced dividends (as explained above). Nevertheless, the French tax authorities confirmed that as a facilitation measure such dividends continue to qualify for the more favourable EU/EEA treatment on the condition that they are received during the French recipient’s financial year which was opened before 31 December 2020. On 11 March 2021, the French tax authority published guidance (BOI-INT-DG-15-20) regarding the withdrawal of the UK from the EU, which included guidance on the transitional provisions for the tax treatment of dividend distributions.
The domestic participation exemption regime applies whether the subsidiary is domestic or foreign and, in the latter case, whether it is resident within or outside the EU. Therefore, a French parent company may elect for the participation exemption in respect of non-EU participations under the same conditions and procedures as outlined above for domestic or EU participations.
However, as of 1 January 2011, the participation exemption regime is denied if the subsidiary is resident in a non-cooperative jurisdiction (see list under Sec. 13.5.) unless it can be proven that the structure is genuine and does not involve the abusive shifting of profits.
Similar to the case of domestic and EU participations, the exemption is limited to 95% of the gross dividend received in the case of foreign participations. The remaining 5% is added back to taxable income and is subject to corporate tax at the normal rates. The rationale of the add-back is to recapture the costs (deemed to have been) incurred by the dividend recipient with respect to the participation.
In its guidance issued on 11 March 2021, the French tax authority stated that the add-back (5% of dividends as mentioned above or 1% in the case of consolidated groups, as the case may be) cannot be considered as leading to the partial taxation of dividends. However, on a request made by a taxpayer for a repeal of the statement on grounds of abuse of power in interpreting the application of the participation exemption regime, the French Supreme Court (Conseil d'Etat) ruled in its decision of 5 July 2022 that the flat-rate nature of the add-back does in fact result in the partial taxation of the dividends when the actual cost is less than the flat-rate amount.
In principle, the foreign withholding tax attached to the dividends received, if any, is forfeited and cannot be set off against the recipient’s tax liability, also not against the tax due on the 5% dividend add-back. However, the observation of the Supreme Court that the add-back results in partial taxation could lead to the availability of a foreign tax credit for foreign withholding taxes paid on dividends received from foreign subsidiaries that qualify for the participation exemption. This interpretation would be consistent with the observation of the Court of Appeals of Lyon in its decision of 27 January 2022 n French]. In this decision, the Court of Appeals held that where a tax treaty applies, the foreign withholding tax attached to the foreign dividends must be allowed as a credit against the tax due in France on the 5% dividend add-back. However, further guidance is needed on whether the foreign tax credit is to be calculated based on the full flat rate of add-back or on the amount by which the add-back exceeds the actual cost incurred.
In case the exemption is retroactively denied, the dividends previously exempted are recaptured and assessed to tax at the normal rates, and late interest can be imposed. Whilst not clearly specified by the regulations, it ought to be possible for the recipient in that case to avail of the previously forfeited foreign tax credit if a treaty applies.
Capital gains realized by a holding company on the disposal of shares in its subsidiaries and/ or profits from share buy-back transactions may benefit from a quasi-participation exemption regime whereby 88% of the amount of the gain is excluded from the taxable base. The remaining 12% is added to taxable income and subject to corporate tax in the ordinary way.
In order to qualify for this partial exemption regime, the capital gain must have been realized on so-called qualifying participations. Basically, a participation will qualify as such if it is entered as such in the accounts, represents at least 10% of the capital, and has been held for at least 2 years. There are, however, exceptions to this main rule. Hence, shares in real estate companies and certain venture capital companies will not qualify. Further, shares in entities established in non-cooperative jurisdictions (see list in Sec. 13.5.) are not eligible for the regime.
Where shares of the same type had been purchased at different dates, the shares deemed to be sold are, in principle, those which have been purchased first (the "FIFO" rule). Companies are, however, allowed to assess the capital gain on the basis of the average price cost of the shares. In that case, the holding period is determined on a proportional basis.
The Revenue considers, in particular, that:
- Shares without voting rights ("actions à dividende prioritaire and certificats d'investissement") do not qualify as participations, unless the shares are recorded as participations, and the shareholder also owns ordinary shares in the same company;
- If a company holds its own shares (which is possible under French company law in certain cases), the shares do not qualify as participations;
- Shares in a sister company, to be held for a significant period of time, qualify as participations, provided that they are recorded as such in the balance sheet;
- If a company does not exercise significant influence or control over its subsidiary alone but instead exercises the influence or control with a group of other companies, the shares held may still qualify as a participation, provided that they are held for a significant period of time and are recorded as such in the balance sheet; and
- Shares in French or foreign UCITS, i.e., undertakings in collective investments in transferable securities, do not qualify.