• Tax Treatment of Interest Rate Swaps
  • November 12, 2015 | Authors: Nicolas Andre; Siamak Mostafavi
  • Law Firm: Jones Day - Paris Office
  • The issuance of the so-called "repackaged TSDIs" was very much in favor in France in the '80s and early '90s.

    In essence, the structure was as follows:
    • The French issuer would issue perpetual subordinated bonds ("TSDIs") with a defined coupon for, say, 15 years.
    • The issuer would keep, say, 75 percent of the issue price, and transfer the balance of 25 percent to an offshore trust.
    • The trust would use the 25 percent to buy a sovereign zero coupon bond that would mature in 15 years for an amount enabling the trust to buy the TSDIs from their holders.
    • After the purchase by the trust, the TSDIs would remain outstanding, but would pay a de minimis coupon.
    The French tax authorities ("FTA") used to issue rulings in respect of these TSDIs, whereby:
    • The issuer would not be taxed in respect of the accrual of the zero coupon bond in the hands of the trust.
    • However, only 75 percent of the coupons (in the above example) would be tax deductible.
    The rulings were interesting given that the non-taxed accrual on the zero coupon bond was higher than the non-deductible coupon on the TSDIs.

    Later on, the French legislation was modified, and, as a result, the repackaged TSDIs were no longer tax efficient.

    On June 24, 2015, the Conseil d'Etat issued a decision related to an interest rate swap ("IRS") that was contracted by an issuer of repackaged TSDIs. In essence, the IRS, which was contracted with the financial institution placing the TSDIs, enabled the issuer to transform the variable rate paid to the TSDI holders into a fixed rate, i.e., under the IRS, the issuer was receiving the variable rate and paying the fixed rate.

    The FTA had argued that since, under the ruling, only a portion of the coupon on the TSDI was deductible, the same limitation should apply to the fixed rate paid by the issuer under the IRS. The treatment of the IRS was not covered by the ruling.

    The Conseil d'Etat took the view that since the payments under the IRS are fully linked to the coupons due under the TSDIs, the tax treatment of the fixed rate paid by the issuer should follow the treatment applied to the coupons on the TSDIs.

    The decision of the Conseil d'Etat seems to reassure the FTA on its position that the treatment of certain IRSs should follow the treatment of interest expenses. For example, the FTA have issued regulations whereby the non-deductibility rule, applied to 25 percent of net financial expenses of French borrowers, should take into account the payments made and received by the borrower under any IRS contracted by it. This seems a very broad reading of the underlying legislation, which refers only to interest paid and received on actual sums of money provided to or lent by the borrowers, whereas IRSs generally do not imply any exchanges of principals.