• French CFC Rules
  • February 12, 2016 | Authors: Nicolas Andre; Siamak Mostafavi; Alexios Theologitis
  • Law Firm: Jones Day - Paris Office
  • For French corporate tax purposes, the basic rule is that of a strict territoriality, i.e., a French corporate taxpayer is taxed in respect of the income generated in France, and/or in respect of any income the taxation of which is attributed to France under a given international tax treaty.

    As an exception to the above principle, under the Controlled Foreign Corporation ("CFC") rules (article 209 B of the FTC) a French taxpayer may be, under certain conditions, taxed in respect of income generated by a foreign subsidiary or foreign permanent establishment; such taxation is, inter alia, conditional upon the subsidiary or permanent establishment being located in a jurisdiction where the effective tax charge is significantly lower than the equivalent French tax charge.

    The CFC rules, however, enable the taxpayer to avoid taxation if, inter alia, it can be proven that the operations of the subsidiary (or the foreign permanent establishment) were not principally motivated by tax enhancement ("Safe Harbor").

    In two decisions dated December 30, 2015, involving a major French banking institution, the Conseil d'Etat has provided some clarity as to the application of the Safe Harbor.

    In one case, the financial institution had a subsidiary located in Hong Kong, dealing with Asian currencies; in the other case, the relevant subsidiary was based in Guernsey and dealing in private banking.

    In the case of the Hong Kong subsidiary, the Conseil d'Etat decided that the Safe Harbor should be applicable given that (i) the subsidiary was, effectively, active in dealing with Asian currency assets of the financial institution, and (ii) such activity could not be organized from France because of the specificities of the functioning of the relevant Asian markets.

    The French tax authorities ("FTA") were arguing that it has not been proved that some of the clients of the subsidiary were not French tax residents, and some of the funds used by it were not of French origin. However, the Conseil d'Etat ruled that any such consideration was beside the point, i.e., they had no relevance to the finality and reality of the subsidiary's operations in Hong Kong.

    In the case of the Guernsey subsidiary, the Conseil d'Etat again ruled that the Safe Harbor should be applicable. The approach taken by the Conseil d'Etat was the same as in the above Hong Kong case: the financial institution has proved the effective operations of the subsidiary, and these operations were feasible because certain clients were attracted only by the specificities of the Guernsey banking and tax environment.

    Again, the Conseil d'Etat rejected as non-relevant the argument of the FTA whereby certain of the clients of the subsidiary were French tax residents and some of the assets managed by it were of French origin.

    In other words, the Conseil d'Etat makes it clear that the application of the Safe Harbor is based on the actual non-principally tax objectives of the relevant corporate taxpayer, and not any tax motivations of the clients of the relevant subsidiaries. Once the taxpayer has proved its business reason to be in a certain jurisdiction, it is for the FTA to prove that the tax reasons were nevertheless predominant.