Arsene Taxand - Corporate Tax management and strategy

The new method of managing business tax in restructuring operations

The big day of the business tax reform in France has not yet come. By extending the effect of tax exemption for new investments made in 2004 and 2005 until December 31, 2007, the French government has implicitly set the date of entry into force of the reform at January 1, 2008. However, this date still seems to be surrounded by uncertainty. The legislation to be developed is in fact long, complex and technically difficult to draft.

Moreover, it will be noted that the orientation proposed by the Fouquet commission for the evolution in business tax, namely taxation that is more broadly assessed based on value added, naturally raises a few questions with regard to the compatibility of such a tax with the Sixth VAT Directive. In the light of this uncertainty, the project probably deserves further reflection before the reform is finally adopted.

At the same time, the tax legislator, the French tax administration, the case law of the French administrative courts and the French accounting authorities have not been inactive. Their most recent legislation and decisions have considerably altered the impacts of restructuring operations on business tax in its current form.

Inasmuch as this tax could well continue to exist for several years, we have therefore considered it important to draw attention to these new developments in order to put them into perspective and to draw a few conclusions from them for sound tax management.

1. Business tax in restructuring operations

Restructuring operations (contribution, merger, lease of a business or change of premises) may have both a favorable and unfavorable impact on companies with regard to business tax. In a few quite rare cases, these operations will simply have no impact at all. These effects must be measured in advance by anticipating the impact that the operation will have firstly on business tax bases and secondly on value added generated during the year of the operation and the following years. The work of anticipating these consequences for the various companies that are parties to the operation (the contributor and the beneficiary) is sometimes a complex task to carry out but it is essential to avoid extremely nasty surprises (or work out the value of the nice surprises).

Before describing the new developments in detail, we wish to remind the reader here that the rules regarding capping and the minimum tax payment assessed on the basis of the company's value added have changed little since it was clearly established by case law that the retroactive effect of a restructuring operation could not have any impact from a business tax standpoint. It will merely be noted that certain tax reassessments have endeavored to put forward the idea whereby the minimum business tax payment assessed based on value added is allegedly a tax that is separate from business tax and could be payable by a company which does not perform any activities as of January 1 and which is therefore not liable for business tax pursuant to Article 1478 I. This analysis seems to us to be open to dispute.

2. Tax base relief for restructuring transactions

We wish to remind you firstly that pursuant to Articles 1467 and 1469 of the French Tax Code, business tax is based on the rental value of the property, plant and equipment used by the taxpayer for the requirements of its business activities. This rental value is equal to 16% of their cost. Furthermore, Article 1518 B of the French Tax Code specifies that the rental value of the property, plant and equipment acquired following contributions, split-ups, demergers, company mergers or sales of establishments may not be equal to less than 80% of the rental value previously applied by the contributor. In other words, for the property, plant and equipment transferred, the bases to be declared by the beneficiary after the operation may not be equal to less than 4/5ths of the bases previously declared by the contributor.

If this calculation does not pose a problem for transactions carried out at actual value, where the cost of the property, plant and equipment duly corresponded to the entry value of the assets when recorded in the beneficiary's books, the situation appears to be more delicate for restructuring operations carried out at net book value. For such operations, the beneficiary transfers to its own balance sheet, both for accounting and tax purposes, the balance sheet entries made by the contributor (initial value, depreciation and provisions for impairment) and continues to calculate depreciation charges base on the initial value of such property, plant and equipment on the contributor's balance sheet (it should be noted that, from a corporate income tax perspective, only restructuring operations that are subject to the preferential treatment applicable to mergers and assimilated transactions may be carried out on the basis of book value).

The French tax administration maintains in this latter case that the cost of the property remains the gross value of the item of property, plant and equipment as recorded in the contributor's balance sheet. The tax administration bases its position on the provisions of Article 310 HF of Annex II to the French Tax Code, whereby, in order to determine the rental value to be used as a basis for assessing business tax, the "cost of the property, plant and equipment is the amount that is to be used to calculate depreciation." As we have just stated, when the contribution values used are the net book values, the beneficiary simply continues to use the depreciation schedule adopted by the contributor and the gross value of the item of property, plant and equipment remains its initial value.

Most of the first instance decisions made by the administrative courts have found in favor of taxpayers, holding that the tax base relief is also available when the operation is carried at net book value, except for a judgment by the Rennes administrative court, which followed the line of argument defended by the tax administration. The decision by the Nantes Administrative Court of Appeal was therefore awaited impatiently.

Against all expectation, the Nantes Administrative Court of Appeal in fact confirmed the first instance decision. This decision, that has been criticized by most observers (see, in particular, the comments under this decision in the Revue de Jurisprudence Fiscale), is based in law exclusively on the provisions of Article 310 HF of Annex II to the French Tax Code. However, this tax provision, which originates from the regulations, may in no event provide for an exception to the law. Furthermore, Article 1469 of the French Tax Code, which defines the basis for levying business tax, makes no reference to a decree.

The notion of cost may be understood in several different ways: it may either involve the initial value, as such notion is defined in Article 38 quinquies of Annex III to the French Tax Code (in the case of contributions, the initial value is the contribution value), or it may involve the basis for calculating depreciation pursuant to the above-mentioned Article 310 HF of Annex II, or, finally, it may also involve the fair market value (this is the solution which is adopted by the Conseil d'Etat for property allocated to a société en participation (joint venture)).

In our opinion, the cost of an item of property can only, except in the event of a specific legislative provision, be identical regardless of whether the company has purchased it or received it as a contribution. A contribution is only in fact a sale in consideration for shares. Only the case of a simplified merger of a wholly-owned company carried out at net book value could give rise to a reserve as there is no share issue.

It will be noted in particular that a con tribution "carried out at net book value" is only in fact an operation carried out at actual value but transferred to the accounts of the beneficiary at book value. In this regard, the parity is always calculated on the basis of the actual values. It is moreover on this basis that both the share capital increase in consideration for the contribution at the level of the beneficiary and the share exchange at the level of the parent company of the contributed company are carried out. This is the amount which constitutes the cost for the beneficiary within the meaning of Article 1469 of the French Tax Code.

Accordingly, it appears to us that the decision made by the Administrative Court of Appeal will in all likelihood be overturned by the Conseil d'Etat.

However, it is also appropriate to look at the impact that, firstly, the new accounting standards applicable to mergers and, secondly, the new sub-paragraph 3° quater of Article 1469 of the French Tax Code introduced by the amended finance bill for 2004 have on this debate.

3. The new accounting standards applicable to mergers (and assimilated operations)

For mergers that are carried out from January 1, 2005 onwards, French accounting law states that the contribution values to be used are net book values for operations carried out between companies placed under common control and actual values for operations between companies controlled by different entities (with the exception of reverse mergers, i.e. operations where the shareholders of the merged company take control of the surviving company upon completion of the merger). Common control means that one of the companies taking part in the merger must hold a prior controlling interest in the other or that both companies must have previously been under the control of the same company.

In practice, this means that, from now on, mergers taking place within a group of companies can only be carried out at net book value. The companies will therefore no longer have the possibility to use actual values, which are the only values that unequivocally avoid all discussion in the field of business tax with regard to the possibility to benefit from the tax base relief.

It is therefore urgent for the Conseil d'Etat to settle once and for all the debate regarding the determination of the business tax base of property, plant at equipment not liable for any property tax and with a depreciation period of less than thirty years.

However, a new provision introduced by the amended finance bill for 2004 puts an end to all controversy in this connection for the future.

4. The scope of application of Article 1518 B after the amended finance bill for 2004

The amended finance bill for 2004 provided for the insertion of a new paragraph into Article 1469 of the French Tax Code: "There is no change in the cost of property sold when such property is allocated to the same establishment both before and after the sale and where, either directly or indirectly: a) the transferee company controls the transferor company or is controlled by it; b) or both companies are controlled by the same company".

In the absence of any definition of the term "transfer", it should be considered that this provision will apply to any transfer of property, plant and equipment, whatever the legal method used to effect the transfer (sale, contribution, merger, etc.) inasmuch as this transfer takes place between affiliated companies and the assets concerned are allocated to the same establishment both before and after the sale.

This new provision means that the rule regarding the lower limit on rental value provided for in the above-mentioned Article 1518B, whereby the new rental value must not amount to less than 80% of the rental value prior to the operation, will no longer serve any pur pose when operations are carried out within a group.

From now on, in such a case, the new rental value will be equal to 100% of the rental value prior to the operation.

More generally, on the basis of this new provision, there is no longer any debate with regard to determination of the notion of "cost" in the case of restructuring operations carried out within groups from January 1, 2004 onwards.

Conclusion
Experience shows that companies in the same business segment may find themselves in quite different situations with regard to business tax depending on whether or not they have taken part in restructuring operations over the past few years. Such operations will have had the indirect impact of reducing the purchase price of the property, plant and equipment and will therefore frequently have led to a reduction in the business tax payment. Thus, on the basis of the same value added, some companies will be subject to capping while others that are comparable in all respects at the start but have taken part in restructuring operations will pay a business tax payment assessed on the bases alone without any capping being made (or, even more favorably, they may only be liable for a minimum business tax payment).

The effect of the new accounting provisions and more especially of the tax provisions is to put an end to these differences for property, plant and equipment subject to business tax (it will be noted that most new investments are currently excluded from the tax bases). Therefore, the companies who come out best are those who completed their restructuring operations prior to January 1, 2004!

It will however be noted that the order of future restructuring operations may still have a significant impact on the tax bases to be declared: thus the acquisition of a company from a third party followed by its merger will not grant entitlement to the tax base relief whereas a merger followed by the sale of the shares resulting from the merger would make it possible to obtain such tax base relief. In the same way, the impact of these operations on the value added of the companies still leads to significant extra costs or savings in many cases and these must always be anticipated.

Naturally, restructuring operations should only be carried out if they serve a real economic purpose, as otherwise the French tax administration could use the abuse of law procedure to apply sanctions, as this procedure is now also applicable in the field of business tax.


Olivier Vergniolle