Arsene Taxand - M&A Private Equity

What remains of the Charasse amendment?

A year after the introduction into France of the tax consolidation regime, the lawmaker used the amended 1988 Finance Bill, under the auspices of the Minister for the Budget at the time, to “retroactively” introduce the seventh paragraph of Article 223 B of the French Tax Code, better known to tax practitioners as the “Charasse Amendment”, which sought to prevent misuse of the effects of the tax consolidation mechanism.

This paragraph was in fact aimed at dealing with operations whereby a company was able to generate liquidity thanks to a "sale to itself" of its subsidiaries thereby causing the French Treasury to bear part of the cost, primarily by creating a holding company to make the acquisition that contracted a debt for this purpose; the finance costs of this holding company were consolidated with the income of these subsidiaries from a tax standpoint. To put a stop to these transactions, part of the finance costs in question were no longer deductible from a tax standpoint including during the 14 fiscal years following the transaction.

The recently passed finance bill for 2006 and amended finance bill for 2005 have attempted to modernize the text set out below by amending the underlined sections:

"when a company has purchased, (…), the shares of a company which becomes a member of the same group from the persons controlling it, directly or indirectly, or from companies controlled directly or indirectly by such persons, within the meaning of Article 233-3 of the French Commercial Code, the finance costs deducted by the companies that are members of the group are added to the Group's consolidated income for a fraction equal to the ratio between the acquisition price of such shares and the sum of the average amount of debt, for each fiscal period, of the companies belonging to the group. The acquisition price to be applied is reduced by the amount of the funds contributed to the purchasing company at the time of a share capital increase carried out at the same time as the acquisition of the shares. (…). The add-back requirement applies during the fiscal period of acquisition of the shares and over the next fourteen fiscal years (…)."

The Article goes on to specify that these provisions do not apply:
"a. If the sale is carried out between companies that are members of the same group;
b. In respect of fiscal periods during which the acquired company is no longer a member of the group on condition that its exit from the group does not result from a merger with another group company;
c. If the shares sold to the company that is a member of the group have been acquired immediately beforehand, from persons other than those referred to in the seventh paragraph, and with a view to reselling them
d. in respect of fiscal years during which the company is no longer controlled by the persons referred to in the first sentence of the seventh paragraph."

In these few short lines, we will only highlight the new elements of assessment which should be borne in mind when completing transactions which are liable to fall within the scope of application of the paragraph redrafted in the above manner:

1. With regard to the impact of the merger of the acquired company with another company of the group: Right from the first version of December 1988, the text suspended application of this system in respect of fiscal periods during which such acquired company was no longer a member of the consolidated tax group. When it is known that up until then a merger led to the merged company leaving the tax group, it can be understood that, in the absence of any other tax problems (quick merger, exit costs, loss of the right to deduct loss carryforwards, etc.) the merger of the acquired company could mechanically lead to the end of application of the provision! In order to apply the provision, the tax authorities then had to argue the theory of abuse of law and prove that the sole purpose of the merger was to bypass the Charasse amendment.

From now on, the provision will continue to apply in the event of a merger of the acquired entity with another group company carried out in respect of fiscal years beginning as from January 1, 2006 onwards (and whatever the tax treatment applied to the merger). Presented as a type of counterpart for the mechanism of tax neutralization of capital gains or losses on disposal and other intra-group assistance introduced by the Finance Act for 2006 in the case of mergers subject to the preferential tax treatment provided for in Article 210 A of the French Tax Code, this change above all eliminates a method used to bypass the provision that the tax authorities had difficulty in combating. Here the letter of the provision is now more in keeping with its spirit (although it has not managed to cement all the cracks)…

2. With regard to assessment of the notion of control at the time of the acquisition: the parliamentary debates clearly wished to move towards greater legal security with regard to the notion of control which up to now was left more or less to the assessment of the tax authorities. The new wording of the provision therefore departs a little in this respect from the original spirit to the benefit of the taxpayer as it makes it more difficult to assess situations of "de facto control". Accordingly, (although without any certainty that the desired objective has been reached!) it should be noted that:

• it does not seem possible for the important notion of "joint control" to blend into the notion of "acting in concert" and that majority control does not rule out de facto joint control;

• the French tax authorities should no longer be able to put forward presumptions of control related, firstly, to the holding of a higher fraction of voting rights than the blocking minority and, secondly, a calculation made by considering the control exercised by several sellers who are also shareholders of the purchasing structure as joint control.

3. With regard to assessment of the notion of control over time: This is undoubtedly an area of real progress in the paragraph which does not betray the spirit of this provision. In fact – all other things being equal (notably with the acquired company not leaving the group) -, until these recent changes were made, irretrievable harm had been done!

Now, if there is a change in control of the purchasing company, this interrupts the application of the provision although it is subsequently reactivated in the event of acquisition by the original "controlling" entity. No doubt this change should in particular facilitate "secondary LBOs" without however encouraging any form of speculation by the main market players.

In the end, if the letter of the law is still perfectible (and what practitioner would complain?) and does not therefore always reflect its spirit, the sanctions provided for by this anti-abuse system make it a potent weapon which continues to inhibit certain restructurings. The refusal by Parliament to reduce the period of application of the provision from 15 to 10 years in order to take into account the decrease in the average term of borrowings reinforces the prophylactic character of the provisions: the spirit of the provisions will continue to haunt the most audacious until the system is overhauled from top to bottom …

Denis Andres