Services or Intangible Property
1. If a senior manager or management team is relocated into or out of your jurisdiction, does your country have a view about whether the transfer is purely a services transfer, or includes an intangible asset such as goodwill (or even workforce in place); or of an intangible such as profit potential?
As a matter of principle, the French tax legislation does not qualify "human capital" as constituting an 'asset.' Therefore, in the current state of the French law, "workforce - in place"would be viewed as a component of a company's function. Consequently, since such tax law is aiming at taxing asset transfers, no compensation would be required on a transfer of a work force, to the extent the transfer is not reflective of or associated to any other asset transfer, in particular of an intangible.
If the aforementioned transfer is purely made of a transfer of personnel (managers, directors or employees), without any other single tangible or intangible asset, it is unlikely to be seen as a taxable transfer of a profitable business, if externalized out of a French company. Even if there is no formal guidance on the characterization of a taxable "business restructuring"under French tax law, such a taxable event is generally evidenced by the transfer of several assets in addition to the transfer of personnel, in a single or in successive times. Such assets would notably include a clientele or going-concern, as the case may be, i.e. a bundle of client contract relationships enabling to transfer the corresponding underlying profit potential. In this case, and in line with the OECD developments on 'transaction delineation", it is likely that the French Tax Administration would seek to establish that the transfer of personnel takes place within a wider context and, as such, is part of a taxable event.
In business restructuring situations, it is expected as well that the French Tax Administration would pay due attention to the compliance with contractual and commercial law. If the previous contractual relation-ship between the parties has not been duly cancelled and, possibly, indemnified (e.g. in case of an early termination), it is likely that the French Tax Administration would seek to establish a tax reassessment on these grounds.
It is only in exceptional, and possibly abusive, situations, that a "pure"transfer of personnel would be seen as taxable in the hands of the transferee, notably if the latter is not indemnified while the activity carried out by said personnel is also indirectly transferred to the beneficiary (for instance if the contractual relationship with third party clients is somehow transferred to the beneficiary, or ended without compensation by the transferee or if the contract between the transferee and the beneficiary for the services rendered by the transferred personnel is unduly cancelled without proper indemnification).
The way these 'transfers' are operated should also be reviewed, as they could be seen as 'revealing' a taxable transaction or a business restructuring. Indeed, a simple expatriation or temporary relocation of a single person or a team should not be seen in itself as such a taxable event, notably if the relocation is temporary or made for the direct or indirect benefit of the transferee (for example a parent company agreeing to relocate some of its management in certain subsidiaries, for specific assignments, such as integration or local development purposes).
Also, given the recent BEPS developments, the profit position of the transferee or transferor should be scrutinized post transfer, in order to assess whether the transfer has indeed led to a loss of activity or margin for the transferee, which should have been indemnified.
In short, the current practice of the French Tax Authorities ('FTA') would be to request compensation for a transfer of assets only, as opposed to a mere transfer of personnel, based on the French tax legislation. However, more sophisticated and state-of-the-art positions have been recently taken by the FTA for significant functions transfers. For such transfers, it is believed that the following action plan should be followed:
- An economic mapping of the existing functions and risks borne by the French company that locates the activity concerned (and possibly shared with other related companies within a single group) should be performed;
- A legal analysis should be carried-out to check whether the French company should be compensated;
- A financial analysis should be performed to check whether the French company can have an individual interest in the function restructuring;
- If, pursuant to these reviews, it cannot be demonstrated that (i) the French company had no right to a compensation or (ii) had its own interest in the restructuring, a compensation should be paid by the company that is taking the functions (in the event of a transfer of activity) or by some companies of the Group, notably the parent company (in the event of a closing of activity).
As an illustration of this approach, the Administrative Court of Paris ruled that a transfer of a cash pooling activity from a French company managing the cash pool to a foreign entity belonging to the same group without compensation was deemed to be an indirect transfer of benefits under article 57 of the French Tax Code. The judge confirmed the tax reassessment carried out by the FTA, through (1) an increase of the taxable basis subject to corporate income tax of the French company by the deemed compensation, together with (2) the application of a withholding tax on the corresponding amount, resulted in profits that were deemed transferred to the related foreign company as an undisclosed distribution of dividends.
Apart from transfers of functions, the FTA can also proceed to certain reassessments pursuant to the termination of certain functions (e.g. total or partial closing of a business in France, without any transfer to a related or third party). It can notably be considered that the expenses related to the closing of such activity/function cannot necessarily be borne, totally or partially, by the French company locating this activity/function if such closing has been unilaterally decided by the foreign parent company of this French company, particularly if the activity was profitable. Correspondingly, the tax deductibility of closing expenses (particularly severance payments) as well as capital losses on asset write-offs could be challenged by the FTA. Therefore, if pursuant to the transfer of employees, some costs in relation to them or their terminated activities remain borne by the transferee, then their tax deductibility could be challenged, and this could be seen, again, as an undisclosed distribution of dividends to the beneficiary.
2. What factors would be considered to determine how to characterize this transfer? In particular, might it make a difference whether it is a single person or a group of managers?
Obviously, given section 1 above, in most cases, the transfer of a single person is unlikely to trigger a taxable event or the transfer of an intangible. Circumstances under which this could occur could include:
- if this sole person would be seen as a director of a company (1) having the legal ability to represent and take binding commitments for said company. In such a case, the company (2) employing that person could be seen as housing the permanent establishment of the company (1) in its premises.
- If the transfer of this person may convey the transfer of valuable intangible, such as know-how. In these situations, we would expect the transferor to be willing to pay for such transfer since it would have had to develop such know how if it had not benefited from the transfer.
The transfer of a larger group of people is more likely to raise more scrutiny. In practice, such transfer might correspond to transfer of complex functions and risks. But in such a case, a transfer of goodwill / clientele could still only be characterized under the conditions set out under section 1 above.
3. What difference might the duties of the management team make? (For example, suppose this was a sales person or team, as opposed to a management team? Or an R&D group?)
The transfer of sales people would require more specific attention, as they are the most likely to carry the client relationship from the transferee to the beneficiary. However, the transfer itself should not result in the transfer of relationships with the corresponding clients, as contractually, the transferor would still be in relationship with the clients. However, if the transferee also transfers this contractual relationship, or agrees to terminate it without any proper indemnification while being legally justified to ask for it, this would be seen as an abnormal act of management, requiring to reassess its taxable profit by the amount unduly surrendered, from a French corporate income tax perspective. This would also be seen as a form of undisclosed distribution of dividends (as raised above under section 1) to the beneficiary, possibly triggering a withholding tax leakage upon the gross amount of this unjustified advantage.
The transfer of a management team of a company 1 could generate a permanent establishment of that company if transferred to company 2, if the management team keeps its duties in company 1 after the transfer.
Valuing the Item Transferred
1. Are there any local tax or valuations rules or conventions on such valuations? How would the Hard-To-Value Intangibles concepts apply?
As mentioned previously, a valuation would be required only when the transfer of personnel takes place within the wider context of a business restructuring, or it typically relates to, simultaneously, a transfer of intangible such as know-how, rights, or 'anything of value'.
In those situations, the accurate delineation of transaction, and the consideration of options realistically available ought to be critical in the valuation.
There is no French regulation on how to value intangibles - or teams - for French tax purposes. The French Tax Administration in 2006 published a non-binding booklet on equity valuation which is not used or might not be used systematically, by practitioners.
In practice, the French tax administration enforces the arm's length principle, as per the OECD Transfer Pricing Guidelines. Consequently, it can be argued that the methodology to value such items would be the same - but for transfer pricing specific concepts - that the one which would have prevailed for dealings between unrelated parties.
Methods typically used to value intangibles include the Discounted Cash Flow method. However, in the case of intangibles associated with a workforce, the Replacement or Replication Cost Method may also be used.
Supporting the Company Position
1. What features does a transfer pricing policy need in order to use it to support a calculation of this value reliably (given that the management team provides current services but may also be involved in important intangible asset DEMPE decisions)?
Quantitative Analyses, such as Discounted Cash Flow, Replacement or Replication Cost Methods require a thorough analysis. When applying such methods, critical parameters and assumptions ought to be carefully identified and justified, based on external, unbiased references. It is recommended to test the sensitivity of the results to alternatives values of key variables impacting the valuation results.
Mr. Madelpuech is a Principal within the Transfer Pricing Practice of NERA Economic Consulting in Paris. He may be contacted at:
Reproduced with permission from Transfer Pricing Forum, 07 TPTPFU 82. Copyright R 2017 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com.
Cour Administrative d’Appel de Versailles, n°10PA00748, December 31, 2012, Sté SOPEBSA