Transfer Pricing Forum - Transfer Pricing for the International Practitioner

30 minute read
10 April 2018

1. Does your country specify permissible methods for evaluating an arm's length interest rate on related party loans? What methods does it specify – or which does it permit if it does not specify methods – (e.g., CUP, reference to interest indices, or percentage mark-ups over a base such as the national bank interest rate)? Do local tax inspectors tend to apply particular methods over others? What methods have you found to be effective, or do you see most often used for financial transactions, and what evidence do taxpayers or the government's examiners use to establish the rate under those methods?

Among the terms and conditions of a loan, the interest rate will likely be one (and sometimes the only) component reviewed by the French Tax Administration ("FTA"). In the event of cross-border financing, the FTA will generally apply  Article 57 of the French Tax Code ("FTC"), which provides  the general French transfer pricing ("TP") rules that enable the FTA to reassess non-arm's length operations between related parties in an international context. The French TP rules specifically apply to cases where a non-arm's length transaction is carried out between two related parties. In such situation, the taxable income derived by such an operation is determined by reference to the income which would have been derived between parties, had they been acting independently .

The FTA may also apply the concept of the abnormal management act ("acte anormal de gestion") to disallow in full or in part the tax deductibility of interest expense of a French borrower (if it considers that the latter should not have agreed to the terms and conditions of the corresponding intra-group loan) or to recapture a portion of taxable interest expense of a French lender (if it considers that the interest rate applicable to the granted loan is insufficient). In these situations, the FTA would not have to apply a specific tax audit procedure and/or re-characterize the loan agreement, as long as the abnormality of the loan terms and conditions are demonstrated.

Should the FTA challenge the deductibility of all or part of the interest expenses, it will bear the burden of the proof and will have to demonstrate the abnormality of the terms and conditions of the challenged financing (except under the very specific conditions of an "abuse of law").

The abnormal management act concept will generally be used for intra-group financing operations involving French related parties only (and in exceptional cases, financing operations between third parties), while Article 57 of the FTC will be used for operations involving non-French related parties.

Finally, the FTA may rely upon Article 212-1.a of the FTC which sets a limit to interest deductibility as the upper of the two limits below:

  • Interest rate stated in Article 39-1-3° of the FTC. According to this article, the maximum rate is determined by reference to the annual average of the effective rates used by the credit institutions for loans granted to companies at variable rates, for a period exceeding two years (the applicable rates for the last two FYs were: 2.06% for the last quarter of FY 2016; 1.69% for the last quarter of FY 2017; 1.64% for the first quarter of FY 2018). This maximum rate is applicable to any financing between related parties, i.e. not only in a parent-subsidiary relationship but also between sister companies or companies indirectly held by the same end-shareholder.
  • "Market" Interest rate.

Any interest in excess of either the maximum rate or, if applicable, the "market" rate, is not tax deductible at the French borrower's level.

In practice, to determine "arm's length" or "market" rates, the FTA most often complies with the OECD Transfer Pricing Guidelines, and, accordingly, would typically abide by the Comparable Uncontrolled Price ("CUP") Method, as defined in the OECD Transfer Pricing Guidelines.

Yet, it was also commonly observed that individual examiners would request, under the provisions of Article 212-1.a of the FTC, formal offers or quotes by banks or credit institutions in order to grant full deductibility for certain interest charges . This position seems to have been recently disavowed through a number of case laws . This should further facilitate the acceptability of the CUP method and of appropriate economic analyses by the FTA, as early as the audit stage.

Finally, please note that interest expenses are also limited by French corporate income tax rules otherwise known as "thin-capitalization rules" (please see section 7).

2. Does the country officially (or do tax inspectors in practice) express a preference for valuation methods or approaches that are different for outbound transactions (domestic lender/foreign borrower) than for inbound ones?

In practice, it is not uncommon that, during the audit phase, the position taken by an individual auditor in one context seems to contradict a position taken by another auditor in a seemingly very comparable situation, but where the interests of the FTA would be reversed.

It is worth mentioning that the "Safe Harbor" rates (see Section 1), referred to in Article 39-1-3 of the FTC (2.06% for the last quarter of FY 2016; 1.69% for the last quarter of FY 2017; 1.64% for the first quarter of FY 2018) are often favourably considered, when documenting the inbound (domestic borrower) charges.

3. Assume a typical related-party borrowing situation in your country: a foreign member of a multinational group has lent money to a domestic affiliate. It must be established whether the borrowing is on an appropriate arm's length basis. How are these issues dealt with in your country?

a. What factors are examined to establish the loan's "bona fides;" that an advance or a loan agreement sets out genuine debt? Is it necessary to show that the loan would have been made by an unrelated lender, absent a guarantee? Is there a separate consideration of whether the "borrowing" is in fact an equity infusion? What happens if the loan is interest-free, and what happens if there is no written agreement?

Based on certain case law from the French Supreme Tax Court ("Conseil d'Etat" or "CE") , it is often considered that the FTA may not rely upon Article 57 of the FTC to challenge the financing policy, and in particular the use of debt vs. equity.
However, in a number of situations, the FTA may supplement Article 57 or 212-1.a with the theory of the abnormal act of management. This enables the FTA to reassess a taxpayer on the grounds that certain of its operations would not be aligned with the interest of the entity . The borrower should demonstrate that interest rate provided by the loan with a related company would have been equivalent if the loan has been obtained from a financial institution.  For this purpose, it could help to produce a loan offer showing equivalent interest rate.

Accordingly, the theory of the abnormal act of management echoes certain OECD concepts such as, "Options Realistically Available" or "Transaction Delineation."

As an example, the FTA successfully relied upon the abnormal act of management theory to reassess a taxpayer in a situation where an interest-free loan had been established .

More generally, the lack of written agreement exposes a taxpayer to having the repayment of the principal of a loan classified as a deemed dividend .

b. Under the current regulatory regime and case law, should the borrower be evaluated as a stand-alone borrower, or as a member of a multinational group benefiting from passive association with its group? Is implicit support from affiliates assumed, or what factors must be identified to suggest that such support might be given? Is this viewed as an exception to the traditional arm's length standard or as a necessary interpretation of it, or something else?

In General Electric , the Conseil d'Etat examined the elements of the abnormal nature of the remuneration of intragroup loans as defined by Article 212 II of the FTC. The Conseil d'Etat confirmed the approach under which the intrinsic rating of the borrowing company must prevail, and affirmed that if the membership in a group can have an influence on the group's credit rating, and therefore on the interest rate supported, this influence is not automatic and can only be apprehended from a detailed qualitative analysis of each of the factors taken into account in the valuation of the credit risk of the subsidiary.

This decision confirms the solution adopted by the Administrative Court of Appeal of Bordeaux ("Cour administrative d'appel de Bordeaux" or "CAA") in the Stryker Spine case which did not directly apply the abnormal management act but instead applied the provisions of Article 57 of the FTC and the arm's length principle.

In practice, the level of implicit support may be analysed in light of (i) the willingness of the parent company to provide support and (ii) the ability of the parent company to provide support. Rating agencies issue methodologies to analyse the implicit support which may be helpful in this regard.

The typical factors that are considered to analyse the willingness of the parent company to provide support may include:

  • Intricacy of reputation;
  • Operational integration; and
  • Role of financial regulators, (in particular in the financial services industry).

The typical factors that are considered to analyse the ability of the parent company to provide support may include:

  • Parental credit rating;
  • Correlation of business conditions; and
  • Magnitude of expected support.

In a recent judgment, the Administrative Court of Montreuil("Tribunal administratif" or "TA") relating to the burden of proof incumbent on the taxpayer in the context of Article 212-1 of the FTC considered that the administration was unfounded to require the production of an offer of contemporary loan operations. The relevance of interest rates applied can be demonstrated by economic studies based in particular on the intrinsic credit rating of the borrowing company. This position, even if it is only a decision of first instance, gives hope for a coherent approach for assessing the full competitive nature of intra-group borrowing, regardless of the rule implemented (Article 39 or 212-1 of the FTC).

In the view of the foregoing decisions, the intra-group interest rates on the cost of external financing should be monitored.

It is hoped that these decisions, which are in line with the OECD position (as it should be made explicit in the draft report on intra-group financial instruments expected this summer) and a significant number of tax administrations, are expressly accepted and applied by the tax administration to provide greater legal certainty in this area.

c. What other factors than the borrower's position as a stand-alone entity or member of a multinational group would be taken into account in evaluating the borrower's credit worthiness?

Please refer to b. for the Conseil d'Etat approach adopted in recent case law.

The analysis of the stand-alone position as well as of any other relevant group effect should provide a reasonable ground to analyze the borrower's credit worthiness.

Please note that the consideration of the entity's borrowing conditions with third parties may often provide relevant reference points, in the context of the analysis.

Other aspects, such as factors related to the financial instrument per se, are also critical in the transfer pricing analysis.

d. What sources of data for comparable loan benchmarking are typically referenced when undertaking an intercompany loan analysis?

The FTA are believed to be routinely presented with analyses using authoritative capital markets database sources, including, amongst other, Bloomberg, Reuters or Loan Connector as well as proper database.

e. What, if any, safe-harbor rates or indicative or "suggested" margins are provided? Does the tax authority have (or has it indicated) an intention to provide such guidance?

Please refer to Section 2

f. How do you deal with negative interest rates in the context of deposits (e.g., in related financing institutions or similar situations)? How do you deal with base rates that are negative (such as Euribor, which as this is written are negative)?

The authors are not aware of any formal position taken by the FTA, as regards the context of negative interbank interest rates. Taxpayers should expect that the FTA would assess the appropriateness of the interest rates in light of the conditions which would have prevailed between unrelated parties.

We would typically recommend that taxpayers avoid, if possible, charging negative interest rates to foreign borrowers. Nevertheless, we are aware that some French MNEs have taken a position to charge negative intercompany interest rates, in certain circumstances.

g. Does intra-group lending present other issues under your country's tax system, and how are those dealt with by taxpayers?

Other important issues related to intercompany lending include:

  • Thin capitalization rules,
  • Arm's length nature of the overall financing policy and tax characterization of the financial instruments, and
  • Features of the loan (e.g. convertibility, early reimbursement clause by the lender, by the borrower, etc.).

4. In light of BEPS Action 2 (Hybrid Mismatch Arrangements) a number of countries during the last year have been enhancing, modifying, or adopting rules that affect transfer pricing of financial transactions. If changes have recently been made to your country's rules, what changes are those, and when do they take effect?

On August 5 2014, the French Tax Authorities (FTA) released their final regulations on the "anti-hybrid financing" provisions enacted as part of the 2014 Finance Bill.

The 2014 Finance Bill introduced, under Article 212 I (b) of the FTC, a new interest limitation rule (also referred to as "anti-hybrid financing" provisions) which provides that interest paid by a French enterprise subject to Corporate Income Tax (CIT) to a related French enterprise or a non-resident related enterprise is not tax deductible for French CIT purposes if the interest paid is not subject to tax, at the level of the beneficiary company, at a rate of at least 25% of the French CIT that would have been due under the standard French rules (Minimum Taxation Test).

This provision clearly aims at limiting interest deduction at the debtor level if such interest is not taxable at the creditor level, notably if it is treated as an excepted dividend or as a capital contribution reimbursement.

In the current French context, the specific thin capitalisation provisions will likely be used by the FTA to assess the arm's length nature of intra-group financial transactions.

However, since such specific rules do refer to market rates, it is possible that the FTA and/or the concerned taxpayer have to use transfer pricing analysis to assess such market rate, using available benchmarks in databases (see Issues 1 and 2 above).

Reference can be made to the BNA Transfer Pricing Forum (December 2013), French Chapter on the topic of Re-characterisation, in which we discussed two French cases relating to loan versus equity qualifications, issued prior to Article 212-I b. of the FTC.

The concept was notably discussed in the recent Stallergènes case, which deals with the traditional question of qualification of a single amount as equity in one country and debt in the other country. The operation had been legally qualified as a loan.  The French Tax Authorities challenged the lack of interest on the operation and proceeded to a corresponding reassessment based on article 57 of the FTC (TP reassessment).

Another GSE case from the Conseil d'Etat acknowledged the right of a French company holding a Portuguese subsidiary, to make "supplemental contributions" as defined under Portuguese law and not request interest from the subsidiary, even if these contributions were financed in France by a loan, and provided they have been treated as capital for accounting purposes .

These re-characterizations of debt into equity (or the reverse requalification) would, of course, impact correspondingly the thin capitalization rules applicable either to a French borrower or lender, or to the entire Group, when such rules are applied at Group level.

  • Proof of the minimum taxation

Upon request of the FTA, French taxpayers must provide documentation that supports that the CIT applicable at the level of the lender on interest accrued and deducted by the debtor is at least equal to 25% of the CIT normally due under standard French CIT rules.

The draft regulations required the French debtor to provide evidence that the interest paid is effectively recorded in the profit and loss accounts of the lender (in addition to demonstrating that tax legislation applicable in the lender's jurisdiction provides for a sufficient tax rate on such interest). In the final regulations, the FTA require the debtor to provide evidence that it was actually included in the lender's taxable income, e.g., by providing both the accounting entries made by the lender and the lender's tax return.

Where the lender is part of a French tax consolidated group, the final regulations specify that it must be evidenced that the interest is included in the tax consolidated income. No specific comment is made for foreign tax consolidated groups.

  • Deemed dividend classification

French tax laws provide that certain non-deductible interest payments are classified as deemed dividends and may, thus, be subject to domestic dividend withholding taxes and a 3% dividend distribution tax. The final regulations provide that disallowance of interest under the "anti-hybrid financing" rule does not trigger such reclassification.

5. How do your country's rules for attribution of income to a permanent establishment work with the rules on debt financing? In particular does the "distinct and separate enterprise" view of a PE's income calculation permit (or require) separate entity evaluation of the PE?

The FTA consider that Article 212 II of the FTC rules apply to French permanent establishment of foreign Companies.

In addition, the FTA holds the view that the breakdown of indebtedness between the permanent establishment and the foreign parent company has to comply with territoriality rules provided by Article 209, I of the FTC as well as the provision relating to profits in Bilateral Tax treaties.

This position contradicts the position adopted in several decisions by the French Tax Supreme Court according to which, the determination as to whether branches must be provided for equity capital or not is at the option of each enterprise. In these decisions, it has been ruled that the FTA were not allowed to reject the deductibility of interest at the level of French branches for a lump sum corresponding to the alleged equity capital these branches had to be provided for.

6. If a foreign affiliate provides an explicit loan guarantee, when do your country's rules or your country's practice indicate that a guarantee fee must be accounted for? (If it must, when can it be an adjustment to the interest rate, or when must a separate guarantee fee be deemed to be paid to the foreign affiliate?) How is the appropriate charge for a guarantee determined?

A number of methods may be set forth to determine the appropriate guarantee charge:

  • Actuarial method, relying upon the modelling of the Expected Loss associated with the calling of the guarantee. This method often relies, in particular, upon the consideration of:
    • the default probability of both entities;
    • the correlation between these default probabilities; and
    • the opportunity cost of capital.
  • Credit Default Swap pricing.

It happens that simpler approaches (direct comparison between the Group / parent borrowing conditions and of the Stand-alone borrowing conditions) may also be used and deemed sufficient.

Based on our experience, the 50 basis point referenced in particular case law has sometimes been considered as an acceptable reference by field auditors, in the context of tax audits.

Similarly, pursuant to French tax case law, a company granting a guarantee to a foreign related party without requesting any remuneration for such service has correspondingly transferred some of its profits to such related party. This profit can be reassessed under Article 57 of the FTC .

However, if the company granting such guarantee is able to demonstrate that a specific counterpart has been derived from the guaranteed operation, it may justify the lack of any remuneration. In this respect, French case law has ruled that:

  • the lack of remuneration on guarantee granted a French parent company on loans to a foreign subsidiary can be justified by the significant boost in sales of said subsidiary . However, it is important to note the specific context of this case, since the local legislation applicable to the subsidiary was forbidding any remuneration on guarantee and the amount of unrequested fees for the guarantee was particularly low when compared to the increase in sales;
  • on the contrary, such lack of remuneration is a transfer of profits which cannot be only justified by a mere increase in the value of the subsidiary to which the fee-free guarantee has been granted .

Therefore, as a matter of principle, remuneration for guarantees should be requested and, it is only in exceptional circumstances under which a clear counterpart or advantage to the granting party can be identified, that no fee could apply to the guarantee. A counterpart or advantage can be found in the commercial relationships between the parties (e.g. need to preserve the viability of the beneficiary if it is a supplier or a distributor of the grantor) and, less frequently, in their shareholder-subsidiary relationship (since a specific advantage for the party granting the guarantee is required, the sole increase in the value of the beneficiary throughout the guaranteed operation being viewed as insufficient to justify a lack of fee on the guarantee).
Other French case law, not based on Article 57 of the FTC but on the abnormal management act, have set out the very same principles. It is noted that within a network of supermarkets, a current member can grant a guarantee to a new member without requesting any remuneration, provided this lack of remuneration is grounded by its contractual commitments of sponsorship of new members toward said network .

7. If your country has adopted interest deduction limits, such as the OECD's suggested ratio or group ratio approach, what are those measures? Do you expect that those measures will reduce the need for strict enforcement of transfer pricing in regard to related-party loans, by making it less tax-efficient to erode the domestic tax base through interest charges? Do thin capitalization or other specific limits such as debt vs. equity rules limit the operation of transfer pricing more generally? If so, how do these affect decisions that companies might make?

Since 2007, the French government has adopted various rules providing a limitation of the interest paid to related companies described below.

  • General financial expenses deduction

The Finance Act for 2013 introduced a general financial expenses deduction cap based on the amount of the net financial expenses incurred during a Fiscal Year (i.e., the financial expenses reduced by the financial income). Only 85% of the net financial interest incurred in Fiscal Years open on December 1st, 2012 and 2013 (for the UTC French companies), is tax deductible, and 75% for the expenses incurred in FY open on December 1st, 2014 and onwards.

In the case of a tax consolidated group, pursuant to Section 223 B bis of the French Tax Code, the financial expenses deduction cap applies to the net financial expenses of the tax group (excluding inter-company transactions), at the tax group level only (i.e. no cap applies on a standalone basis, except for employee profit sharing computation purposes).

This financial expenses deduction cap does not apply if the net financial expenses incurred by the company or by the tax group during a FY are below 3 million Euros.

  • Scope of Article 212 of the FTC:

These provisions apply regardless of the location of the lender (French resident, EU resident or non-EU resident).

Article 212 applies to loans granted by direct or indirect shareholder of a French company, and also granted by companies belonging to the same Group, when directly or indirectly held by the same parent company.

Article 212 of the FTC provides however for some specific exceptions. French companies managing a cash pooling within a group, financial credit establishments, leasing institutions and financing in the course of normal commercial relationships, are not subject to these limitations.

  • Analysis of the interest rate and the level of global financial debt:

The interest expense borne by a French company for loans granted by its direct or indirect shareholder or by a related company is tax-deductible as a matter of principle, but subject to two different limits: the applicable interest rate (See Question 1) and the level of financial indebtedness of the borrower and possibly the Group it belongs to (i.e. "thin capitalization rules").

The limitation of deductible interest will also apply when the three following cumulative conditions are met:

  • The loans or current accounts from the direct / indirect shareholders or related companies having the same shareholder exceed 1.5 times the amount of the shareholders' equity (or the amount of the paid-up share capital, if superior) ;
  • The interest expense is higher than 25% of the operating income before tax increased by depreciation and interest expenses ;
  • The intra-group interest expense borne by the French company is higher than the intra-group interest expense it received.

The interest expense is only deductible up to the highest of the three above-mentioned amounts.

The excess amount over the highest of these three limitations although not deductible for the current fiscal year can be carried forward over the following fiscal years. This excess amount remains deductible from the income of the following fiscal year, or from the next fiscal years, with a reduction of 5% per year of the carried-forward amount.

Besides, if the excess amount of interest is lower than €150 K, the interest remains fully deductible when incurred.

Furthermore, the new limits will not apply if the French company can prove that its level of indebtedness does not exceed the level of indebtedness of the group to which it is a member.

Finally, in case of merger or contribution of business by a French company having an available amount of deferred deductible interest, such amount can be transferred to the merging or benefiting company when the operation is carried-out under the so-called French favorable Tax regime. Also, specific rules have been issued for tax-consolidated companies, which will not be developed any further in this analysis.

Although these specific rules have increased the limitation of interest deductibility, there is still room for leveraged structure in a French context. Therefore, the opportunities and associated risks in relation to leverage finance will remain and so will the scrutiny of the FTA on such operations.


Last paragraph of article 57 of the FTC.

BOI-IS-BASE-35-20-10-20140415 n°110

CE, June 19, 2017, GE Money Bank ; Administrative Court of Bordeaux, November 13, 2014, Siblu ; Administrative Court of Montreuil, March 20, 2017, Sté BAS.

CE, Sect., December 30, 2003, rec. N°233 894, SA Andritz

CE July 31, 2009 SARL Domaine Ste Claire and SARL Jean Marc Brocard

CAA Nantes June 14 2010, Slobic

CE, 9e et 10e ch., June19 2017, n° 392543, min.c/ Sté General Electric France

CE, September 2, 2014, No. 12BX01182, Stryker Spine Company.

Such as Moody's (2003) Rating non-guaranteed subsidiaries

TA, March 30, 2017, No. 1506904, BSA company.

TA Paris, December 31, 2008, n°03-9446 and 04-22396, Stallergènes.

CE, September 7, 2009, n°03303560, SNC Immobilière GSE

BOI-IS-BASE-35-20-10-20140415 n°10

CE, April 11,  2014, n°346687, 10e  and 9e s-s., Sté Unicredit – Banca di Roma Spa;  CE, April 11 2014, n°344990,  10e  and 9e s-s, Bayerische Hypo and Vereinsbank AG, CE, April 11, 2014,n°359640, 1àe and 9e s-s., Caixa General de Depositos.

CE n°342753, October 5, 2011, SA Sofitec

CE, March 9, 1979 (n°10454)

CE, March 3, 1989 (n°77581)

CE, February 17, 1992 (n°81690-82782), Carrefour

CE, September 26, 2001 (n°219825), SA Rocadis

This ratio being determined at the opening or at the closing of the concerned fiscal year, depending on      the French company's choice.

Reproduced with permission from Transfer Pricing Forum, 07 TPTPFU 82. Copyright R 2017 by The Bureau of National Affairs, Inc. (800-372-1033)

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