End of the transition period: The main tax consequences of Brexit in France

22 January 2021

Author(s):

The UK officially left the EU and EEA on 1st February 2020 but it took 11 months of negotiations to reach an agreement on the terms and conditions of a new "free trade" area.



The UK officially left the EU and EEA on 1st February 2020 but it took 11 months of negotiations to reach an agreement on the terms and conditions of a new "free trade" area.

The agreement signed on 24 December 2020, which was due to be ratified on 31 December 2020[1], avoids the catastrophic scenario of a "no deal" and protects many sectors (industry, food processing, automobile, construction, etc.) from the application of customs duties.

The agreement does not contain any specific provisions on taxation (apart from VAT provisions for Northern Ireland, which are the result of a separate agreement entered into between Northern Ireland the EU). Yet, Brexit has a number of implications for the taxation of cross borders investments.

1. Consequences for companies

In accordance with the agreement entered into between the European Union and the United Kingdom on 12 November 2019 (Agreement 2019/C 384 1/01), France introduced a transition period ending on 31 December 2020 or on the closing date of the financial year in progress on that date (the "Transition Period"), during which the effects of Brexit are suspended.

In other words, until the end of the Transition Period, UK companies are deemed not to have left the EU. The effects of Brexit are thus expected during 2021.

Tax consolidation

As from 1st January 2021 (or from the beginning of the financial year following the one in progress at 31 December 2020), (i) French subsidiaries held through an intermediary company resident in the UK (the so-called "butterfly tax group") will exit from French tax consolidated groups, and (ii) French companies that are members of horizontal French tax groups held by a non-resident parent company established in the UK will no longer be eligible to the tax consolidation regime – unless their shares have been transferred to an eligible company (i.e. a French or EU/EEA resident company) before the end of the Transition Period.

Withholding tax on French-source dividends

Until the end of the Transition Period, dividends paid by a French company to a UK parent company are exempt from withholding tax, provided, in particular, that the shareholding of the latter in the former is at least equal to 5% (EU "parent-subsidiary" directive transposed under Section 119 ter of the French Tax Code).

As of 1st January 2021 (or as of the beginning of the financial year following the financial year in progress on 31 December 2020), the EU "parent-subsidiary" directive will no longer apply. To date, however, the tax treaty between France and the UK allows companies holding at least 10% of the capital of a French subsidiary to benefit from a withholding tax exemption on dividends, which neutralises the effects of Brexit in most scenarios. Only dividends relating to shareholdings between 5% and 10% will be negatively impacted: these dividends will now be subject to the 15% withholding tax provided for in the tax treaty (while they were previously exempt under the EU "Parent-Subsidiary" Directive).

Taxation in France of UK-source dividends

Dividends received from a company located in the EU or the EEA are exempt from French corporate income tax, up to 99% of their amount, provided that the subsidiary meets all the conditions required to join a French tax consolidated group had it been established in France (in particular, it shall be subject to corporate income tax in its State of residence and owned at 95% at least by the parent company). In a tax ruling dated 6 March 2019, the French tax authorities confirmed that this regime did continue to apply until the end of the Transition Period.

As from 1 January 2021 (or the beginning of the financial year following the financial year in progress at 31 December 2020), however, the exemption will be reduced to 95%[2].

Withholding tax on French-source interest and royalties

In accordance with the EU "Interest and Royalties" Directive of 2003, interest and royalties paid to an EU company are exempt from withholding tax in France, provided that the paying and receiving companies are "related" within the meaning of the Directive (i.e. one holds at least 25% of the capital of the other or a third company holds at least 25% of the capital of both companies).

As from 1st January 2021 (or the beginning of the financial year following the one in progress on 31st December 2020), interest and royalties paid to a UK company can no longer benefit from this exemption. In practice, however, the financial consequences should be limited for the following reasons: (i) France does not apply any withholding tax on interest under domestic law, subject to exceptions[3], and (ii) to date, the provisions of the tax treaty entered into between France and the UK also allows UK companies to benefit from a withholding tax exemption on French sourced royalties.

Mergers

On the French side, Brexit will have no immediate impact on mergers or similar operations involving a UK company. Indeed, the French favourable tax regime provided under Sections 210 A and 210 B of the French tax code not only apply to mergers involving EU member companies, but also to mergers involving companies having their registered office in a State that has signed a tax treaty including administrative assistance provisions to combat tax fraud and tax evasion with France.

R&D Tax Credit (CIR)

Only R&D expenditures incurred by French companies directly, or delegated to a subcontractor located in France, in the EU or in the EEA are eligible to the French research tax credit.

From 1st January 2021, any expenditure in relation to R&D works delegated to a UK subcontractor is thus excluded from the tax credit basis. In practice, only invoices issued by public and private research organisations located in the UK until 31 December 2020 will be taken into account for the calculation of the tax credit.

VAT - Great Britain

As of 1 January 2021, France and Great Britain became export territories.

Imports. Goods purchased from a seller established in the UK now fall within the scope of import VAT. As a result, VAT shall be paid to the customs authorities upon importation (and can only be offset on the VAT return filed the month after). The VAT self-assessment mechanism (neutralising cash impact to the extent VAT is 100% deductible) is still available, but subject to a formal election filed with the Direction Générale des Douanes et des Droits Indirects. To be allowed to self assess import VAT on its CA3 returns, the French importer shall comply with a number of conditions relating in particular to its duration of existence, solvency and good standing. Furthermore, the VAT basis will no longer equal the sale price of goods but will be computed with reference to the customs value increased, notably, of import duties and ancillary costs (packaging, transport, insurance).

An optional simplified regime should be introduced shortly for remote sales worth €150 or less from third-party States (such as the UK now). The VAT exemption on imports of goods worth less than €22 would correlatively be abolished.

Exports. Trades of goods between France and the United Kingdom no longer have to be reported on the "Exchange of Goods" tax forms but shall comply with all formalities related to the customs export procedure (presentation of goods, pre-departure declaration, exit certificate).

Services. The place of taxation of services provided to or by a UK company is generally unchanged, except for intangible services provided to a non-taxable customer established in the UK: French VAT will only be applicable if the service is actually used or operated there.

Representation. UK companies carrying out transactions subject to VAT in France without being established in France are not required to nominate a tax representative in France to pay output VAT. However, if they also have input VAT in France and need to claim a VAT credit refund, they will be required to appoint such a representative (it will no longer be possible to use the electronic portal in their state of residence). As a reminder, this tax representative may be (i) a French company that is a member of the same group, or (ii) a company specialising in tax representation (and whose activity is remunerated).

They shall now liaise and file their tax returns with the local tax services for foreign companies (SIEE).

VAT - Northern Ireland:

Northern Ireland entered into a separate agreement with the EU under which EU rules on VAT on goods continue to apply as if Northern Ireland were an EU Member State. Transactions involving services are not covered by this agreement.

2. Consequences for individuals

The transition period available to companies is not available to individuals. France however introduced a few specific measures allowing additional time for taxpayers to organise themselves before drawing the consequences of Brexit.

PEA (savings plan):

For the record, PEAs are French savings plans allowing individuals to benefit from tax advantages while investing in shares (exemption from capital gains tax – but not from social security contributions – on the sale of shares if they maintain shares and/or cash on the PEA account during at least five years). Only (i) shares issued by companies having their registered office within the EU or the EEA and (ii) shares of collective investment funds whose assets comprise at least 75% of the shares referred to in (i) are eligible to the PEA.

According to Regulation no. 2020-1595 of 16 December 2020 and Decree dated 22 December 2020, shares of UK companies remain eligible to (i) the PEA and (ii) the 75% quota applicable to collective investment funds until 30 September 2021.

Private equity funds:

Specific measures have been introduced for private equity funds, concerning the quotas of shares in EU required in their asset mix.

At least 50% of FPCI"s assets shall consist in:

  • unlisted shares issued by SME companies (without any headquarters location condition for regulatory purposes, but still having their registered office in the EU, Norway or Iceland if the FPCR/FPCI intends to comply with the tax quota enabling it to offer a favourable tax regime to its holders); or
  • up to 20% of all assets, stocks of companies listed on a regulated market of an EEA State, with a capitalisation of less than €150 million (in the latter case, not only tax rules but also regulatory rules impose that the company be located within EU).

The Regulation no. 2020-1595 dated 16 December 2020 introduced a 12 months transition period, ending on 31 December 2021. Until that date, shares of UK listed companies with a capitalisation not exceeding €150 million remain eligible to the 20% quota, to the extent acquired before 31 December 2020. On the other hand, the Regulation n°202-1595 does not specify what will happen to the shares of unlisted British companies that are included in the legal quota of 50%: the tax authorities will have to specify whether their retention as assets is likely to result in non-compliance with the tax quota.

At least 70% of FCPI and FIP's assets shall consist in shares of eligible SMEs, i.e. SMEs (i) in the meaning of EU definition, (ii) unlisted, (iii) operating for less than 10 years, and (iv)having their registered office within European Union or EEA country. The above-mentioned Regulation introduced a grandfathering clause for shares issued by UK companies and held on 31 December 2020 or acquired subsequently under an agreement entered into before that date. These shares will remain eligible without any time limit to the 70% quota of FIP and FCPI.

Gifts to charities:

Gifts to charities are eligible to (i) an income tax reduction equal to 66% of the gift amount, capped to 20% of taxable income and (ii) a reduction of real estate wealth tax (hereafter "IFI") equal to 75% of their amount, capped to €50,000 per person and per year.

Foreign organisations eligible for this reduction are those whose head office is located in an EU or EEA Member State. Consequently, gifts made to UK-based charities or organisations are no longer eligible to the income tax reduction nor to the IFI reduction.

Social security contributions

Brexit has a detrimental impact on social security contributions payable by UK resident individuals.

Since 1 January 2019 (Social Security Financing Act for 2019), non resident individuals who are covered by a social security scheme in an EU or EEA State or in Switzerland are exempt from CSG and CRDS on capital income derived from French real estate assets (e.g. income from land, capital gains from real estate located in France, etc.) and are only liable for a levy equal to 7.5%.

Since 1 January 2021, individuals covered by the UK social security system no longer benefit from this exemption and are subject to the standard French social security contribution, i.e. 17.2%.

3. International taxation

Both the US tax treaties and the multilateral treaty contain "Limitation of Benefits" ("LOB") provisions allowing State parties to test the economic rationale of holding patterns and to deny treaty benefits to structures that appear to have been set up solely for the purposes of receiving such benefits.

For example, a company located in State A owned by non-resident shareholders located in State A or State B cannot, in principle, benefit from the agreement concluded between State A and State B. Since one cannot assume that all structures are abusive, the agreement provides for safeguard clauses.

The company established in State A will notably continue to benefit from the treaty benefits (such as an exemption of withholding tax in State B) if:

  • its shareholder(s) are members of the EU, EEA (or North America Free Trade Agreement); and
  • less than 50% of its gross profits are paid, as deductible expenses, to persons who are not "equivalent beneficiaries" (i.e. persons who, had they invested directly, would have not been eligible to the same treaty benefits).

Post Brexit, the taxation of indirect investment structures involving UK companies could therefore be heavily impacted. This will be the case, for example, for UK investments in the US made through a Luxembourg or Dutch company.

4. Looking forward

With the UK being freed from some of the constraints of EU membership, the scenario of a significant overhaul of the UK tax system and the creation of new and highly advantageous local schemes cannot be fully excluded.

French companies hoping to take advantage of these new tax opportunities should bear in mind that the French CFC rules, codified in Section 209 B of the French tax code, allow the French tax authorities to tax the results of foreign companies, in proportion to the shareholding held by a French company, if the subsidiary benefits locally from a privileged tax regime (i.e. bears a tax that is more than 40% lower than the French tax). These rules apply differently depending on whether the foreign company is located outside or within the EU. Shareholdings in European subsidiaries are in principle exempt from CFC rules, which may apply only if the tax authorities can demonstrate that the establishment abroad constitutes an artificial arrangement.

The burden of proof is reversed for French companies owning shareholdings in non-European subsidiaries: they must demonstrate that the main purpose and effect of the establishment abroad was not to transfer profits outside France (i.e. that the subsidiary has an effective industrial or commercial activity in the territory where its registered office is located).

Substantial changes in the economic balance between France and the United Kingdom could also lead one or the other of the Contracting States to request the renegotiation of the tax treaty entered into between the UK and France.

Footnotes

[1] MEPs had announced as early as 21 December that it would be impossible to ratify this agreement before 31 December 2020. The agreement provisionally entered into force on 1 January 2021 pending its ratification by the European Parliament.
[2] Subject to compliance with the other conditions: (i) shareholding of 5% or more for at least two years and (ii) the subsidiary is subject to corporate income tax in its State of residence.
[3] Amounts of so-called "excess" interest, i.e. in excess of the interest that would have been paid under normal market conditions, are considered distributions and are subject to the provisions of the Franco-British tax treaty on dividends.


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