On 18 October, the Assemblée Nationale (lower chamber of the French Parliament) adopted the draft legislation proposed by the French Government for the implementation into French law of the measures to combat hybrid mismatch arrangements provided for in the EU Directives 2016/1164, known as ATAD 1, and 2017/952, known as ATAD 2.
As a general background, the ATAD 1 and ATAD 2 address hybrid mismatches within the EU as well as with third (non-EU) countries. The terms and concepts included in the ATAD 1 and ATAD 2 are very similar to those in the OECD's BEPS Action 2 Recommendations. Member States have until 1 January 2020 to implement these measures into national laws.
For France, Article 13 of the 2020 Finance Bill, as adopted by the Assemblée Nationale, is proposing to almost literally implement the ATAD 2 into French law. It should be enacted in the very last days of December, following parliamentary review, and should apply to fiscal years opening from 1 January 2020 (except for provisions relating to reverse hybrids which shall apply to fiscal years opening from 1 January 2022).
As a result of the implementation of the ATAD rules, Article 13 of the 2020 Finance Bill, as adopted by the Assemblée Nationale, is further proposing to repeal the existing French domestic anti-hybrid rules, as set forth in Article 212-I-b of the French Tax Code, due to inconsistency with the new ATAD rules.
1. Key features of the new anti-hybrid rules
Whereas presented as rules designed to fight against tax avoidances practices, the new anti-hybrid measures shall have a much wider impact on international tax planning operations.
Scope of the new rules
The new rules address situations in which, due to conflicting tax rules between two or more jurisdictions, a same payment is deducted twice for tax purposes, or is deducted in one jurisdiction without inclusion/taxation in the other. They do not address situations in which little or no tax has been paid due to a low tax rate or the favourable tax system of a jurisdiction.
The new rules apply only in case of hybrid mismatch between "associated enterprises", between the head office and secondary establishment or between two or more establishments of the same entity, as well as to hybrid mismatches resulting from "structured arrangements" (i.e. where the mismatch is priced into the terms of the arrangement).
The term "associated" is defined in the Bill and generally covers direct and indirect interests of 50% or more. However, this percentage is reduced to 25% notably for hybrid financial instrument mismatches. In determining whether these thresholds are met, the direct and indirect interests of persons who are acting together have to be aggregated. Furthermore, an associated enterprise also means (i) an entity that is part of the same consolidated group for financial accounting purposes as the taxpayer, (ii) any situation in which an entity has a significant influence on the management of another. As per Article L. 233-17-2 of the French Commercial Code, significant influence shall be presumed from any party holding 20% or more of the voting rights.
The new rules apply without distinction to hybrid mismatches with EU or no-EU countries, so long as at least one of the parties involved is subject to corporate income tax in France, as well as to "imported mismatches". A mismatch is "imported" in France if a deductible payment under a non-hybrid instrument is incurred in France to fund expenditure under any hybrid arrangement between associated enterprises or under a structured arrangement out of France.
Types of hybrid mismatches
The new rules address the following categories of hybrid mismatches:
- Hybrid financial instrument mismatches, i.e. deduction without inclusion mismatches attributable to the differences in the characterization of a financial instrument, a transfer of financial instruments, or any underlying payment.
- Hybrid entity or permanent establishment mismatches, i.e. deduction without inclusion mismatches attributable to payments made between a hybrid entity or permanent establishment and an associated enterprise, or deemed payments between the head office and permanent establishment, or between two or more permanent establishments.
- Double deductions: the hybrid mismatch definition also captures all double deduction outcomes, where the double deduction arise from a same payment, expenses or losses, including "dual resident mismatches".
Neutralization of hybrid mismatches
Hybrid mismatch involving France will be settled pursuant to the following principles:
- in case of double deduction in France and in another EU or non-EU jurisdiction: the tax deduction should be denied in France
- in case of deduction in France with no inclusion in another EU or non-EU jurisdiction: the tax deduction should be denied in France,
- in case of deduction in another EU or non-EU jurisdiction with no inclusion in France: the income payment should be included in the taxable base of the French payee.
2. Focus on hybrid entities
A hybrid entity mismatch occurs if an entity is treated as transparent for tax purposes by one jurisdiction and as non-transparent by another jurisdiction.
Hybrid entity mismatch
If an entity is treated as non-transparent for tax purposes in the jurisdiction in which it is tax resident, payment, expenses or losses of the entity may be deductible from the taxable base of that entity. If the same entity is treated as transparent in the jurisdiction of its parent company, those payments, expenses or losses may be deductible from the taxable base of the parent company in that jurisdiction as well, leading to a double deduction within the hybrid mismatches rules.
Similarly, if an entity is treated as non-transparent in the jurisdiction in which it is tax resident, it may deduct from its taxable base payments paid to its parent company. If nevertheless the entity is treated as transparent by the jurisdiction of the parent company, the payments will not be recognized and thus not included in the taxable income of the parent company in that jurisdiction, leading to a deduction without an inclusion within the hybrid mismatches rules.
However, income of the hybrid entity might be included as taxable income in more than one jurisdiction as well. To take into account this so-called "dual inclusion" of income the new rules aim to neutralize a double deduction only to the extent that the same payment, expenses or losses deducted in two jurisdictions exceed the amount of income that can be attributed to the same hybrid entity and that is included in both jurisdictions.
Reverse hybrid mismatch rule
A specific rule shall apply to reverse hybrid mismatches, i.e. situations where an entity is qualified as tax transparent in the jurisdiction where it is formed, whereas the jurisdiction of one or more associated EU or non-EU entities qualifies the entity as non-transparent. In such situations, the reverse hybrid rule will not neutralize the effect of the hybrid mismatch, but rather tackle the hybrid mismatch at the source by making the hybrid entity in its entirety subject to tax.
In France, however, the reverse hybrid rule should have a low impact, due to the specific "semi-transparency" tax regime applicable to partnerships, pursuant to which the tax is paid by the interests holders but determined at the level of the partnership, the profits of which, determined under French tax rules, and submitted to taxation in France.
French collective investment vehicles may further be exempted from this rule. To qualify for the exemption, however, such collective investment vehicle (i) shall be widely held, (ii) shall hold a diversified portfolio of securities and (iii) shall be subject to investor-protection regulation.
We recommend to review in details the impact of these new rules on existing structures, and in particular on hybrid mismatches which could be imported in France under non-hybrid instruments, and on French hybrids entities, i.e. French corporations (e.g. SA, SAS, etc.) that are treated as partnerships or are disregarded for taxation in the jurisdiction of an associate enterprise, including parent companies in the United States.