France's Draft 2019 Finance Bill Reforms Interest Deductibility Limitation Rules

The French government presented the draft Finance Bill for 2019 on September 24, 2018. This draft is currently being discussed by the Parliament and is subject to potential changes. The final version should be enacted by the end of December.

In order to implement the EU Anti-Tax Avoidance Directive (ATAD) into French tax law, Article 13 of the draft Finance Bill provides for new rules governing the limitation of the tax deductibility of "financial expenses." Financial expenses include interested and other expenses assimilated to interest.

The draft Finance Bill would repeal (i) the existing thin-capitalization rules (Article 212 II of the French Tax Code (FTC)), (ii) the "general 25% non-deductibility rebate" (Articles 212 bis and 223 B bis of the FTC) and (iii) the "Amendment Carrez" (Article 209 IX of the FTC). However, the interest rate limitation (Articles 39 1 3 and 212 I a of the FTC), the so-called "anti-hybrid rules" (Article 212 I b of the FTC) and the "Amendment Charasse" (Article 223 B of the FTC) should remain unchanged.

In replacement, the draft Finance Bill introduces a new mechanism that limits the deduction of net financial expenses paid by companies to both related and unrelated parties, to the higher of (i) 30% of the fiscal earnings before interest, tax, depreciation and amortization ("EBITDA") or €3 million, per fiscal year or (ii) 10% of the "fiscal EBITDA" or €1 million if the debt-to-equity ratio of the company exceeds 1.5.

It should be noted that under the current draft Finance Bill:

1. The "fiscal EBITDA" corresponds to an adjusted taxable income of the company.

On the one hand, the amount of deductible financial expenses should be computed in order to determine the "fiscal EBITDA." On the other hand, the amount of deductible financial expenses is based on the "fiscal EBITDA." As a consequence, as the text is currently drafted, it should not be possible to determine (i) the amount of deductible financial expenses and (ii) the "fiscal EBITDA." However, in our opinion, the "fiscal EBITDA" should correspond to an adjusted taxable income of the company without taking into consideration any financial expenses.

2. The amount of debt taken into account to determine the debt-to-equity ratio only refers to debt granted by related parties (and not to debt granted by third parties and secured by related parties).
3. The current administrative tolerance consisting in computing the debt-to-equity ratio using the share capital of the company (rather than its net equity) may no longer be applicable.

However, if the debt-to-equity ratio of the company does not exceed 1.5 (i.e., if the company is not considered to be thinly capitalized), a safe harbor clause would apply if the company can demonstrate that its equity-to-asset ratio is higher or equal to the ratio of the accounting consolidated group to which it belongs. In such case, the company should deduct up to 75% of the net financial expenses not deductible under the previous mechanism (i.e. the financial expenses exceeding the higher of 30% of the "fiscal EBITDA" or €3 million).

The portion of financial expenses not deductible in an fiscal year would be considered a deemed distribution and, thus, a tax could be withheld by the paying company depending on the tax residence of the beneficiary.

In the case where the company is part of a tax consolidated group, the new rules would be applied only at the tax group level.

Finally, the portion of financial expenses not deductible in an fiscal year would be carried forward indefinitely within abovementioned limits, and the portion of deduction capacity not used in an fiscal year would be carried forward over the next five years.

These new French interest deductibility limitation rules would enter into force for fiscal years beginning January 1, 2019.