Tax Accounting Insights

22/01/20

Tax eAlerte

Tax Accounting Considerations on the French Finance Act for 2020 and follow-up of Finance Act for 2019

At a glance

The French Parliament on December 19, 2019 approved the Finance Act for 2020 (the Finance Act), which was published in the French legal gazette on December 29.

The Finance Act postpones, for large companies, the scheduled reduction of the corporate income tax rates and includes EU-compliant measures like the transposition into French law Articles 9, 9 bis, and 9 ter of EU anti-tax-avoidance directive 2016/1164 dated July 12, 2016 (ATAD I) as modified by EU directive 2017/952 dated May 29, 2017 (ATAD II).

Most of the measures apply for tax years beginning on or after January 1, 2020, and impact multinational enterprises (MNEs) with French operations or subsidiaries. However, the changes in corporate income tax rates brings tax accounting impacts for the 2019 year-end closing.

This “In Brief” also includes follow-ups of the Finance Act for 2019 provisions and their tax accounting consequences for 2019 year-end closing, especially regarding the interest deduction limitation mechanism (so called “ATAD I”).

Finance Act for 2020

Finance Act for 2020 Provision: Corporate Income Tax Rate Reduction Change

The Finance Act postpones, with respect to large companies only, the French corporate income tax rate reduction originally enacted as part of the 2018 French budget. For tax years beginning on or after January 1, 2020 and until December 31, 2020, French companies with revenues of EUR 250M or higher will not benefit from the general 28% reduced corporate tax rate but will be subject to a 31% rate for the portion of taxable income exceeding EUR 500,000 (28% below such threshold).

For tax years beginning on or after January 1, 2021 and until December 31, 2021, French companies with revenues of EUR 250M or higher will be subject to a 27.5% rate. No changes apply with respect to the scheduled rate reduction to 25% for tax years beginning on or after January 1, 2022 for all companies.

For companies with revenues not exceeding EUR 250M, the scheduled progressive corporate tax rate reductions remain unchanged over these tax years.

Note that there is a 3.3% surtax on the amount of CIT in excess of EUR 763K.

Tax Accounting Impact

Deferred tax assets and liabilities are measured at the tax rates that are expected to apply when the asset is realized or the liability is settled. The tax rates are based on laws that have been enacted (or substantively enacted, from an IFRS perspective) by the balance sheet date.

The Finance Act for 2020 was enacted on December 29, 2019 (December 28, 2019 in IFRS) therefore before the period-end date for companies closing on a calendar year basis. In practical terms, this new regulation impacts:

  • Only companies (or French tax groups) with a revenue exceeding EUR 250M ;
  • Only temporary differences expected to reverse in 2020 and 2021 will need to be adjusted.
  • No impact in the Current Income Tax Provision for 2019 (change in rate for 2019 was already enacted on July, 2019)

Note that, as always, any change in the reversal schedule compared to last year schedule will consequently result in a tax rate change effect.

Technical Ref. :

  • IFRS : IAS 12 paragraph 47
  • US GAAP : ASC 740-10-30-8

Finance Act for 2020 Provision: ATAD II regulation on hybrid financing arrangements

The Finance Act transposes ATAD II into French law under new Articles 205 B, C, and D of the French Tax Code essentially focusing on avoiding and neutralizing any effects of double deductions, imported mismatches and deduction without inclusion situations.

The new rules apply not only to interest but to any other types of payments. These Finance Act provisions would apply to tax years beginning on or after January 1, 2020, apart from the reverse hybrid provisions, which would apply to tax years beginning on or after January 1, 2022.

Tax Accounting Impact

For 2019 year-end closing, no impact is expected as the new provisions applies for tax years beginning on or after January 1, 2020.

For future closing, thorough analysis might be necessary to ensure that the deduction for CIT purposes of payments arising from group international flows and structure might not be questioned by the French Tax Authority.

Uncertain tax position recording to be considered upon completion of this analysis, should the “more-likely-than not” test be met.

Technical Ref. :

  • IFRS : IFRIC 23
  • US GAAP : ASC Section 740-10-25

Follow-up on Finance Act for 2019

Follow-up of Finance Act for 2019 Provision: Net financial expenses deduction limitation (ATAD I)

The deductibility of net financial expenses for CIT purposes regarding to (i) non related-party debt and (ii) related-party debt that does not exceed 1.5 times the entity’s equity is now limited to either EUR 3M or 30% of the entity’s ‘tax’ EBITDA, whichever is higher.

Note that the ‘tax’ EBITDA defined by the new law is different from the notion of EBITDA used for financial reporting purposes.

Under the new law, net financial expenses notably take into account related and third-party interest, foreign exchange losses on financings, interest paid on hedging contracts, guarantee fees, debt-related costs, and generally any type of cost or income that is equivalent to interest.

For entities (or French tax group) being part of a group that files eligible consolidated financial statements, a safe-harbor provision allows an additional deduction equal to 75% of the net financial expenses not deducted pursuant to the above limitation.  Thus, the entity’s equity-to-assets ratio must remain equal to or higher than the equity-to-assets ratio of the consolidated group to which the tested entity belongs. However, this safe-harbor is not available to thinly capitalized entities (see below).

Thin capitalization rule: if the tested entity’s (tax group’s) debt-to-equity ratio exceeds 1.5-to-1, the amount of related-party interest incurred in connection with related-party debt exceeding 1.5 times the entity’s equity will be deductible up to either EUR 1M or 10% of the entity’s ‘tax’ EBITDA, whichever is higher. If an entity is over-leveraged, it will be able to rely on a specific safe-harbor if its debt-to-equity ratio is lower than that of the consolidated group to which it belongs.

Financial expenses that are not deducted according to the rules above now can be carryforward indefinitely and deducted in the future under the same conditions.  However, in case of thin capitalization, the non-deducted net financial expenses under the 10% tax EBITDA limit will only be eligible for carryforward for one third of its amount.

The unused interest deduction capacity of a current tax year can be used over the following five tax years, but only against financial expenses incurred in those tax years.  This measure is not available to thinly capitalized entities.

Interest carried forward pursuant to the previous regime (until December 31, 2018) are still available but need to apply the above rules to be deducted (30% EBITDA, thin capitalization test, etc.). Thus, previous rules are not grandfathered for those carried forward interest.

Tax Accounting Impact

Financial expenses not deducted according to these rules now can be carried forward indefinitely. They generate a new deductible temporary difference and thus a deferred tax asset, to be measured with the appropriate rate (see above). This is new as the previous interest limitation mechanism caused the disallowed financial expenses deduction to be lost (permanent difference).

The recognition/valuation allowance assessment for this deferred tax asset should consider both:

  • The ability of the entity (tax group) to generate enough Tax EBITDA to allow the deduction of (i) the current year interest expense firstly and then (ii) any interest carried forward from previous years;
  • Any taxable temporary difference, but only those impacting the Tax EBITDA.

The unused interest deduction capacity (if 30% or 10% Tax EBITDA > current year net financial expense and interest carried forward if any) can be used over the following five tax years, but only against net financial expenses incurred in those tax years. This unused interest deduction capacity does not meet the definition of a temporary difference as it is only an used deduction capacity, that will never exceeds the amount of financial expenses (no excess deduction).

Technical Ref. :

  • IFRS : IAS 12 paragraph 5 (b)
  • US GAAP : ASC 740-10-20

Follow-up of Finance Act for 2019 Provision: New patent box regime

The new patent box regime applies to tax years beginning on or after January 1, 2019.

Prior to enactment of the Finance Act for 2019, income and gains from patents and assimilated IP rights - including gain from the disposal of eligible patents - benefited from a reduced 15% tax rate for entities subject to corporate income tax.  Under the rule enacted in Finance Bill for 2019 (end of December 2018), the preferential corporate tax rate decreases to 10%.

Other considerations apply (nexus ratio, documentation, etc.) but not relevant in terms of Tax Accounting.

Tax Accounting Impact

If a company acquired a French business and recognized eligible patents as intangible assets (because they qualified for identifiable assets) in its consolidated financial statements, the taxable temporary difference arising from this recognition would be measured using the new 10% rate.

Analysis of the election criteria to the privileged patents regime might be necessary to ensure that the reduced rate applies.

Technical Ref. :

  • IFRS : IAS 12 paragraph 47 and IFRS 3 paragraph 10
  • US GAAP : ASC 740-10-30-8 and ASC 805

Contacts

François Roux

Directeur, Paris / Neuilly-sur-Seine, PwC Société d'Avocats

Email

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