Transfer Pricing News Issue 32 - December 2019

Intra-group loans rates: French Administrative Supreme Court ends tax uncertainty

Since 1984, French banks have had a monopoly on credit transactions which may be carried out only by approved credit institutions and finance companies[1]. Thus, as a principle, only banks and other regulated financial institutions are authorised to grant loans. However, that banking monopoly is softened by several exceptions, notably the one allowing companies with direct or indirect capital ties to perform intra-group credit transactions. A parent company can therefore grant loans to its subsidiary or sub-subsidiary and vice versa, to fund its investments or working capital without resorting to financing on the bond or banking markets[2].

During the period covering 2007-2008, the French Central Bank noted firstly, an increase of the credit demand from companies with rising credit cost even for average credit risk[3], and secondly a fall in banking credit demand (-70%) due to rising interest rates[4]. As a result, a great majority of MNE groups took massive recourse to intra-group financing - more interesting than bank loans - as part of a cash pooling agreement or conventional loan agreements.

Nevertheless, following the Financial Crisis of 2008, France (in common with many other countries) implemented economic policies aimed at lowering interest rates on the market to facilitate businesses’ access to funding credit, to boost the economy. Regarding this general decrease of interest rates on the market - in which certain intra-group situations are likely to be disproportionate - the French Tax Authorities (FTA) considerably tightened their audits, focusing on intra-group interest rates and the justification of the arm’s length nature of these rates.

Ever since, intra-group interest rates are systematically questioned by the FTA. In the presence of potential negative interest rates on the market, the FTA can easily challenge applied intra-group rates. As part of these audits, the strategy pursued by the FTA is simple: as a first step, it is meant to take advantage of the legal interest rate[5], referring to the annual average statutory interest rates charged by banks. Facing the very low market interest rates, the burden of proof shifts, and it is therefore incumbent on the audited companies to justify the arm’s length nature of the higher intra-group interest rate[6].

The French Tax Authorities’ excesses?

The FTA not only systematised audits in the presence of intra-group financing, it also required the production of a contemporaneous and firm offer from banks for similar loans as the only means of evidence to justify the rate relevancy. Consequently, the FTA brushes aside the studies produced by audited taxpayers.  

This dogmatic and restrictive position of the FTA was inconsistent for several reasons. First of all, while intra-group financing also responds to a business-specific need for speed, that position entailed that for each intra-group loan agreement there had to be a contemporary loan offer.

However, the realisation of such offers requires significant work in terms of time and costs for the banks in order to highlight the economic and financial reality of the loan. 

Secondly, the huge amount of work required by this type of request would dissuade the bank from responding favourably to such a request, given that the offer required would only be used in the context of a tax audit. Thus, the audited companies could not cope with the FTA injunctions and were likely to face huge tax reassessments.

A pragmatic official opinion from the French Administrative Supreme Court

In this situation, the French Administrative Supreme Court’s (FASC) highly anticipated Opinion puts an end to tax uncertainty. Indeed, the lower administrative courts disagreed on the proof that could be produced by audited companies. Some jurisdictions endorsed the FTA’s reasoning in the requirement for banks’ firm loan offers[7], while others supported the freedom of proof, admitting that the relevance of the intra-group interest rates charged could be demonstrate by detailed studies[8].

In the face of the divergences, the Administrative Court of Versailles stayed the proceedings and sent a request for an Opinion to the FASC. In its Opinion issued on 10 July 2019, the FASC states as a principle that the intra-group interest rate relevance can be demonstrated by any means. Then, it definitively accepted bond market references (external benchmarks) to justify intra-group arm’s length rates, and rejected the taxpayer’s obligation to provide FTA with contemporary bank loan offers to do so (CE Avis, 10 July 2019, No. 429426, SAS Wheelabrator Group).

Ultimately, although an FASC Opinion has, in principle, only an advisory scope as opposed to a Court ruling, the Administrative Court of Versailles which will rule on the case as court of first instance, would be well advised to follow the pragmatic reasoning led by the French Administrative Supreme Court.

Material implications

Further to the FASC Opinion, it is important to note that the production of bond market references must be relevant, i.e. only bond references comparable to the questioned intra-group loans would be acceptable. In this respect, searches for comparable bond references must be conducted following a three-step process:

  1. The borrower’s credit risk profile should be estimated by determining its own rating (i.e. not the Group’s rating) by means of the assessment systems developed by the big rating agencies;
  2. The search for comparable bond references: Based on the rating obtained, a search for comparable bond financing tools should be carried out taking into account comparability criteria such as amount, issue date, subordination, currency, priority/subordination etc.;
  3. An arm’s length interquartile range must be determined, based on the rates obtained from comparable bond financing tools in order to set the scope of relevancy.

According to the OECD Guidelines, because transfer pricing is not an exact science, it will not always be possible to determine the single correct arm’s length price[9]. Hence, it should be emphasised that the ultimate goal of a transfer pricing study is not to set the exact interest rate that could have been applied between unrelated parties, but an arm’s length interquartile range of rates.     

Sabine Sardou

[1] Article L.511-5 of the French Monetary and Financial Code

[2] Article L.511-7, I, 3 of the French Monetary and Financial Code

[3] Banque de France, 2007 Annual Report, p. 42-43

[4] Banque de France, 2008 Annual Report, p. 27-28

[5] Article 39-1,3° of the French Tax Code

[6] Article 212-I, a of the French Tax Code

[7] TA Paris, January 30th 2018, No. 1707553, SAS Studialis; CAA Paris, December 31st, 2018 n°17PA03018, Société WB Ambassador

[8] TA Montreuil, March 30th 2017 No. 1506904, BSA

[9] Cf. OECD Guidelines, §3.48