Is the French tax treatment of LBOs still attractive?

The acquisition of shareholdings in French companies is impacted by tax increases included in the Finance Act for 2012 and the 4th Amended Finance Act for 2011, which were recently voted and came into force as of January 1st, 2012.
However, some of these new measures are (already!) due to be modified by the Draft 1st Amended Finance Act for 2012.

Increase of transfer duties

Prior to January 1st, 2012, the acquisition of shares in French joint-stock companies (sociétés anonymes and sociétés par actions simplifiées) was subject to a 3% transfer duty, capped at € 5,000 per transaction.

The Finance Act for 2012 cancelled the €5,000 cap, and introduced the following new rates:
(i) 3% on the portion of the price below € 200,000;
(ii) 0.5% on the portion of the price between € 200,000 and € 500,000,000;
(iii) 0.25% on the portion of the price exceeding € 500,000,000.

The transfer tax applies to transactions concerning unlisted shares, and listed shares if a transfer deed is executed (i.e. essentially OTC transactions).

This reform obviously results in significantly higher acquisition costs. For instance, the acquisition of shares for a price of € 50,000,000 is now subject to a € 255,000 transfer tax (compared with € 5,000 until December 31st, 2011).

The reform also introduces transfer tax exemptions for (i) buy-backs of shares by the issuing company, (ii) acquisitions of shares in companies subject to a safeguard or insolvency procedure, (iii) transfers of shares within a tax consolidated group, and (iv) share-for-share exchanges resulting from eligible mergers or spin-offs.

This new tax treatment applies to transfers of shares which are registered since January 1st, 2012. However, amendments are (already!) expected in connection with the Draft 1st Amended Finance Bill for 2012, which is currently examined by the French Parliament.

This Bill creates a new 0.1% tax which would apply to financial transactions (a “Tobin tax”), i.e. essentially transfers of listed shares in large French companies. In connection with this new tax, the Government proposed to modify again the above transfer tax rates in order to limit the overall increase of transfer taxes.

According to the Bill’s current status, the transfer tax rates (not including the new “Tobin tax”) would become as follows as from August 1st, 2012:
(i) 0.65% on the portion of the price below € 200,000;
(ii) 0.4% on the portion of the price between € 200,000 and € 500,000,000;
(iii) 0.15% on the portion of the price exceeding € 500,000,000.

However, as this Bill remains to be discussed in the Parliament, new changes cannot be excluded until the final vote (i.e. probably not before mid-March). Until then, investors and groups involved in proposed acquisitions or restructurings in 2012 will have to face major uncertainties as to what the final tax cost of their operations will be.

Limitation of tax deductibility of interest expenses

The 4th Amended Finance Act for 2011 limits the deduction of interest and other financing expenses connected with the purchase of shareholdings by French companies which are considered as not having enough substance in France.

Until 2011, French holding companies benefitted from a very competitive tax treatment, thanks to (i) the 95% tax exemption of dividends from shareholdings which are eligible for the participation exemption regime (i.e. generally shareholdings of 5% or more of the share capital held for at least 2 years), (ii) the 90% tax exemption of capital gains on the disposal of said shareholdings, (iii) the tax consolidation of gains and losses realized by the holding company and its 95% subsidiaries, (iv) the full deduction of financing expenses (subject to thin capitalization rules), and (v) the unlimited carry-forward of losses.

As from January 1st, 2012, a portion of interest and financing expenses incurred in connection with the acquisition of eligible shareholdings (as defined above) is not deductible when the French acquiring company cannot demonstrate that (i) the decisions relating to such shareholdings are “effectively” made by itself (or by a French related company), and (ii) the control or influence over the acquired company is also exercised by itself or a French related company.

The portion of non-deductible expenses is determined by applying to the overall financing expenses of the acquiring company the ratio between the acquisition price of the shareholding and the average indebtedness of the acquiring company.
This recapture applies over a 9-year period starting on the year of acquisition, which means that it may impact financing expenses incurred in connection with acquisitions realized in 2004 and later.

The limitations do not apply where (i) the total value of the shareholdings is less than € 1,000,000, (ii) the acquisition is not financed through a loan incurred by the acquiring company or by a related company, or (iii) the acquiring company’s debt-to-equity ratio is lower than the group’s debt-to-equity ratio.

Even though the French tax treatment of acquisitions remains competitive, it is made less favorable by these new provisions, combined with other adverse rules enacted in 2011 such as the extension of thin capitalization rules to third-party loans guaranteed by related companies, and the limitation of losses that may be carried forward (to €1,000,000 + 60% of the current year’s taxable profits).

Specific attention will therefore have to be paid to the acquisition structure for international groups and foreign private-equity investment funds willing to perform leveraged acquisitions in France.

In practice, ensuring that “the decisions relating to such shareholdings” are “effectively” made in France and whether “the control or influence over the acquired company” is “effectively” exercised in France might prove difficult, as neither the scope or nature of the concerned “decisions” are defined by the new provisions.

The preamble of the 4th Amended Finance Act for 2011 only indicates that the acquiring company will have to demonstrate, based on an analysis of facts, decisions processes and organizational charts, that it is, as far as the management of the shareholding is concerned, an autonomous decision center, by reference to the same criteria as those applicable to permanent establishments.

The administrative guidelines commenting on the new rules will hopefully provide more details. It should also be outlined that the compatibility of these new provisions with the freedom of establishment required by the EU treaties is questionable – but that this question will eventually have to be raised before the courts, and will therefore only be answered in several years.

In the meantime, international groups or foreign private-equity investments funds willing to make equity investments through a leveraged French holding company should carefully structure the acquisition so as to ascertain that:

- the acquiring company’s level of substance (i.e. staff, premises, equipment, activities…) enables it to be considered as an autonomous decision center;
- the decision-making processes concerning the acquisition and the management of the shareholding are properly designed. In this regard, all limitations of the powers of the acquiring company’s managers (whether through corporate control procedures or by shareholders agreements) must be carefully analyzed;
- the relevant legal and corporate documentation (e.g. minutes of meetings, delegations of power) evidences, to the extent possible, that the key decisions regarding the shareholdings are made by the French company’s management.

By Jean-Christophe Amy, M&A lawyer, partner at de Gaulle Fleurance & Associés, Paris.