In a recently published decision of 11 March 2005 (SA Guerlain, No. 01PA01206), the Court of Appeals of Paris held that the debt waivers granted by a French parent company to two branches of its 99.9%-owned Hong Kong subsidiary constituted a transfer of profits under Art. 57 of the French Tax Code (Code Général des Impôts (CGI)). The details of the decision are summarized below.
(a) Background. Under Art. 57 of the French Tax Code (CGI), the tax administration may add back to the taxable income of French companies, or branches of foreign companies, profits indirectly transferred to related companies or head offices abroad (Art. 57 CGI). This arm's length rule applies to profits transferred to: "foreign enterprises controlled by the French enterprise, or which control the latter ... or which are controlled by an enterprise or group which has control over the enterprise outside France". The provision is thus broad enough to cover virtually any transfer within a related group of companies or branches. Transfers of profits include, amongst others, interest free loans, or loans at abnormally high or low rates of interest and any other means.
(b) Facts. The French company SA Guerlain granted in 1990 and in 1991 two debts waivers, each to the Australian and Singapore branches of its 99.9%-owned subsidiary located in Hong Kong. The tax administration considered that the debt waivers constituted an abnormal transfer of profits and as result, added back to the taxable income of the French company, the amount of debt waivers. The company brought the case before the Lower Administrative Court of Paris, which accepted the claim of the taxpayer on 28 November 2000 and considered that such debt waivers did not to constitute a transfer of profits within the meaning of Art. 57 of the CGI. The tax administration appealed to the Court of Appeals, which overturned the earlier decision from the Lower Court.
(c) Issue. The issue was to determine whether or not such debt waivers directly granted by the French parent company of a 99.9%-owned Hong Kong subsidiary to two branches of that subsidiary constituted an abnormal transfer of profits under Art. 57 CGI.
(d) Decision. The Court of Appeals held that the debt waivers were justified by the financial difficulties encountered by the two branches, and by a strategic interest for the French parent company. However, the consolidated accounts of the Hong Kong subsidiary, including the financial results of the two branches, showed a positive financial result in 1990 and 1991, so that the subsidiary was able to distribute substantial dividends to the French parent company. As a result, the Court concluded that the debt waivers were abnormal and constituted an indirect transfer of profits under Art. 57 CGI.
Hence, the Court refused to take into account the respective financial situation of the branches but adopted a global approach by determining the abnormal character of such debt waivers at the subsidiary level, even if the subsidiary was not the direct shareholder.
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