French court reaches surprising conclusions on cost plus transfer pricing method

By Terence Wilhelm, Cara Avocats, France 

 As most tax practitioners know, France always has been very imaginative when it comes to inventing taxes. Among these stands the so-called “CVAE” (literally “tax on value-added generated by the enterprises”, which differs from the value-added tax, the latter being an indirect tax) which finances regional and local authorities.

As the CVAE hits the value-added generated as part of the activities being operated, any variation of the profit or charges recorded by a company automatically yields changes in the calculation of the CVAE and to potential CVAE reassessments.

As a matter of fact, the CVAE and the corporate income tax share common items that form their base for calculation, which suggests that any change to one of these taxes will influence the magnitude of the other. No wonder then that the CVAE tax ranks as a direct collateral consequence of transfer pricing reassessments, as the latter adjustment modifies the very profitability of a company (and hence, its value-added).

French Courts so far always maintained the intrinsic bind that ties corporate income tax consequences levied as part of transfer pricing adjustment and the consequences in the field of CVAE

A recent decision, Labs France (TA Montreuil, Feb 14, 2019, n°1801945), seems to reinforce this bind and, by the same token, the double taxation that results from it, by considering that the CVAE constitutes a charge that falls within the ambit of the cost base subject to the cost plus method.  

The facts were as follows: Labs France SAS was specialised in software and IT-related services which it provided to its German parent company. This transaction was framed in a research and development service agreement that set the remuneration of the French company pursuant to an OECD-type of cost-plus method with a mark-up at 6%. The agreement at stake explicitly stated that all income taxes, including withholding tax, that would apply on the amount paid by the parent company to its affiliate pursuant to the agreement would be supported by the French company.

As part of a tax audit, the French tax administration concluded that the French company should have invoiced the CVAE to its German related entity. Failure to do so created a transfer of profit by way of non-arm’s length transfer prices, hence leading to tax reassessments under the meaning of Art. 57 of the French tax code, which reproduces the arm’s length principle.

Although this decision may still be overruled in appeal, it sheds light on various interesting and – to the best of our knowledge – genuine features of French law.

First, this decision creates an adverse technical loophole. As mentioned above, both the CVAE and the corporate income tax (which is levied as part of a transfer pricing adjustment) share common items that form their tax base.

If the CVAE must be embedded into the cost base subject to recharge, the provider’s profitability will, by the same token, increase; which in turn will increase its value-added; and in turn increase the amount of CVAE to be paid.

It is surprising that this aspect was not discussed as part of the decision.

Second, it is interesting to note that when rendering its decision, the Court did not proceed to a comparison with independent and comparable references.

As such, the Labs France decision might appear contradictory with a previous Philipps decision, where the question as to whether the tax credits received by a French company should be part of the cost base was at stake.

In the Phillips case, the Court squashed the reassessment on the ground that the French tax administration did not provide comparables searches likely to demonstrate that independent comparable companies recharge (or not) the tax credit they receive as part of their remuneration to their client (related or not).

On the opposite side, in the Labs France decision, the Court simply referred to the intercompany agreement which stated that the income tax and any withholding tax should remain with Labs France, whereas any other charge should be recharged as part of the cost plus.

In this respect, the Court, together with the assessor, reminded that the CVAE is a tax for sure, it also ranks as part of the expenses that lie on the P&L of the company. Following the intercompany agreement binding the two entities, such charges, whatever their purpose, should therefore be recharged.

 In doing so, the Court reminded us of a simple, though ancient, principle that forms the fundamentals of French law: benchmarking studies are not mandatory to demonstrate that a transfer of profit took place if a fair intercompany agreement suggests it in the first place.

Benchmarking studies are indeed deemed to be the last recourse under Article 57 of the French tax code.

Needless to say, this decision will cause turmoil in taxpayers’ calculation of cost plus. This decision also seems to enhance a very recent judicial trend which witnessed several wins by the French tax administration before the Courts and greater pressure in the way the taxpayer can defend its positions.

One may see here an effect of the BEPS, which clearly led to narrowing transfer pricing schemes which led to a transfer of profit abroad.

 At this stage, no one knows if this case will be brought before the Court of Appeal. We hope so, though, as this decision may constitute a complete game changer for all entities.

Clelie Ardellier contributed to this article.