French rule denying tax deferral on merger is contrary to EU law, court rules

by JP Canavan

The Court of Justice of the European Union (CJEU) delivered its highly anticipated decision in the Euro Park Service case (C-14/16) on March 8, further defining the limits of EU Member States’ ability to restrict tax deferral benefits on mergers, reorganisations, and similar transactions.

The judgement stems from a preliminary ruling referred to the CJEU from the French Supreme Administrative Court in January 2016 regarding Directive 90/434/EEC on a common system of taxation applicable to mergers, divisions, transfers of assets, and exchanges of shares concerning companies of different Member States (EU Merger Directive), as amended.

The case centred on the French tax authority’s refusal to defer French capital gains tax on the merger by acquisition of a French company (Cairnbulg) with a Luxembourg company (Euro Park).

The refusal was based on the grounds that the companies involved had not sought advance approval from the French tax authority prior to the merger and, had approval been sought, it would not have been granted as the taxpayer was unable to show that the transaction was for commercial reasons and not for the purposes of tax evasion or avoidance.

EU Merger Directive

The main objective of the EU Merger Directive is to remove fiscal obstacles, namely negative tax consequences, to cross border group reorganisations involving companies situated in two or more EU Member States.

Where a company transfers its assets and liabilities to one or more receiving companies situated in another EU Member State, the Directive provides for the deferral of income or capital gains taxes related to the transferred assets.

However, Article 11(1)(a) of the Directive provides a Member State may deny or withdraw the benefits of the Directive if one of the principal objectives of the transaction is the avoidance or evasion of tax.

When incorporating the Directive’s principles into national legislation, some Member States have added complex tax rules and requirements for the benefits of the Directive to be conferred.

The French tax provisions transposing the Directive require a taxpayer to obtain prior approval for a merger for the taxpayer to benefit from tax deferral.

In particular, where a merger involves a non-French entity there must be demonstrable commercial grounds for the merger and the principle objective, or one of the principle objectives, must not be the avoidance or evasion of tax. In contrast, where a merger takes place between French resident entities, there is no requirement to meet the above criteria.

Euro Park Service case

In the instant case, following the merger, the companies sought to rely upon the French tax provisions which transposed the EU Merger Directive, to defer any net capital gains relating to transferred French assets to the now Luxembourg shareholder.

The French tax authority challenged the applicability of the Directive’s provision as Cairnbulg did not report its net capital gains and profits relating to the assets transferred to Euro Park, to the French tax authority prior to the merger.

The CJEU held that although the Merger Directive provides that EU Member States may deny the benefits provided for in the Directive, denial based on the taxpayer failing to seek prior approval of the merger was contrary to EU law. According to the Court, the derogation from providing such benefits can only apply in cases where the merger has as its principal or one of its main objectives the purpose of evading or avoiding tax.

The presumption of evasion or avoidance can only be restrictively applied where the merger has no valid commercial reasoning. Furthermore, where the benefits are to be denied, taxpayers should be provided with the basis for refusal and be given the opportunity to appeal this reasoning before a competent authority.

Tax avoidance

The CJEU concluded that the derogation of Article 11(1)(a) of the EU Merger Directive allowing a Member State to deny the benefits afforded within the Directive must be interpreted and applied restrictively.

Thus, where a Member State seeks to deny the benefits there should be prima facie reasoning that the main purpose, or one of the main purposes, of the merger is the avoidance or evasion of tax and there are no valid commercial reasons based on the merits of the scenario presented.

Only where this has been shown, can a Member State view the relevant transaction as one that can fall within the remit of Article 11(1)(a) of the Directive.

In the short term, EU cross border corporate restructuring may be more widely applied now that the CJEU has confirmed the potential invalidity of certain domestic attaching conditions EU Member States have pinned on to their domestic transpositions of the Directive.

However, this invariably creates a period of uncertainty for groups as to the identification of those potentially ‘invalid’ attachments.

JP Canavan

JP advises on international direct tax matters. He has particular experience with pre-sale restructuring, international corporate structuring, intellectual property planning, transfer pricing, foreign direct investment proposals, tax treaties, and withholding taxes.

His experience includes work in various sectors, such as FinTech, renewable energy, media, e-commerce, technology, and pharma industries. He has significant experience in import/export and acquisition/dispatch of goods, statistical reporting, customs procedures and e-commerce services.

JP previously specialised in Irish and EU VAT within a Big Four practice, working with a wide range of clients in various industries.

JP Canavan

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