Intra-group interest rate in line with market rate…

The problem is the proof!   As the rulings are published, we are gradually seeing the emergence of a methodology for establishing proof of an arm’s length rate, providing a degree of visibility and legal and tax certainty in an area hitherto systematically challenged by the tax authorities.  

• The principle: tax rate or market rate

The deduction of interest paid by a company subject to corporation tax to its shareholders or affiliates is limited to the reference rate for shareholders’ current accounts (article 39.1-3° of the French General Tax Code (“CGI”)), or to the market rate if this is higher (article 212.1.a. of the CGI). As a reminder, the reference rate for current shareholder accounts corresponds to the average effective rate charged by credit institutions and finance companies for variable-rate business loans with an initial term of more than two years.  

• The borrowing company bears the burden of proof

In the event of a tax audit, if the interest paid exceeds that calculated on the basis of the maximum reference rate (“fiscal” rate), the French borrowing company bears the burden of proof, which it can provide by any means. The borrowing company must provide proof of the normal nature of the interest rate applied, based on the rate it could have obtained from independent financial institutions under similar conditions. This is the rate that such an institution would have granted, taking into account its specific characteristics, in particular its risk profile.  

• An initially very restrictive approach by the tax authorities

In the face of an initially very restrictive approach to the types of evidence considered admissible by the tax authorities, which would only admit a bank loan offer contemporaneous with the intra-group loan, case law is providing the taxpayer with ever greater flexibility, by admitting types of evidence refused by the authorities in the course of their audits.  

• Methods of proof accepted by jurisprudence after being rejected by tax authorities during audits

The Conseil d’Etat has already ruled that the following may constitute evidence: – Comparison with rates applied on the bond markets by third-party companies in comparable economic conditions (CE July 10, 2019, n°429426 ; CE December 10, 2020, n°428522); – Use of the Riskcalc software developed by the Moody’s rating agency (CE December 11, 2020, n°433723 ; CE December 22, 2022, no. 446669); – The possibility of relying on the rates of bank loans granted under arm’s length conditions, by companies in the non-financial sector, which have obtained credit ratings close to that which can be determined for the borrowing company (CE December 29, 2021, no. 441357). In a decision dated April 5, 2024 (CE, 8è et 3è ch., April 5, 2024, n°471139, SAS GEII Rivoli Holding), the Conseil d’Etat once again censured an overly restrictive approach to the ways in which the taxpayer can demonstrate that the interest rate applied to the intra-group loan complies with the arm’s length principle. The Conseil clarifies the methods used to determine the market rate, and in particular the use of bond market data. In this case, a company belonging to a group benefited from a current account contribution from its parent company in order to acquire a building, at an interest rate of 5.08%. Following an audit of the accounts for the 2013 and 2014 financial years, the tax authorities questioned the deductibility of the interest paid to the parent company on the grounds that it exceeded the “fiscal” rate set at 2.79% (the rate stipulated in article 39.1-3° of the French General Tax Code). After the Paris Administrative Court and Court of Appeal rejected the request for discharge of the additional corporate income tax, the company appealed to the Conseil d’Etat. Ruling 1: The Conseil d’Etat confirms the need to take into account a borrowing company’s sector of activity when establishing its credit rating. In this case, the borrowing company had produced a risk rating based on the Riskcalc software, without entering the company’s sector of activity in the tool. For this reason, the Conseil rejected the rating as inconclusive, since it did not take into account the company’s particular economic situation. 2nd contribution of the decision: contrary to what had been held by the Court of Appeal, the Conseil d’Etat indicates that the loan whose rate is under review must be taken into account to establish the company’s credit rating (in which it participates). Ruling 3: a comparison based on the bond market rates of larger companies is allowed.To justify that the 5.08% rate paid to its parent company was an arm’s length rate, the company relied on bond market data from the Standard Poor’s Capital IQ financial database, which gave a rate of 5.21%. The Court of Appeal rejected this rate, considering that it concerned larger real estate companies already present on the bond market, and that the company had not demonstrated that a bond loan would have been a realistic alternative to an intra-group loan. The Conseil d’Etat refutes this analysis, ruling that: – the size of a company is not in itself an obstacle to accessing the bond market; – the realistic nature, for a company taking out an intra-group loan, of the alternative hypothesis of a bond loan can only be assessed in the light of the specific characteristics of the company and the transaction; – the rates observed on the bond market must, where appropriate, be adjusted to take account of the specific characteristics of the company. 4th contribution of the decision: the Conseil d’Etat accepts the use of a public database (rate curves) without identifying a specific comparable. The administrative court of appeal had rejected the use of yield curves published by Standard Poor’s Capital IQ to establish an arm’s length interval, on the grounds that the company had not provided a specific comparable whose relevance the court could have assessed. The Conseil d’Etat found that the company had erred in law, and ruled that the arm’s length rate put forward by the company as corresponding to its level of risk, based on the use of rate curves established on the basis of all transactions recorded, for loans of the same duration taken out by companies with the same risk profile, taken from bond market data in a financial database, was likely to constitute a relevant comparable, even in the absence of any reference to rates granted to a precisely identified company.