CJEU rules former French tax consolidation scheme infringes freedom of establishment

This article was first published on Tax@Hand, and is reproduced on this blog with the authorization of its authors.

On 11 May 2023, the Court of Justice of the European Union (CJEU) issued its judgment in joined cases C-407/22 and C-408/22, concerning the reimbursement of French corporation tax in respect of dividend income received from subsidiaries established in European Union (EU) member states other than France. The CJEU held that French legislation providing a dividend exemption only for a French resident parent company that has opted for tax integration with French resident subsidiaries infringed the EU principle of freedom of establishment. Although the CJEU’s decision related to the application of the former French tax consolidation rules, it remains relevant to the present legislation.

Background

Under French law, dividends eligible for the domestic participation exemption regime are 95% tax exempt. The remaining 5% is deemed to represent nondeductible costs relating to the exempt dividends and is added back to the taxable result, to be taxed at the standard corporate income tax rate. The 95% exemption applies regardless of whether the dividends are received from a French subsidiary or a subsidiary in another country (whether within or outside the EU, except for noncooperative states).

For fiscal years commencing prior to 1 January 2016, the 5% lump sum add-back was “neutralized” within tax consolidated groups, by allowing the 5% deemed expense to be deducted from profits, resulting in a full exemption for intragroup dividends. Only a French parent company and its French resident 95% held subsidiaries are permitted to be members of a French tax consolidated group, hence parent companies with subsidiaries established in other EU member states could not benefit from the full exemption.

On 2 September 2015, the CJEU ruled in case C-386/14 (Groupe Steria) that the fact that deemed expenses related to dividends received from subsidiaries established in other EU member states were not eligible for the same benefit violated the freedom of establishment principle in the Treaty on the Functioning of the European Union. As a result, for fiscal years commencing on or after 1 January 2016, the lump sum add-back has been reduced to 1% (i.e., an effective 99% participation exemption) for dividends paid: 

• Within a tax consolidated group; and
• By a subsidiary located in an EU or European Economic Area member state that would meet the conditions required to belong to a tax consolidated group if it were located in France.

In the case at hand, two taxpayers established in France received dividend income from subsidiaries located in another EU member state in 2011 and 2012, respectively. According to French tax law, they were allowed to deduct the dividend income received from their net profit, except for the 5% lump sum add-back representing costs and expenses. The taxpayers requested full deduction of the dividends received from subsidiaries located in other EU member states, without reinstatement of the 5% element for expenses, on the basis of the decision in Groupe Steria. The French tax authorities rejected their claim. The taxpayers appealed to France’s Versailles administrative court of appeal, which ruled in favor of the taxpayers, stating that the French tax law violated the principle of the freedom of establishment. The Council of State of France referred the case to the CJEU for a preliminary ruling.

Decision of the CJEU

The CJEU first clarified that it had already been determined in Groupe Steria that denying the same benefit for dividends received from subsidiaries established in other EU member states as available for dividends received from French subsidiaries violated the EU’s freedom of establishment principle.

In the case at hand, the two taxpayers are not part of a tax consolidated group despite the fact that they would be eligible to be, as the necessary share capital ownership links exist between the taxpayers and other resident companies in France. However, the taxpayers could only form a tax consolidated group with French resident companies and not with their subsidiaries established in other EU member states. Hence, a parent company with subsidiaries in France could always benefit from the neutralization of the 5% add-back, while it could not enjoy the same tax advantage for dividend income received from subsidiaries in other EU member states, unless it was previously part of a tax consolidated group with resident companies. The explanation for this is that following the amendments to French tax law in light of the Groupe Steria decision that allow a French company to benefit from an effective 99% exemption for dividends received from an EU subsidiary, provided the French resident company is itself part of a tax consolidated group with resident companies, the French tax authorities maintained the same position when applying the pre-Groupe Steria legislation. In the case at hand, the taxpayers could have opted for the tax consolidation regime with their resident subsidiaries but chose not to do so, and the French tax authorities consequently denied them the benefit of the neutralization of the 5% add-back on dividends received from their EU subsidiaries. The CJEU determined that this difference in treatment results in the exclusion of a parent company that is not part of a tax consolidated group and owns a subsidiary in another EU member state from the tax advantage of neutralization.

In order for a difference in treatment to be compatible with the freedom of establishment, it must either relate to situations which are not objectively comparable or be justified by an overriding reason in the public interest. The CJEU ruled that the neutralization of the 5% add-back should apply to a French parent company regardless of whether it is part of a French tax consolidated group, since the parent company incurs the costs and expenses associated with its ownership of the subsidiary. In this context, the mere fact that a resident parent company does not opt for the tax consolidation regime with regard to its resident subsidiaries, even though it would be eligible to do so, cannot lead to the conclusion that the parent company does not wish to form such a group or to benefit from a tax integration scheme with its nonresident subsidiaries. Hence, the situation of a resident parent company wishing to form a tax consolidated group with a resident subsidiary and the situation of a resident parent company wishing to form a group with a nonresident subsidiary are objectively comparable insofar as each seeks to benefit from the preferential tax treatment for dividends. Therefore, the French rules that lead to refusal of neutralization to a resident company on the basis that it has not opted for tax consolidation with its resident subsidiaries, constitute an unjustified restriction of EU law.