This article was first published on Tax@Hand, and is reproduced on this blog with the authorization of its authors.
Further to its July 2022 decision that the add-back of a 5% lump sum on dividends that are tax-exempt under the French participation exemption regime should be treated as a tax paid on part of the dividends, the Administrative Supreme Court (Conseil d’Etat) on 7 April 2023 confirmed how to calculate the amount of foreign tax credit which may be offset against the lump sum (Conseil d’Etat, 7 April 2023, n°462709).
Background
According to French law, dividends eligible for the participation exemption regime are tax-exempt, with the exception of a lump sum to be added back to the taxable result (up to 1% or 5% of the gross dividends received, depending on the facts).
In its July 2022 decision, the Conseil d’Etat canceled French Tax Administration (FTA) guidelines that stated that the add-back of a 5% lump sum on dividends that are tax-exempt under the participation exemption regime could not be treated as a tax paid on part of the dividends, thus denying the use of foreign tax credits to offset the add-back. The Conseil d’Etat ruled that the purpose of the add-back is to neutralize the deduction of expenses incurred by the taxpayer in obtaining the dividend income (i.e., the costs associated with acquiring and retaining the participations from which the dividends are derived), but also to subject to corporate income tax (CIT) a portion of the dividends when those expenses are lower than the lump sum add-back (Conseil d’Etat, 5 July 2022, n°463021).
The question of what portion of the 5% lump sum add-back on dividends should be treated as tax against which foreign tax credit could be offset remained unanswered by the judgement. It was not clear whether the foreign tax credit could be offset against the full amount of the add-back or only the portion exceeding the expenses actually incurred by the taxpayer in obtaining the dividend income.
Facts of the case
A French parent entity received from its Italian subsidiary dividends eligible for the participation exemption regime. As such, the dividends were exempt from corporate income tax in France, and only a 5% lump sum was added back to the French company’s taxable result. The entity decided to offset the foreign tax credits corresponding to the Italian withholding tax imposed on those dividends against its French CIT liability.
The FTA challenged the use of the foreign tax credits to offset the entity’s CIT liability based on its position as stated in its administrative guidelines (BOI-IS-BASE-10-10-20) that the lump sum add-back could not be regarded as a tax on the dividends but simply a means to neutralize the expenses incurred in relation to the tax-exempt dividends. The Conseil d’Etat canceled the relevant section of the guidelines in its July 2022 ruling.
Decision of the Conseil d’Etat
In settling the dispute, the Conseil d’Etat initially provided a recap of its earlier decision that the add-back on dividends:
- Is a lump sum that is not limited to the actual amount of expenses effectively incurred by the taxpayer in obtaining the dividend income; and
- Has a hybrid nature: (i) to neutralize the deduction of expenses incurred by the taxpayer in obtaining the dividend income and (ii) to tax a portion of dividends if the actual expenses are less than the lump sum.
Consequently, the court ruled that when the amount of expenses effectively incurred by the taxpayer in obtaining the dividend income is less than the 5% add-back, the foreign tax credit corresponding to the withholding tax on dividends that may be offset against the French CIT liability is calculated as:
CIT rate x (add-back on dividends – expenses incurred in obtaining the dividend income).
In the case at hand, the Conseil d’Etat ruled that the administrative court of appeal’s decision was invalid as the court had not verified whether the amount of the add-back on dividends was higher than the expenses effectively incurred in obtaining the dividend income. On that basis, the Conseil d’Etat referred the case back to the administrative court of appeal for a new review.
Potential implications of the decision
French companies that did not claim foreign tax credits to offset the tax imposed on the portion of foreign dividends eligible for the participation exemption regime where the amount of the add-back on dividends was higher than the expenses effectively incurred in obtaining the dividend income, may be entitled to claim a refund of CIT based on the Conseil d’Etat’s decision. Due to the statute of limitations, claims may be filed for dividends received in fiscal year 2020 and subsequent years only, with claims for 2020 being filed with the FTA before 31 December 2023.
