While the valuation of unlisted shares is a classic and recurring exercise in finance, the choice of the applicable valuation method and its many variables (discounts, etc.) remains at the heart of litigation debates before the French courts.
In the context of international transactions, investors from one country may be invited to invest in securities of companies located in another country. Whilst it is best practice that the valuation exercise should reflect any country-specific requirements or nuances, often, in practice, the value of such securities is determined according to the standards established in that other country. This is the case, for example, for employees of French subsidiaries of foreign companies who save in foreign savings plans equivalent to our French company savings plan (“PEE”); as well as in the case of management packages, especially when a French employee participates in a foreign stock option plan.
In some countries, valuation rules may be subject to specific tax legislation, with well-defined rules laid down either directly by the law, or through well-established case law and/or instructions from the local tax authorities. For example, the UK valuation framework refers to over a century of jurisprudence, and the UK tax authority, HM Revenue & Customs, has a valuation division responsible for reviewing and negotiating valuation positions.
Tax Valuation of Unlisted Company Shares
In France, there are neither specific legislative texts nor detailed comments from the tax authorities on tax valuation. However, sporadic comments from the French tax administration can be mentioned, particularly regarding French qualified free shares (or Restricted Stock Units – RSUs). The French tax authorities also published a report on valuation in 2006, specific to the valuation of companies (i.e. does not concern all instruments) and not enforceable against the French tax administration.
That being said, there have been a number of tax cases in France in which valuation has been considered, in particular with respect to the types and rates of discounts that may be applied. These cases have covered income tax, real estate wealth tax and registration duties.
Subject to any questions that may arise in the context of the Conseil d’Etat decisions issued on July 13, 2021 (nos. 428506, 435452 and 437498), recent French jurisprudence calls for the following comments.
The Multi-Criteria Approach
When comparable transactions are not available or not relevant, at the very least, the French tax authorities will expect a multi-criteria approach: for example, regarding French Qualified free shares, or RSUs, the French tax authorities specify (BOI-RSA-ES-20-20-20 §140) that the multi-criteria method should be considered by taking into account the company’s specific characteristics, its net accounting position, its profitability and its business plan. The choice of methods to in the multi-criteria approach will also depend on the type of instrument used (ordinary shares, preferred shares, stock options, etc.). For example, the market practice regarding management packages tends to generally use Black-Scholes, binomial, Discounted Cash-Flow (DCF) or Monte-Carlo methods to value optional instruments (or instruments with an economic substance similar to options). A multi-criteria approach is in line with the International Valuation Standards and widely expected by tax authorities around the world.
The Discount Rate
Secondly, it is necessary to consider whether the discount rate (or rebate) applied is in line with the case law, particularly regarding the impact of an approval clause on the illiquidity discount (French Highest Court, 15 February 2023 n°20-19.451), or on a minority discount of 20% (French Highest Court, 23 November 2010 n°09-17.295). It is important to note, however, that, whilst case law and precedent can provide guidance, any discounts applied should be selected based on the specific facts and circumstances of the securities in question.
The assessment of a significant discrepancy
Finally, in practice, the French tax authorities themselves will carry out the valuation of securities and compare this value to that determined by the taxpayer. If the difference between these two values is considered significant, the taxpayer’s value will likely be questioned. Traditionally, judges consider a 20% difference to be significant. However, it should be noted, a judgment of the Conseil d’Etat of April 7, 2023 (No. 466247) held that a difference of 14.1% was “significant”, while a judgment of the CAA of Douai of June 22, 2023 (No. 21DA02705) held that a difference between 12% and 15% was not significant! The assessment by judges is therefore central to determining the challenge to the valuation.
When a valuation is questioned, the adjustment of the valuation of shares for French beneficiaries may be required. The French Administration may also treat the difference as an advantage to the French employees or managers when acquiring their investments, resulting in a different overall tax treatment to that expected i.e. taxation at investment date as a benefit in kind (cf. Conseil d’Etat, 13 July 2021, see above).
Our recommandations
Without a good understanding of the differences between the French tax authority’s expectations and requirements for the valuation of equity acquired by employees or management teams, by using a valuation prepared in a different jurisdiction, companies risk exposing themselves and their employees to valuation disputes.
In this regard, as soon as an investment is contemplated based on a valuation that has not necessarily been determined in accordance with known French tax rules and case law, we strongly recommend being particularly vigilant and consulting a French tax advisor to confirm whether the valuation used is likely to be accepted by the French tax authorities.
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