LeXcom Law firm

New withholding tax on share-option gains

Stéphanie Le Men-Tenailleau — 2011-04-08T15:32:38Z

The Amending Finance Bill for 2010 created a withholding tax which applies to profits made by non-residents on share-option gains, free shares and BSPCEs (stock warrants for business creators). But far from fulfilling the intention stated in parliament of “resolving the difficulties” of applying the existing law to this type of profits, the new withholding tax system proves to cause many technical contradictions and practical difficulties.

Scope of application of the system

The new section 182 A (c) of the French Tax Code states that tax will be withheld at source on “profits of French origin” made from share options, free share allocations and BSPCEs, when the shares are sold “by people who are not domiciled in France for tax purposes in the year of the sale”. Each part of this text raises a question:

The notion of a profit of French origin:

To this day, no legal definition of this notion exists in the context of profits from share options. On the issue of salaries, the withholding tax in article 182 A of the FTC also applies to revenue of French origin, defined as salaries in payment for professional activity exercised in France. How can this definition be applied to share-option gains? The answer should normally be given in the tax circular to be published on the taxing of share-option gains in an international context. The various draft circulars in circulation for a number of years repeat in effect the principles laid down by the OECD comments on this point. A this titre, the position of the French tax authorities would be that the acquisition gain made by beneficiaries of options is only taxable in France on that part of the profits derived from an activity performed in France. In accordance with the position of the OCDE, the acquisition gain would be considered as acquired during the “vesting” period (or period of acquisition of rights over the options) applicable under the plan. The acquisition gain would therefore need to be linked with each of the countries in which the employee performed his professional activity during the vesting period, applied pro-rata according to the time spent in each country. The withholding tax under the new section 182 A (c) would therefore be applicable on the part of the acquisition gain relating to the exercise of an activity in France. For example, if the employee spent two years in France over a total vesting period of four years, half of the gain would relate to France and would therefore be taxable there.

The question of the tax residence of the beneficiary:

The law states that the tax will be withheld at source if the beneficiaries of the gains are not resident in France for tax purposes for the year of sale. How is this to be applied when the beneficiary has changed tax residence during the course of the year? It would be more logical to base it on the date of the sale to determine when the withholding tax is actually applicable, especially since there might be several sales in the same year. Unless such an interpretation is adopted, the law would seem difficult to apply.

How the tax is withheld

Again, several questions arise on reading the rest of section 182 A (c), where it states that the tax must be withheld by “the person who pays out the sums derived from the sale of the shares”, and that the specific rates laid down in the schemes for options, free share allocations and BSPCE are applicable, unless the scheme for taxing wages and salaries has been opted for.

The person responsible for the withholding of tax:

The responsible for withholding the tax is the person who pays out the sums derived from the sale of the shares or, if the plan does not qualify, who confirms the advantage granted or (in the case of free share allocations) hands over the shares. In practice, it will therefore be the company, or much more frequently, the bank (French or foreign) which has been made responsible for handling the plan, which must levy the tax. Remember that if the tax is not withheld, or not sufficiently, or more than a month late, a fine of € 9,000 and 5 years' imprisonment are applicable. The question of who is responsible for the payment is therefore a weighty one… Therefore banks are now in an uncomfortable position if they are appointed as responsible for withholding and paying in the tax. But they may not necessarily have the information required to implement this tax (particularly concerning the division of the employee's activities during the share vesting period). So, if the sanctions mentioned above are imposed, banks are very likely to pursue the French companies issuing the options or employing the beneficiaries whenever faulty information is to blame for the absence or inadequacy of the tax withheld. The companies involved will have to institute efficient systems for providing information to the banks managing the plans, and the efficacy of these systems will be all the more crucial when the plans are managed by foreign banks…

The rate of the tax withheld:

The law states that the tax must be withheld and paid to the relevant tax centre before the 15th of the month following the date the sums are paid, at the rates stated by the special regime applicable to each option, each free share allocation and BSPCE. The exception is if the taxation as salaries has been opted for (if the plan does not qualify within the meaning of French law, the withholding tax still applies). Given that the tax must be paid in the year the sums are received, and that the option of asking for it to be taxed like pay or salary does not take effect until the year when the income is declared, i.e. the year following the payment, how should the person responsible for withholding the tax decide what rate to apply? Since the decision lies in the hands of the beneficiary alone, it seems difficult to allow the bank to apply the special regime on its own authority. Besides, as the rates of tax imposed on profits from options vary according to the amount of the profit, it will not be possible to determine the rate actually applicable to the overall acquisition gain (30% or 41%, respectively on sums below or above € 152,500) before the end of the year of sale, an additional difficulty arises when the shares held by one beneficiary are distributed between several banks. In this type of situation, the tax authorities will have to propose some practical solutions for applying the law, sometimes requiring a particularly flexible interpretation of it…

One final point: Article 57 of the Amending Finance Bill for 2010 states that the withholding tax is applicable to gains realised from 1 April 2011 onwards. There are two ways of interpreting this provision: either the law is referring to profits “taxable” from 1 April 2011 onwards, in which case the gains made from options taken up and shares definitively acquired before 1 April 2011 would be taxable at source, so long as the sale of the shares occurs after that date; or the law only refers to profits actually “realised” after 1 April 2011, i.e. only the options taken up and the shares finally acquired from that date onwards. This second solution appears more in line with the letter of the law. However, when it comes to options, given that the taking up of the options and the sale of the shares are very often simultaneous, businesses and banks will have very little time to put practical methods in place for applying the withholding tax, and the many uncertainties described above are not likely to make matters any simpler…

Transfer tax in case of shares held in a foreign real estate entity

2010-06-07T13:39:23Z

The French tax administration rules on the possible use of a credit for foreign taxes

The French rectifying bill for 2009 put the end to a long litigation story and agreed with the position of the French tax administration : French registration tax (at a 5% rate) is due on the sale of shares held in a foreign entity whose assets are, or have been for the year preceding the transfer of shares, composed for more than 50% with French real estate or French real estate rights.

In a ruling 7D-2-10 of May 20, 2010, the French tax administration comments on the possible credit for foreign tax paid on the sale of shares of the foreign entity.

In case the foreign tax exceeds the French tax, the exceeding amount is not refunded by the French tax administration. The credit is possible only to the extent the foreign tax administration issues a certificate mentioning the amount paid abroad and the corresponding type of tax (i.e such a tax must be similar to a French registration tax).

Finally, the French tax administration reminds that the French registration tax is due even in the absence of any written agreement on the transfer of the shares.

Stock options and international assignments

Stéphanie Le Men-Tenailleau — 2010-03-26T17:21:42Z

Taxation of the gains derived from stock options in a cross-border context has been a debated question for several years on the international scene. However, France, unlike other European countries, has not yet taken a stand in this area. The French Supreme Administrative Court (“Conseil d'Etat”) has just partly settled the debate in a decision dated March 17, 2010, in accordance with the guidelines developed by the OECD since 2004.

The referred decision relates to the situation of a French taxpayer who was granted stock options in 1995, as an employee of Total Final SA France. This employee was further assigned to Belgium from August 1st, 1999, until August 31st, 2000. During this period he exercised part of his options, the shares subsequently acquired being immediately sold.

Afterwards, the French tax authorities noticed that the tax residence of this employee had remained in France during such assignment period and that he omitted to declare the gains derived from the sale of the shares acquired upon the exercise of the options. The corresponding amount was therefore included in the taxable income of the taxpayer for the year of the sale as a salary (the 5 years holding period, in force at that time, having not been complied with by the employee).

The Court rejects the yearly taxation principle for the taxation of the acquisition gain

The first court and the court of appeals of Versailles both decided, in accordance with their line of precedents, to include in the taxable income only the part of the acquisition gain corresponding to the time effectively spent in France by the taxpayer during the year of exercise of the options. On the contrary, the French Supreme Administrative Court refused the reference to the yearly taxation principle for the allocation of the right to tax the acquisition gain between France and Belgium. The decision of the Court is based on the following grounds:

Classification of the acquisition gain as salary for the application of the tax treaty between France and Belgium

Taking into account, on the one hand, the classification as salary of the acquisition gain when the shares are sold before the expiry of the holding period (section 80 bis of the French Tax Code), and on the other hand, article 11 of the tax treaty between France and Belgium relating to employment income, the French Supreme Administrative Court considers that the gain is only taxable as a salary in France when the activity from which the grant of stock options derived was performed on the French territory. This interpretation of article 11 of the treaty between France and Belgium is in conformity with the OECD commentaries, which state “the Article allows the State of source [the one in which the activity is performed] to tax the part of the stock-option benefit that constitutes remuneration derived from employment exercised in that State even if the tax is levied at a later time when the employee is no longer employed in that State.”

Reference to the vesting period in order to allocate the right to tax the acquisition gain

With respect to the determination of the employment services remunerated through these options, the French Supreme Administrative Court states that when the stock option plan provides that the right to exercise the options is subject to the achievement of certain conditions, the activity from which the grant of options derived is the one performed between the date of grant and the date on which the beneficiary is allowed to exercise these options. The French Supreme Administrative Court is thus referring to the notion of “vesting”, which appears in the OECD recommendations and in many French and foreign plans. According to these principles, the right to tax the acquisition gain is thus allocated between the States in which the taxpayer performed his employment activity during the vesting period, on a pro rata basis, based on the number of days worked by the beneficiary on each territory respectively. Last, the French Supreme Administrative Court explains that in the specific situation where the exercise of the options by the beneficiary is not restricted in any way by the plan, the options are considered to be granted only with respect to the activity performed at the grant date. Taxation of the whole acquisition gain is in this particular situation allocated to the State on the territory of which the employee performed his activity upon the date of grant of the options.

Conclusion

The decision of the French Supreme Administrative Court is a significant step in solving issues raised by cross border situations with respect to incentives. It seems nevertheless important to note that his decision was held, under the former writing of section 163 bis C of the French Tax Code, in a case where the holding period of the options was not met. This acquisition gain was thus, in accordance with French law, taxable as employment income. As a consequence, the question of the tax treatment of this gain remains in cases where the holding period is met. Although the additional salary nature of the acquisition gain is hardly challengeable, since it results from the actual drafting of section 80 bis of the French Tax Code, when the holding period is met, the acquisition gain remains taxed as a capital gain on sale of securities, under particular conditions and rates. The deletion of the reference to section 150-0 A by the TEPA law, dated August 21st, 2007, weakens the classification of the acquisition gain as capital gain on sale of securities; however, the threshold applicable for taxation of capital gains remains applicable. In the absence of a decision of the French Supreme Administrative Court confirming that this approach also applies in the case the holding period is met, it seems that there is still a risk that the French tax authorities would not apply the solution of the decision dated March 17, 2010, if the shares are sold after the expiration of such period. They may indeed in such cases allocate to the State of residence of the taxpayer at the date of sale of the shares the right to tax the acquisition gain, thus applying the article of the OECD Model Tax Convention on capital gains.

Exceptional tax on bonuses paid by French banks and investment institutions (Corrective Finance Bill for 2010)

Stéphanie Le Men-Tenailleau — 2010-03-26T10:55:00Z

The French Parliament adopted on March 9 the Corrective Finance Bill for 2010, which creates an exceptional 50% tax on variable compensations paid to some of their employees by bank institutions.

The main characteristics of this tax, which is payable by French finance companies and investment institutions , are the following:

Beneficiaries of the bonuses

The tax applies on bonuses paid to employees who are financial markets professional « whose activities are likely to significantly influence the risk exposure of the company » and to the persons "under the control of which" the above defined employees perform their activities. The text does not mention the corporate officers but only employees meeting the above definition. The main issue will be to determine, for each company subject to the tax, the list of its employees falling into the scope of this particularly vague definition.

Basis of computation of the tax

The variable part of compensations referred to by the provisions of the Bill is defined as the gross amount of the compensation items paid to the abovementioned beneficiaries for their 2009 individual or collective results, including when the actual payment and vesting are conditional. Such variable part will be taken into account for the computation of the tax only for its portion exceeding EUR 27,500. Such compensation items are included in the basis of tax whatever the year of payment or of vesting would be. Consequently, as long as such compensation items would find, even partly, their source in activities performed in 2009, they will be subject to such tax, even in the event their actual payment would be deferred by one or several years. The only compensation items excluded from the scope of the Draft Bill would be the amounts paid with respect to legal compulsory and non-compulsory profit-sharing schemes, “Participation” and “Intéressement” (which are already subject to a 4% special tax, the “forfait social”).

Nature of the variable compensation items

The tax is computed to only on cash variable compensation items, but also on the ones granted through stock options, conditional share awards or any other share-based preferential awards. This tax applies even if the awards are granted by a foreign parent company or subsidiary. In case of grant of stock options or of conditional share awards, the tax is computed on the fair value of the options, shares or other securities, as defined for IFRS purposes (consolidated accounts). The computation basis is therefore identical as the one of the special employer's contributions (for the above defined beneficiaries) payable on such awards by French employers. The tax is therefore likely in certain cases to be paid on compensation items which will never be actually paid out, in the event the applicable conditions provided for the vesting of the awards would not be met. Should this happen, the draft bill provides that no amount of tax shall be reimbursed.

Rate and payability date

The tax is due, at the rate of 50%, on the first day of the month following the grant decision. The tax will be declared and paid within twenty-five days of its payability date, using a form which will be issued by the French tax administration. The tax will be paid upon filing of the declaration. However, for bonuses paid before March 9, 2010, the tax will be payable as from April 1st, 2010, and before April 25, 2010.

Stock-Options and termination for cause

Stéphanie Le Men-Tenailleau — 2010-02-08T11:12:57Z

The French Supreme Court confirmed for the first time, in a decision dated October 21, 2009 (n°08-42.026, Nebon-Carle c/ Sté Acxiom France), that section L. 1331-2 of the French labour code related to prohibited financial sanctions applies to stock-options.

Section L. 1331-2 of the French labour code provides against employees that “fines or other financial sanctions are prohibited. Any provision to the contrary is null and void”. The French Supreme Court regularly confirms that any salary reduction, as well as the suspension or suppression of any compensation item decided by the employer in retaliation to a behavior considered faulty by the employer is an illicit financial sanction, e.g. the employer decides to cut a premium when this decision is not linked to the purpose of the premium. It is particularly true when a productivity premium is cut because of the faulty behavior of the employee, but not in consideration of his efficiency (French Supreme Court, November 22, 1995, n°4523 P, Civ. Bull. V n°309). Section L. 1331-2 of the French labour code does notdraw a list of the items the unilateral termination of which is considered as a prohibited financial sanction. The prohibition principle would thus apply to any compensation item (notably to benefits in kind such as company cars, French Supreme Court December 12, 2000, n°4985, Portanguen c/ Sté Cecorev). However, the French supreme court had so far not confirmed it applied to stock-options. In the case at hand, an employee whose employment contract had been terminated for gross misconduct, asked for the payment of her stock-options, forfeited according to the plan provisions due to the nature of the termination of her employment contract. The plan indeed provided that options were immediately forfeited in case of termination of the beneficiary's employment for gross misconduct. Unlike the Court of appeals, which considered such clause, like any classical presence clause, prevented the former employee from exercising her options, the Supreme Court indicates that the deprivation of the rights to exercise the options in case of termination for gross misconduct is a prohibited financial sanction which cannot be set forth in a stock-options plan. The incriminated provision of the plan is therefore null and void, but the actual consequences of such decision are yet to be determined: Given the Supreme Court past case law regarding the validity if the presence condition and regarding the consequences of unfair dismissal with respect to option rights, such consequences could be the following:

Either the stock option plan of the company provides for a presence condition for the employee to be entitled to exercise his options: in such case, the employee whose employment contract is terminated, for whatever reasons, could only be entitled to damages in compensation for the loss of his/her options;
Or the stock option plan of the company does not provide for a presence condition, in which case it might be considered that the options should not have been forfeited and that, provided they did not expire for another reason, they should remain valid in the hands of the beneficiary, even though he/she is no longer employed by the Company.

This case law is likely to apply to foreign plans providing for the forfeiture of the options in case of termination for cause. It is therefore advisable, when possible, to avoid making any difference in a stock-option plan between different cases of termination of employment of the beneficiaries. This case law will most probably also apply to conditional awards plans such as Performance Shares or Restricted stock Units plans.

The audit of the employer's annual accounts upon request of the works council

Loïc Héron, Nicolas Léger — 2010-01-26T10:01:44Z

Two Supreme Court cases were issued on December 15, 2009 in relation to the prerogatives of the works council and the outside accountant they may appoint. The first case relates to the moment when the works council can request an audit of the annual accounts (n°08-17.722), while the second case relates to the right for the expert appointed by the works council to be provided with information about the annual accounts (n°08-18.228).

1. A works council gathered on February 21, 2007, in order to be informed by the employer about the company's 2006 annual accounts. On April 25, 2007, the works council formally appointed an outside accountant for assistance in the review of the 2006 accounts, even though the company's shareholders meeting supposed to approve the 2006 accounts was called for only a few days ahead, on May 10, 2007. The employer challenged such appointment (as well as the financial cost thereof), based on the fact that (i) the outside accountant should have been appointed at the time the accounts had been provided to the works council, (ii) the works council had been provided with all the information related to the annual accounts during the meeting on February 21, 2007 and (iii) the two-month period between the communication of the accounts and the appointment of the outside accountant proved that such appointment had been made too late. The request filed by the employer against the ruling of the Paris Court of Appeals was rejected. In its decision, the French Supreme Court holds: “although the right for the works council, when invited to review the company's annual accounts, to appoint an outside accountant (whose fees are to be borne by the employer) is to be acted upon when the accounts are transmitted to the works council, it does not result from the provisions of articles L.2325-35, L.2325-36, L.2325-37 and L.2325-40 of the French Labour Code, interpreted in the light of the European Directive n°2002/14/CE dated March 11, 2002, which provides for a general framework for the information and consultation of workers within the European Community, that the appointment of such accountant must take place during the information meeting during which the annual accounts are presented to the works council”. Neither the contents of the February 21, 2007 meeting, nor the very short period between the appointment of the accountant and the shareholders' general meeting invited to approve such accounts are valid reasons to limit the right for the works council to be assisted by an outside accountant for the understanding of the accounts and the assessment of the company's situation. The decision of the Paris Court of Appeals was thus confirmed, i.e., “the appointment of the outside accountant took place at a reasonable period and not too late.”

2. On December 6, 2006, a company's central works council appointed an outside accounting firm for the review of the company's 2006 annual accounts and the 2007 budget. On March 6, 2007, the economic committee of the central works council decided to include in this mission the analysis of the company's pay policy. In a letter dated June 5, 2007, the outside accountant requested the communication of various documents from the company, which refused. Through summary proceedings, the Paris Court of Appeals ordered that the company provide the outside accountant with the documents requested (Paris Court of Appeals, June 16, 2008). Before the French Supreme Court, the company claimed that there was no obviously illicit tort (“trouble manifestement illicite”), since (i) it was not proven that the documents requested were necessary for the understating of the company's accounts, (ii) the information requested, related to the age, gender and annual gross remuneration of each employee belonged to the employee's personal situation, so that the accountant's request was tantamount to a trespass to the employee's private lives and (iii) the outside accountant could not validly demand the communication of documents that did not exist and were not legally mandatory. The request filed by the employer was rejected. The French Supreme Court indeed held: “the outside accountant appointed by the works council may, as part of a mission that is necessary for the understanding of the company's accounts and for the assessment of the company's situation, be provided with all the documents that they see fit”. The Supreme Court further considered that, on the one hand, the initial judges were not expected to check whether the documents requested were necessary for the performance of the accountant's mission and, on the other hand, the outside accountant, who is bound by a confidentiality and secrecy duty under article L.2325-42 of the French Labour Code, may not be objected that the documents requested are confidential. The Court last stated that the judge may order the communication “not of one summary document but of data, which incidentally the employer did not claim did not exist”.

VAT on services

2009-09-28T09:23:00Z

VAT Directive implemented in France

As from January 1st, 2010, and for the rendering of services, the VAT territoriality rules will be modified. With numerous exceptions, the basic rule will now be that VAT is due in the country of the client when the client is subject to VAT (“assujetti”) and in the country of the supplier when the client is not subject to VAT.

This new rule will imply a high level of vigilance to obtain and to ensure the validity of the VAT number of clients.

In order to audit the application of those new rules, a new declaration will be created : the declaration of exchange of services

Social security regime of the conventional termination indemnities and of "Golden parachutes"

Stéphanie Le Men-Tenailleau — 2009-09-21T16:25:00Z

Circular of the French social security direction dated July 10, 2009 in relation to the new social security treatment of some termination indemnities.

The social security treatment of indemnities paid in certain cases of termination of the employment contract was recently amended by two laws dated respectively June 25, 2008 and December 17, 2008. The purpose of the circular dated July 10, 2009 is to give guidelines related to the implementation of such new provisions, related on the one hand, to the social security treatment of indemnties paid in case of conventional termination and, on the other hand, to the social security treatment of indemnities paid in case of forced termination of the employment contract or of the corporate office.

1. Conventional termination of the employment contract (article 5 of the law dated June 25, 2008)

The tax treatment of the legal dismissal indemnity paid in case of conventional termination of the employment contract varies depending on whether the employee may benefit from a retirement pension from a legally compulsory scheme (this is the case of all employees aged 60 years or more) or not. At the date of termination of the employment contract, the employee who would be in a position to receive his retirement pension, either at a full rate or not, would not be entitled to benefit from the favorable social security regime provided for by section 80 duodecies of the French tax code. In such a case, the conventional termination indemnity would be subject to social security contributions, to CSG and CRDS as from the first euro. It would be the case of all employees aged 60 years and more. Regarding employees aged between 55 and 59 years-old who enter into a conventional termination agreement, the employer will have to be able to provide the social security auditor with a document relating to the situation of the employee with regards to his rights to the basic retirement scheme.

Regarding employees who are not in a position to receive their retirement pension, and who had less than one year seniority, the indemnity shall be excluded from the basis of computation of the social security contributions as provided by section 80 duodecies of the rench tax code (twice the amount of the compensation paid during the year preceding the one of termination of the employment contract or half the amount of the termination indemnity paid). The indemnity is excluded from the basis of computation of CSG and CRDS up to the indemnity due prorated according to the number of month of presence in the company.

2. Implementation of section 14 of the law dated December 17, 2008

As from January 1st, 2009, indemnities paid for an amount above thirty times the amount of the annual social security cap (EUR 1,029,240 for 2009) are subject to social security contributions, CSG and CRDS as from the first euro, including when the amount of the indemnities corresponds to legal or conventional indemnities.

The other amounts paid, if any, upon termination of the employment contract, and which are subject to social security contributions in normal conditions, are not taken into account for the computation of the threshold.

Regulated agreements and corporate officers' compensation

Stéphanie Le Men-Tenailleau — 2009-09-21T10:18:14Z

Non approval of a regulated agreement by the Shareholders meeting does not trigger nullity of the agreement.

When a company director is linked to the same company by an employment contract, any amendment to such employment contract, including in relation to his compensation as an employee, falls within the regulated agreements procedure provided for by the French commercial code. Such procedure requires, in addition to the prior approval of the agreement by the Board of Directors, a special report by the company auditors and the approval of the Shareholders. In the case the approval of the Shareholders would not be obtained, such agreement may not be considered as null and void, but the company may claim for damages against the corporate officer.

The French supreme Court confirmed this principle in a decision dated July 8, 2009, where the company was claiming for the reimbursement of the amounts paid, including a bonus, to an employee who was also a delegate general manager and has been revoked after a change of control. The Court recalled that the company could only claim for damages, and only in the case it would be able to show that the payment of such amounts caused a damage to the company. Regarding an employee's compensation, it means according to the Court that the company should have shown that such amounts has been paid without consideration or were excessive and inappropriate, which was not the case.

Registration taxes

2009-09-21T09:23:51Z

A transfer of shares may be recharacterized into a transfer of going business

In a case dated 12/16/2008, the French High Tax Court (Sté Forocean) decided that the acquisition for a one Euro of a more than majority stake (79% of the share capital) of an existing 20% subsidiary facing financial difficulties then followed by forgiveness of debts and dissolution of the subsidiary was in fact a transfer of going business subject to registration tax on the value of said going business. No reference is made to any abuse of law in such Court which is in contradiction with numerous Court cases that denied such a re-characterisation into a transfer of going business.