French tax incentives to drive innovation
Posted on 05 February, 2016 by King & Wood Mallesons
This comment piece was first published in law firm King & Wood Mallesons' newsletter.
At the end of last year, the French Parliament made a number of important tax changes, some of which are likely to have a direct and mostly positive effect on the venture capital and private equity sector. Broadly, the relevant changes are designed to encourage investment in young innovative companies – while adjusting some existing rules to comply with EU state aid rules – and to tackle tax avoidance, particularly through "harmful" international tax competition.
Amendments designed to facilitate investment and innovation include changes to rules which came into effect in 2014 to promote equity investment in small, medium and intermediate-sized companies (SMEs and ISEs). The so-called PEA (plan d'épargne en actions) is the most popular savings scheme for French individuals, and in 2014 a special SME/ISE version was created. The current qualification criteria for this latter scheme have now been broadened to make it easier for certain small or mid-cap listed companies to qualify, provided they meet certain criteria relating to their size and ownership structure. In addition, the scheme has been extended to other forms of financing: convertible bonds, and units in European Long Term Investment Funds (ELTIFs – the EU's new alternative investment fund wrapper) will qualify if a sufficient proportion of the underlying assets qualify. To favour long-term investments, a temporary capital gains tax deferral now applies on the sale of shares in money market funds if the proceeds are re-invested in the scheme. These changes, combined with an amendment allowing ELTIFs to make loans, will increase the incentive for French private equity fund managers to establish such funds.
The ability to grant loans will, as well as ELTIFs, also benefit French alternative investment funds (FPCIs, FPS, including the new French limited partnership or SLP, securitisation vehicles), under certain criteria to be specified in regulations.
Other changes to schemes designed to facilitate investment affected the personal income tax deduction on investments in certain unlisted companies, and the wealth tax reductions available for investments in SMEs. These schemes have now been aligned, with some enhancements but also some restrictions to accommodate EU state aid rules, including restrictions on investing in one's own company.
At the same time, amendments were made to the tax regime applicable to corporate venturing, and the changes have been pre-approved by the European Commission under the state aid rules. The corporate venturing rules allow a tax deduction, spread over five years, for companies investing in "innovative" SMEs, now meaning those undertaking research or attempting to innovate in a way that carries some risk of failure. Companies can invest directly or through French private equity funds, including the new French limited partnership (Société de Libre Partenariat or SLP). SMEs will also have to be pre-revenue or within 10 years of the date of their first sale, and other alterations were made to qualifying criteria.
In addition to these (largely helpful) changes to the various tax incentives for investment, important amendments were made to the "parent-subsidiary" (or participation exemption) regime to comply with EU rules, including a new anti-abuse clause, targeting in particular holding companies interposed mainly for tax purposes.
The full exemption applicable to dividends paid by a French subsidiary in a French tax consolidated group has been replaced by a 99% exemption applicable to all EU subsidiaries. This will have a favourable impact for French groups with EU affiliates, rather than only those which are purely domestic.
Provisions were also included to modify the automatic exchange of tax information (the so-called "common reporting standard") as it applies to management companies and other financial institutions, so that they will have to collect detailed information regarding every account holder and controller. More generally, France has implemented Action Point 13 of the OECD's Base Erosion and Profit Shifting (or BEPS) initiative, requiring country-by-country reporting to allow tax authorities to assess risks associated with transfer pricing and abusive relocations of the taxable base.
Many of these changes, and others introduced at the same time, will have a direct effect on French taxpayers and investment funds. There are opportunities for SMEs and fund managers to take advantage of the enhancements to investment incentives, but careful analysis will be required to factor in anti-avoidance measures.
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