EDF International, a French group finance company, subscribed in 2009 to convertible bonds issued by its wholly owned UK subsidiary. The instrument had a five year term, a low coupon, and a conversion right into newly issued shares after a lock up period. The controlled transaction was this intra group financing through convertible bonds and the related question whether the low coupon reflected arm’s length remuneration once the conversion feature was properly valued, and whether any advantage should be treated both as an Article 57 indirect profit transfer and as a hidden distribution subject to withholding tax.
The tax authorities treated the coupon rate as below the market interest rate for a straight debt instrument and argued that the conversion option had no value to the subscriber because it already owned all shares in the issuer. On that basis the authorities considered that the reduced coupon created an unjustified benefit for the UK subsidiary, required a reintegration of additional interest income in France under Article 57, and characterised the benefit as a hidden distribution of profit to a non resident recipient, triggering withholding tax and related late payment interest.
Not satisfied with this assessment, Electricité de France brought the case to court.
The Court of first instance held in favour of the tax authorities and an appeal was then filed by Electricité de France with the Administrative Court of Appeal.
In a decision issued 25 January 2022 the Administrative Court of Appeal overturned the decision from the court of first instance and found in favor of Electricité de France.
An appeal was then filed by the tax authorities with the Conseil d’État, which in November 2022 annulled the decision from the Administrative Court of Appeal and found in favor of tax authorities and remanded the case.
In November 2023 the Administrative Court of Appeal decided in favor the tax authorities and an appeal concerning this new decision was then brought before the Conseil d’État by EDF.
Judgment
The Conseil d’État ruled that when a convertible bond subscriber already owns all of the issuer’s share capital, the conversion option necessarily has no value. Therefore, the transaction cannot be compared to a third-party convertible bond and must be analysed as intra-group financing and on this basis the court considered that the interest rate was below the arm’s length interest rate.
It confirmed that the tax authorities had established an unjustified difference between the agreed coupon and the market interest rate for straight debt and that the claimed considerations, including the later conversion gain and arguments about financing alternatives, did not justify the advantage, so the benefit was an indirect transfer of profits and also a hidden advantage that could be subject to withholding tax.
Regarding EU law, the court found that the companies could not rely on the free movement of capital to challenge the withholding tax in this case, as the taxed item corresponded to a hidden advantage granted within a subsidiary relationship, rather than income arising from an investment movement.
The court annulled the Court of Appeal’s ruling only insofar as it was insufficiently reasoned with regard to parts of the withholding tax dispute, and insofar as it wrongly exempted late payment interest for 2014. The court then ruled on the merits, dismissing EDF’s discharge claims and upholding the withholding tax and the remaining late payment interest in dispute.
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