Following an audit of GEII Rivoli Holding’s accounts for FY 2013 and 2014, the tax authorities questioned the deductibility, beyond what resulted from the application of a “safe harbor” rate of 2,79% corresponding to the value mentioned in 3° of 1 of Article 39 of the French General Tax Code, of the interest paid to its parent company, at a rate of 5.08%, in return for a loan that the latter had granted it with a view to acquiring a building, and subjected it to additional corporate income tax assessments in respect of these two years.
To justify the arm’s-length nature of this intragroup interest rate, the company provided two different methods. One method where the borrower’s credit risk (Baa1) was determined using a scoring model developed by Moody’s Analytics (RiskCalc) and another method where the credit risk of the borrower had been determined using based on the corporate bond yield curves provided by the S&P database.
Both analyses were rejected by the tax authority and later the Administrative Court and the Administrative Court of Appeal.
An appeal was then filed with the Conseil d’Etat.
Judgment
The Conseil d’Etat rejected the first method but accepted the second method and on that basis set aside the assessment of the tax authority.
Excerpt in English
“…in order to justify the validity of the rate it had chosen, the company submitted a new evaluation to the court, based on the calculation of two financial ratios, one of which, One of these ratios, known as the “loan-to-value” (LTV) ratio, relates the level of debt to the value of the company’s real estate assets, and in this case, by comparison with the ratios of listed French and European real estate companies, led to the conclusion that the financial rating it could have obtained would not have exceeded BBB. In order to justify that the rate of 5.08% paid to its parent company did not exceed the arm’s length rate, GEII Rivoli Holding argued, on the basis of bond market data taken from the Standard & Poor’s Capital IQ financial database, that at the date when the loan in dispute had been contracted, for euro-denominated transactions, the 10-year market interest rate for BBB-rated non-financial companies was 5.21%.
9. In the first place, by rejecting this method, insofar as it made it possible to determine the company’s level of risk, on the sole ground that the LTV ratio in this case had been calculated by taking into account a financial debt corresponding exclusively to the loan whose rate had to be assessed, the court committed a first error of law.
10. Secondly, in rejecting the rate resulting from the application of this method, the Court relied on the fact that GEII Rivoli Holding, in comparing its situation with that of larger real estate companies already present on the bond market, did not justify that a bond issue would have constituted a realistic alternative to an intra-group loan. By ruling out on this ground any possibility of comparison based on the rates charged on the bond market, when the size of a company is not in itself such as to hinder access to this market and when the realistic nature, for a company having recourse to an intra-group loan, of the alternative hypothesis of a bond issue can only be assessed in the light of the specific characteristics of the company and the transaction, with the rates observed on this market having to be adjusted where necessary to take account of the specific features of the company in question, the court committed a second error of law.
11. Lastly, in rejecting the rate resulting from the application of this method, the court also relied on the fact that it had not been provided with any precisely identified comparables whose relevance it would have been able to assess. In so ruling, despite the fact that the arm’s length rate put forward by GEII Rivoli Holding as corresponding to its level of risk was based on the use of rate curves established on the basis of all the transactions recorded in the Standard & Poor’s Capital IQ financial database for loans of the same duration contracted by companies with the same risk profile, and that it was not argued that the transactions recorded in this database were unreliable, the court committed a final error of law.”
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