French Tax Leasing Briefing June 2008 Whilst we are continuing Introduction to witness significant The French Tax Authorities released their official comments on the activity in the UK leasing Article 39C Tax Lease on 4th April 2008. This clarified certain pending issues. We can now expect new developments in the market, focus has recently French market. been shifting to France, French Tax Leases may be applied to any asset which qualifies for where two tax-based depreciation on a reducing balance basis, including ships, aircraft, leasing structures are power plants, equipment and specific real estate, as well as specified "green" assets which qualify for 100% tax depreciation in promising attractive the first year of ownership. A briefing on the French regime for benefits. These structures investments in "green" assets including more detailed information will be released on our website by the end of July 2008. are the single investor tax lease, which has an French Tax Leases only apply to new assets and not to assets which have already been delivered by the manufacturer except for established track record, ships where transactions including a sale and lease-back through a and the new Article 39C tax lease within 24 months from the delivery are allowed. tax lease, which is rapidly Subject to the conditions set out in the "Instruction n°4-D-1-08" gathering interest. released by the French Tax Authorities, currency exchange profits or losses to be taken into account for the determination of the net profit subject to tax can be cancelled. The absence of adverse tax consequences deriving from currency exchange profits or losses will simplify all transactions structured with several loans in different currencies. The French Tax Lease structure does not provide any tax benefit for individuals similar to those existing under for example the German law (i.e.the German KG model). The two structures are described in more detail below. Single Investor Tax Lease The single investor tax lease relies on the ability of the lessor to offset losses created by accelerated tax depreciation in the early years of the lease against profits of other companies in its consolidated tax group. Any tax deferral benefit is shared with the lessee through reduced rental payments. The lessor must be a special purpose vehicle that is subject to French corporation tax, and which is a member of the bank's consolidated tax group. The single investor tax lease can also be used by industrial groups having a consolidated tax group in France and available tax capacity to finance their new investments or to NEW RULES FOR FRENCH TAX LEASE BRIEFING WATSON, FARLEY & WILLIAMS TAX GROUP develop an activity of financing new investments to be leased Article 39C Tax Lease to companies outside of the lessor's group. The Article 39C tax lease utilises a tax transparent partnership Any one of a number of French corporate entities can be in order to enable losses created by accelerated tax depreciation used for this purpose. The lessor acquires the asset using in the early years of the lease to be set against profits of the a combination of equity contributions and bank loans, and members (or their respective groups). Any tax deferral benefit is then leases the asset to the lessee by way of finance lease shared with the lessee through reduced rental payments. with an option for the lessee to acquire the asset at the end of the lease. There are no restrictions in relation to the location, The lessor in the structure must be a specific partnership, operation or registration of the asset, or the location namely a société en nom collectif. Banks or non of the lessee. bank investors or the lessee can participate in the société en nom collectif. The asset is depreciated on a reducing balance basis over either its economic life or the duration of the lease. The economic life The lessor acquires the asset using a combination of equity of a ship is eight years for these purposes. For some assets it contributions and bank loans, and then leases the asset to the may be necessary to distinguish between the structure of the lessee by way of finance lease with an option for the lessee to asset and its components for depreciation purposes. acquire the asset at the end of the lease. In their official comments dated 4th April 2008, the French Tax Fixed assets must be located in France or in an EEA Authorities confirmed that ships can be depreciated as from the country that has an appropriate double tax treaty with France1. tax year preceding delivery subject to the condition that they Movable assets must be operated or registered in France or in were put into drydock before the first day of the tax year in an EEA country that has an appropriate double tax treaty with which they are delivered. The depreciation is calculated on the France. From a French tax perspective an asset is operated in basis of the installments paid on the last day of the tax year an EEA country when it is used in that country or in the EEA preceding delivery which do not exceed 50% of the cost price for more than two thirds of the tax year. The control or of the ship. management of an asset from a permanent establishment located in an EEA country does not result in the asset being This will certainly lead to an enhancement of the financial benefits. operated in an EEA country for this purpose. For example, a ship registered under UK flag will be considered as operated in No limitation applies on the tax deductibility of the losses at the an EEA country, the effective place of operation being level of the consolidated tax group. irrelevant, and a ship registered under Panamian flag and operated in EEA countries for more than two thirds of the tax At the end of the lease the asset may be sold to the lessee and year is also eligible. the capital gain realised on the sale will be subject to corporation tax at the normal rate in France (i.e. currently The lessor may depreciate the asset on the same basis as 33.33%). This will impact the overall benefit resulting from the described above in relation to the single investor tax lease. claim to allowances. This may be mitigated by transferring the shares in the lessor, rather than the asset, to the lessee. The tax deductibility of losses at the member level is capped at Provided certain criteria are satisfied, only 5% of the gain on three times the amount of the rentals accrued by the lessor the transfer of the shares should be subject to French during the first 36 months of the lease (except for the lessee if corporation tax. Alternatively, in relation to ships, the lessor it is also a member). However, any losses restricted in this may join the lessee's French tonnage tax group, where manner will become deductible in the fourth financial year. In applicable, which in turn will enable a partially tax free disposal addition, the members are prevented from deducting losses in of the ship. excess of 25% of their own (or their group's) taxable profits in the first 12 months. It is not possible to gain prior approval of a single investor tax lease from the French tax authorities, so the structure These limitations apply as from the beginning of the lease period. must be carefully analysed to ensure that it does not fall within the scope of French anti-avoidance rules such as the abuse of law principle. 1 For these purposes, the relevant countries include any member of the European Union, Norway and Iceland, but not Liechtenstein. NEW RULES FOR FRENCH TAX LEASE BRIEFING WATSON, FARLEY & WILLIAMS TAX GROUP 02 These restrictions are not anticipated to apply to losses deriving from the depreciation of ships during the pre-delivery period or to losses deriving from "green" assets. However, as only components of a leased asset will typically qualify as a "green" asset, a proportion of the losses deriving from the leased asset are likely to be capped. At the end of the lease the asset may be sold to the lessee, and the capital gain realised on the sale will be subject to corporation tax at the normal rate in France (i.e., currently 33.33%). This will impact the overall benefit resulting from the claim to allowances. This may be mitigated by transferring the shares in the lessor to the lessee rather than the asset. Provided certain criteria are satisfied, only 5% of the gain on the transfer of the shares should be subject to French corporation tax. Alternatively, in relation to ships, the lessor may join the lessee's French tonnage tax group where applicable, which in turn will enable a partially tax free disposal of the ship. Contacts Again, it is not possible to gain prior approval of an Article 39C tax lease from the French tax authorities, so the structure Gilles Cervoni must be carefully analysed to ensure that it does not fall firstname.lastname@example.org within the scope of French anti-avoidance rules such as the +33 (0)1 56 88 21 36 abuse of law principle. Nathalie Cormery Conclusion email@example.com +33 (0)1 56 88 21 37 The combination of high net benefits and greater certainty in tax legislation is making France an attractive alternative for tax- Michael L'Estrange based leasing. firstname.lastname@example.org +44 (0)207 814 8046 The net benefit arising either under a single investor tax lease or an Article 39C tax lease when coupled with a tax efficient exit is in the range of 10% to 15%. Without a tax efficient exit Watson, Farley & Williams LLP the benefit is approximately 5% to 6%. 150, avenue des Champs-Elysées 75008 Paris The Paris office of Watson, Farley & Williams has been closely Tel: +33 (0)1 56 88 21 21 involved in the development and implementation of both single Fax: +33 (0)1 56 88 21 20 investor and Article 39C tax leases. Watson, Farley & Williams LLP For more information, please call Gilles Cervoni or Nathalie 15 Appold Street Cormery in the Paris Office, Michael L'Estrange in the London London EC2A 2HB office, or your usual Watson, Farley & Williams contact. Tel: +44 (0) 20 7814 8000 Fax: +44 (0) 20 7814 8141/2 www.wfw.com WATSON, FARLEY & WILLIAMS LONDON NEW YORK PARIS HAMBURG ATHENS & PIRAEUS ROME & MIL AN SINGAPORE BANGKOK All references to ‘Watson, Farley & Williams’ and ‘the firm’ in this brochure mean Watson, Farley & Williams LLP and/or its affiliated undertakings. Any reference to a 'partner' means a member of Watson, Farley & , Williams LLP or a member or partner in an affiliated undertaking, or an employee or consultant with equivalent standing and qualification. This brochure is produced by Watson, Farley & Williams. It provides a summary of the legal issues, but is not intended to give specific legal advice. The situations described may not apply to your circumstances. If you require advice or have questions or comments on its subject, please speak to your usual contact at Watson, Farley & Williams. This publication constitutes attorney advertising.