Corporations - Mergers & Acquisitions - Business transfer

This chapter is not exhaustive and is limited to broadly outline the tax consequences of the main events occurring when doing business in France. It does not constitute a tax advice or a client - attorney relationship. Materials are not suitable for tax analysis. Visitors are invited to consult a tax lawyer before taking any decision.  
 
24% of French business owners plan to give or to sell their business in the next 5 years. If properly anticipated early enough, many tools are available to manage efficiently the tax, legal and financial aspects of a sale to a non related party or the gradual transfer of the ownership.
  
 
 LBO - LMBO - OBO
 Cohabitation
 Inheritance
 Gift
 Legs de residuo and secondary donation
 PACS (Cohabitation agreement)
 Trust manager
 Children and grand-children
 Protection of the spouse
 Gift of shares to employees
 Division
 Transfer of real estate
 Usufruct - Naked ownership
 Tontine provision
 Lease of stock and shares
 Gift of shares
 Share for share contribution followed by a sale
 Acquisition of shares - Tax deductibility of interest

 LBO - LMBO - OBO

The use of a holding company by the acquirer may, under certain restrictions, leverage the transaction from a tax standpoint (Tax consolidation) but also for legal (Control the target with less than 50% of the shares) and finance purposes (Improve the profitability by a fine tuned arbitration between debt and equity).

The sellers and the buyers, specially the former managers in case of LMBO, must check the tax consequences of this acquisition with respect of Wealth tax rules "Wealth tax" and if applicable, with respect to the rules of the unemployment agency "ASSEDIC" e.g. when former managers are appointed board members in the new organization while keeping their former work agreement.

The buy out of his own business by the seller "OBO" allows the owner of a SME to sell for cash its shares to equity investors while reinvesting part of the consideration received in the company and keeping a senior management position. "OBO" is an efficient technique to transfer a business to non family related parties.

Success of LBO, LMBO or OBO is by many aspects dependent of the tax consolidation of the acquiring holding and the target. Restriction of the tax deductibility of interest must be carefully reviewed.

Management under lease "Management under lease" may be also a valid temporary option.

Recharacterization of sales of shares of the employing entity as earnings from professions.
 
 

 Cohabitation

Gifts between cohabitants suffer a 60% registration duty (Spouses 5% to 40%). False donation may be requalified as an "Abuse of law".

 

 Inheritance

ATTENTION: Reform of rules applicable to succession and gifts applicable as of January 1st, 2007 - Numerous provisions applicable to the transmission of a business.

The entrepreneur's death often drives out of business if this event was not properly anticipated.

On top of numerous legal difficulties and issues (Possible dissolution of the company, freezing of the bank accounts.), the entrepreneur's death triggers the transmission of his estate, business assets included, to his inheritors and the payment of an inheritance tax up to 60%"Facts and figures".

Inheritance tax paid by the surviving spouse:

A survey made in May 2006 by the German government shows that the inheritance of a medium-sized manufacturing business with a market value between 3,9 millions euros and 4,4 millions euros (Sales of 8,1 millions euros, Benefit of 200 000 euros and balance sheet sum of 5,9 millions euros) would suffer an effective inheritance tax burden of 689 000 euros in France i.e. the highest tax burden, Netherlands excepted, among the 13 older member states of the EU. As an example inheritance tax would be 168 000 euros in Germany, 133 000 euros in Belgium and 7 000 euros in Spain. No inheritance tax would apply in UK, Luxembourg and Ireland.

Donation is a very flexible and tax efficient tool to give an enterprise without jeopardizing the continuation of the activity by the beneficiaries of the gift.

The "Donation - partage" is an efficient tool to organize during his life time the transfer of his estate to his inheritors.

Inheritance tax rates are in a range of 5% to 40% between spouses, 35% to 45% between brothers-sisters, 45% to 60% in all other cases. Rebates are available. Inheritance taxes are reduced up to 50% depending the age of the donor. "Facts and figures".

IMPORTANT: French supreme civil court ruled that tax regime applicable to parties to an agreement must be disregard when valuing shares. Only tax considerations specific to the shares itself may influence their value. As a result, French tax authorities are not allowed to increase the value of shares even when gift tax is paid by the grantor although the gift deed is silent or provides that the gift tax must be paid by the beneficiary. 

Tax exempt gift in cash

As of January 1st, 2004, the 50% tax allowance (75% as of August 4, 2005) on the value of companies (without any cap) for the computation of the inheritance tax will also apply for the calculation of the gift tax on donation of the ownership (ownership, usufruct or naked ownership since August 4, 2005) of shares locked for a given period. Since August 4, 2005 it is generally not possible to benefit from this tax allowance in addition to the reduction of the gift rate provided according to the age of the donor.

In order to benefit from the 50% tax allowance (75% as of August 4, 2005), the minimum % of listed shares the beneficiaries of the donation must agree together to lock before the donation is reduced to 20% (25% until December 31, 2003). The 34% applicable to non listed companies remains unchanged.

Last, the penalty applicable when the locked period is not fulfilled is abolished. This abrogation applies to all the penalties already applied but not collected yet.
 
As of March 29, 2004 gift tax paid for the transfer of an individual business is immediately deductible from the business earnings of the grantor or of the business earning of the beneficiary. The beneficiary is no longer requested to continue the business activity during a minimum period of time. 
 
 

 Legs de residuo and secondary donation

Both regimes permit to skip a generation or to organize an inheritance between brothers-sisters at an acceptable tax cost.

Assuming that "A" is the mother of two children "B" and "C".

The "leg de residuo" permit A to bequeath properties to B who for example has the right to use them without any restriction. When B will die, the remaining properties received from A will be transferred to C, the final beneficiary specified by A.

The "donation secondaire" works according to a principle closed from the "leg de residuo".The donor "A" donates properties to B, under the condition that B manage the properties he received and donates all or part of these properties to C at a date specified by A when he made his donation to B.

Both structures are tax efficient. "C" pays the inheritance tax rate applicable between A and C and not between B and C. The inheritance initially paid by B on the properties subsequently donated to C is deductible from the inheritance tax owed by C on the properties received from B. 
 

 PACS (Cohabitation agreement)

Inheritance tax rate applied to parties at a cohabitant agreement "PACS" is lower than the inheritance rate applied to cohabitant without a PACS.

However the PACS rate remains significantly higher than the inheritance tax rate applied to married couples. As of January 1st, 2002, the first 57 000 euros are exempt from inheritance tax. The excess is taxable at rate of 40% for the first 15 000 euros exceeding 57 000 euros and 50% above.

When a PACS is signed for more than 2 years, donations are subject to the inheritance tax rate (See above). However donations are eligible for a reduced rate according to the age of the grantor (Inheritance tax rate in a range of 20% to 50% instead of 40% to 50%).

Therefore it is highly recommended to anticipate the tax consequences of a transfer of estate between cohabitants.

The payment of the inheritance tax by the grantor is not treated as a taxable gift. This solution is tax efficient. 
 

 Trust manager

Under certain circumstances (Accident, illness, etc...) limiting his ability to decide by himself, a manager may loose his right to take key decisions without the supervision of a trustee ("Curatelle" or if a deeper control is necessary "tutelle").

In such circumstances, if the business is structured as a own business or as a partnership, an incorporation may highly simplify the management and the survival of the business.  
 

 Children and grand-children

It is important to remember that the inheritance taxes are significantly lower on the transmission of shares than on the transmission of assets.
The owner of a business who plan to transfer it to his children or grandchildren should evaluate the benefit of incorporating his own business.

As of 2003, donations from grand-parents to grandchildren "Facts and figures" benefit of a 30 000 euros discount for each grandchild receiving a donation. This rebate is added to the 46 000 euros discount applicable when a grandchild receives the donation on behalf of a child who died prior to the donation. We draw your attention of the tax advantages provided by the leg de residuo and the secondary donation. 
 

 Protection of the spouse

As of July 1st, 2002, the surviving spouse who was neither divorced at the time of the death nor living in a separate domicile by court decision, benefit of much higher inheritance rights.

The surviving spouse benefits of the use of the main residence of the couple for one year as of the death of the other partner. In addition the widow(er) has both the right to live until his (her) death in the house jointly owned by the partners or owned by the deceased spouse and the right to use the furniture of the said house.

According to administrative guidelines dated June 6, 2003, the benefit of the deferral rules is applicable to the payment of the inheritance tax on the entailed building.

When all the children are the children of the couple, the surviving spouse may choose between usufruct on the all inheritance (bare-ownership to the children) or full ownership of a quarter to the inheritance. These rights are subject to several conditions and legal restrictions.

When all the children are not from the couple, the surviving spouse cannot elect for usufruct. He/she will receive the full ownership of a quarter of the inheritance. This right is subject to several conditions and legal restrictions,

When the deceased spouse has no descendant and his two parents are alive, the surviving partner inherits half of the estate. When only one of the parents is alive, the widow(er) inherits ¾ of the estate. If both parents are dead, the surviving partner inherits the total estate. In this last case, half of the estate received by the deceased spouse from his (her) parents, may be claimed by the brothers and sisters ( or their descendants) of the deceased partner.

As of July 1st, 2002, the surviving spouse who chose the usufruct on the all inheritance is subject to wealth tax on the full value of the related assets.

Since July 1st, 2002 and subject to the rights of the other inheritors and legatees, the testament is again an attractive tool to organize or to prohibit the control of a business by the partner of the deceased spouse. However it is key to remember that the testator has the right to cancel a testament at any time.

It is also possible to use the marriage settlement to organize the transfer of the ownership of a business and the management right. This is a very efficient protection of the spouse. However it is important to know that it takes 6 to 10 months to modify a marriage settlement and that many legal restrictions apply.
Last it is important to check that the marriage settlement will survive unchanged to an expatriation in another country.

Gift between spouses must comply with several legal requirements ( Notary deed, registration, publication, etc.). Inheritance taxes "Facts and figures" are immediately payable even if the donor has the right to cancel the gift at any time and that the donation must be included back in the inheritance. Donation between spouses is unsettled option.
 
 

 Gift of shares to employees

As of January 1st, 2004 and upon election, gift of full ownership of a business or of shares (up to the value of the goodwill) having a value less than 300 000 € are exempts of gift tax when the beneficiaries are employee(s). (Conditions applies).

This new regime replaces the former 15 000 € rebate granted to each beneficiary.

Valuation of shares
 
 

 Division

A division "Division" is a transaction whereby a company A transfers, on its dissolution without liquidation, its entire assets and liabilities to two or more existing companies or new companies, for example B and C.

When the division is used to transfer a business, the tax free regime is subject to a prior ruling "Ruling" obtained from the French tax authorities.  
 

 Transfer of real estate

When the manager of a business decides to purchase a real estate, he may book it as an asset of the company or he may also acquire the building through a real estate company.

A real estate company facilitates the division or the sale of the real estate. In addition it avoids discounting the building which very often is of no interest for many acquirers. Keeping real estate separate facilitates also the analysis of the business profitability.

Last a building free of any mortgage is valuable collateral to get a bank loan often necessary to pay the inheritance taxes in case of transfer. A real estate company is taxed as a look through entity or may elect for corporate tax. Several restrictions apply. 
 

 Usufruct - Naked ownership

For wealth tax purpose, the value of an usufruct must be added to the tax base of the beneficiary of the usufruct for their full value (Usufruct + bare ownership).

A retiring manager who keeps the usufruct of their business may continue to benefit, under some restrictions, of the wealth tax exemption available for business estate up to their bare ownership value.

French tax authorities indicated that when there is a gift of the naked ownership prior of the gift of the usufruct the consolidated value of the two gifts cannot exceed 100% of the value of the gift of the full property with respect of the calculation of the gift tax (Réponse Biancheri - Question N° 38802 - Response published in JO on 28/03/2006 page 3385) 
 
 

 Tontine provision

See "Private assets ". 
 

 Lease of stock and shares

In order to facilitate the buy-out of companies without acquiring immediately a significant amount of the outstanding shares, it is now possible to lease the shares or the stocks of the target. The lease agreement must be registered with the French tax authorities. The lease holder, who must always be an individual, is treated as the tenant for life. He is taxable on the dividends paid with respect of the leased stocks. When the dividends received are lower than the rent paid, the related losses are not deductible from the taxable basis for personal income tax. It will only be possible to carry them forward during 6 years to offset future years stock and shares earnings. 
 

 Gift of shares

The tax deferral benefiting to capital gains on business incorporation or partial business transfer is maintained in case of gift of the naked ownership of the shares received in remuneration of the transfer. Before, the gift of the full ownership was required.

Tax deferral on capital gain is maintained when the company which benefited from the transfer of assets is subsequently reorganized. Capital gain will be taxable only when the shares will be sold for cash.

 Share for share contribution followed by a sale

When an individual wants to sell his company, he may first exchange his shares at market value against shares in a new holding company. French tax law considers this first step as a non taxable event. The capital gain triggered by the exchange of shares (Contribution value of the shares minus acquisition value by the individual) was frozen until 1999 and is differed as of 2000. In a second step, the holding company may sell the contributed shares without any capital gain (Sale value = contribution value = fair market value) and invest the money in new professional assets or estate.

Until 2005 this scheme, known as "Apport/Cession", was treated as an abuse of law by the French tax authorities in agreement with the position of the Consultative commission for the repression of abuse of law "CCRRAD".

In his 2006 report, the CCRRAD indicates that Apport/Cession implemented as of 2000 (first year when the deferral of the capital gain on contributed shares replaced the freeze of the capital gain) should be deemed as non abusive whatever the selling price received by the holding in consideration of the sale of the shares will be used for.

If the individual sells the shares received in remuneration of the contributed shares 8 years after the share for share exchange, and assuming all conditions are met, the related capital gain will be fully tax exempt. This would also apply in case of gift.
 
 

 Acquisition of shares - Tax deductibility of interest

Employees and Manager receiving a salary have the right to deduct from their salary the interest paid with respect of loans raised for the acquisition of the shares of the company they are working for when they meet the four conditions below:

- Election to calculate their taxable salaries by deduction of the cost for their real value (Frais réel)
- The company must be subject to Corporate Income Tax
- Shares must be acquired in order to be hired by the company or to continue to work for the company (To earn or to continue to earn a salary)
- The interest charge is proportionate to the actual or near future earnings.