Distressed companies against the backdrop of Covid-19: Rescue strategies and their consequences in French tax law


The Covid-19 pandemic has generated an economic environment that most companies are unprepared to face. Insolvency has become a powder keg companies are sitting on and governmental support has become crucial for it not to explode. In March 2020, the French government issued a legal package designed specifically for distressed companies which inter alia includes a deferral of corporate income tax payment, a sped-up refund of VAT credits and other tax credits, a rent waiver with a corresponding income tax credit for the lessor company and a moratorium on local taxes.

Those specific measures set aside, French law provides for a whole paraphernalia that groups may rely on where the rescue of distressed companies is at stake.

François Hellio and Rosemary Billard-Moalic offer a review of the existing French mechanisms that may be used to finance distressed companies and focus on their tax consequences.

Three main routes may be taken:

  • Financing through debt (I)
  • Financing through debt waiver (II)
  • Financing through recapitalization (III)

I. Financing through debt

Basic financing lies in a loan granted to a subsidiary by a shareholder. French law provides for several limitations which may minimize deductible loan interest and are even stricter when the borrowing company is thinly capitalized.  

First, the loan interest rate must not exceed the yearly average interest rate applied by credit institutions to an over two-years loan granted to a company [1].  Still, if the borrowing company demonstrates the normality of a higher interest rate in consideration of the specificities of the financing in question -i.e. under the same terms, a higher interest rate would be applied by credit institutions- deductibility may be granted. The burden of proof as to the consistency of the interest rate with credit institutions’ practice lies with the company. The French administrative Supreme Court ruled that a company could legitimately rely on bond yield to support the regularity of the interest rate applied to and intra-group loan [2]. Two recent rulings by the Paris administrative court of appeal apply this principle [3]. However, in the SAS Willink ruling, the court rejected an interest rate based on scoring determined by software developed by credit rating agencies [4]. If the tax authorities consider that the interest rate is not in line with credit institutions’ practice, interest deducted in excess is to be reinstated to taxable income.

Second, a general limitation has applied since 1st January 2019: interest is deductible up to the higher of 30% of EBITDA or €3 million a year [5]. The rule is different for thinly capitalized companies. A company is deemed to be so where its debt ratio – i.e. total shareholder loans granted over equity – exceeds 1.5 (to be assessed either at the beginning or end of the tax year, at the company’s choice). Interest allocated to debt that does not exceed 1.5 times the equity is deductible within the general limitation. Interest allocated to debt in excess of 1.5 times the equity is deductible up to the higher of 10% of EBITDA or €1 million a year [6].

In the Covid-19 unpredictable economic environment, the interest rate is to be determined in consideration of the risks of interest non-payment insolvency and be accordingly documented. Furthermore, the crisis is very likely to have an impact on companies‘ debt ratio so that the number of thinly-capitalized companies may skyrocket. Therefore, before considering any financing of a subsidiary through debt, a comprehensive audit of the group's situation will have to be performed to secure maximum interest deductibility.

II. Financing through a debt waiver

A company may partially or fully waive a debt owed by a distressed subsidiary. However, it may prove not to be entirely satisfactory nor helpful as the creditor may not be entitled to the deductibility of the waived debt (1.)  whereas the debtor is almost always liable to tax on that waived debt (2.).

1. Tax consequences for the creditor

First and foremost, to be deductible, a debt waiver must not be considered as an act of mismanagement. However, it is generally not considered as such where a company waives a distressed subsidiary’s debt, especially where recovering the debt may result in the latter’s insolvency of bankruptcy.

Second, deductibility pertains to the nature of the debt: either it relates to business between creditor and debtor, either it relates to financing between creditor and debtor.

  • Debt waiver with a business rationale[7]

Typically, the debt arises from a business transaction (purchase of goods or services). However, the business rationale more generally refers to the preservation of the creditor’s business interest. For instance, the debt is waived in order to secure business opportunities between two close business partners: significant volume of business, economic dependence, upholding of a foreign market, etc. Where the debtor is a foreign company, the creditor’s business interest is assessed similarly[8]. Within a group, each company's own business interest will be considered separately[9]. The business interest of the group is not acknowledged for French tax purposes[10].

If there is a sound business reason for the debt to be waived, the creditor is entitled to deduct the debt waiver. However, where a creditor waives a debt of a company under business rescue proceedings, it is always deductible, regardless of the creditor’s business interest[11].

Please note that in case of a tax audit, a company’s business interest in waiving a debt will have to be thoroughly substantiated with relevant documentation. If not, not only deductibility may be denied but the highest penalties may apply (40% for wilful misconduct or even 80% for abuse of law).

  • Debt waiver with a financial rationale[12]

Typically, the debt arises from a financial transaction between a company and a subsidiary (e.g. a shareholder's loan – please note that a 10% share is enough for shareholder qualification) and it is waived for financial considerations only.  For instance, a debt waiver has a financial rationale where a company waives its subsidiary’s debt to secure its shareholding and not to preserve a business partnership[13].

Where the main justification for waiving a debt is a financial one, the creditor is generally not entitled to deduct the debt waiver. However, where the debtor is under business rescue proceedings, a debt waiver with a financial rationale may be deducted by the creditor but only to the extent of the negative net balance of the debtor’s net equity[14].

In case the debt waiver is not deductible, the acquisition cost of the creditor’s shareholding in the debtor may be accordingly affected. If the debt waiver leads to a positive balance of the debtor’s net equity, the purchase cost of the creditor’s shareholding is increased by the amount of waived debt[15]. If, despite the debt waiver, the balance of the debtor’s net equity remains negative, the acquisition cost of the creditor’s shareholding is not affected. In the latter case then, the non-deductibility of the debt waiver does not affect the assessment of a capital gain or loss on the further disposal of the distressed subsidiary’s shares. 

2. Tax consequences for the debtor

  • As regards both business and financial debt waivers

The debtor makes a profit which is taxable at standard corporate income tax rate (in 2021, 26.5% if turnover is less than M€ 250 or 27.5% if turnover exceeds M€ 250). Where the debtor has losses to carry forward from prior years, the profit resulting from the waiver can be offset against those losses, but only up to € 1 million plus 50% of the taxable profit in excess of € 1 million. As a result, 50% of the profit exceeding the € 1 million limit may be taxable unless the debtor is under business rescue proceedings. If so, overall limit is to be increased by the amount of debt waived so that no profit remains to be taxed[16]. Considering the current crisis, a good idea would be for the French government to extend such a rule to any distressed company, be it under business rescue proceedings or not.   However, if it means a lesser tax cost on the short term, taxation on the longer term is bound to be higher for fewer losses are left to carry forward.   

  • As regards financial debt waivers granted by a parent-company to its subsidiary

Where the parent-subsidiary regime applies between two companies (among other conditions, a company holds at least 5% of the subsidiary’s share capital[17]), the profit resulting from a financial debt waiver is not taxable if the subsidiary commits to increase its parent’s share in its capital to the minimum extent of the waiver within the next two years[18].

Against the background of the Covid-19 crisis, as regards rent waivers granted between 15 April 2020 and 31 December 2020 (31 July 2021 according the Finance bill for 2021 still pending in Parliament), deductibility for the creditor is acknowledged whatever the whys and wherefores of the waiver[19]. Besides, be the debtor under business rescue proceedings or not, the limitations set for the use of loss carry-forwards are to be increased to the extent of the rents waived.  Furthermore, the finance bill for 2021 provides for a tax credit awarded to companies that waive the rents owed by their tenant companies where the latter had to suspend their activity in the leased premises because of the Covid-19 outbreak[20]. Please note that both lessor and tenant companies must not be under business rescue proceedings.

III. Financing through recapitalization

A group will recapitalize a distressed subsidiary to change the proportions of its debt and equity in order to make its outstanding debt more manageable, especially where the transfer of the subsidiary is contemplated.  Besides, a capital increase is legally required where a company’s equity is less than half its share capital.

A company’s capital is increased through the issuance of new shares or the increase of shares’ par value. Either cash is directly invested, profits or reserves are capitalized or a claim that shareholders have against the company is contributed. The latter is particularly relevant to distressed companies as it also reduces its debt.

1. Tax consequences of recapitalization

A capital increase will not have any direct tax consequence either for the recapitalized company or the contributing company as long as it does not lead to any taxable profit[21]. For example, a company contributes a claim and is compensated with shares. The conversion of the claim into a cash contribution does not lead to any taxable profit for the recapitalized company. For the contributing company, the claim is converted into an increase of the shares’ par value so that the operation does not have any tax consequence (please note that where the claim was entered as a provision and considered as deductible, the reversal of such provision may lead to a taxable profit).  So, contributing a claim differs from waiving a debt as the latter generally leads to a taxable profit for the debtor and may be non-deductible for the creditor.

2. Tax consequences of a subsequent sale of shares issued from recapitalization

The subsequent sale of the newly issued shares or reappraised shares by a main shareholder may be more problematical. Where shareholding results from recapitalization, the fair market value of the newly issued shares or reappraised shares is generally lower than their book-value and upon a subsequent sale, the fair market value of the shares is even lower than the fair market value upon recapitalization, for the situation of the distressed company has generally not improved. Then, if the subsequent sale of the shares occurs less than two years after recapitalization, the resulting loss is deductible up to the difference between the fair market value of the shares upon selling and their fair market value upon recapitalization[22]. For example, the fair market value of the shares upon recapitalization is 20 while the book value is 50. The fair market value upon subsequent sale is 0. Then deductible loss is 20, not 50, which results in 30 being non-deductible.

This partial non-deductibility rule of losses only applies where shares are sold less than two years after recapitalization (short-term losses) - where shares are sold more than two years after, losses will qualify as long-term losses and be non-deductible as such.  Where a main shareholder is concerned, a question of qualification arises: if the initially acquired shares certainly qualify as shareholding (titres de participation), do shares resulting from recapitalization also qualify as such or do they qualify as securities (titres de placement) instead? If the securities qualification was to be assumed, the loss resulting from a further sale would then be fully deductible. Where a claim is contributed, new shares are issued and they could be excluded from the shareholding qualification as they do not result from the initial capitalization of the company. In 2019, the French administrative supreme court ruled that a distressed company’s newly issued shares qualify as securities and not as shareholding as the shareholder intend to sell them right after recapitalisation which differs from his intention upon capitalisation which was to hold and keep them[23]. Then, if the newly issued qualify as securities, losses derived from their subsequent sale are fully deductible. Yet, this solution was given considering companies in the banking sector and it is not certain that it could work with any type of company even though it would be welcome in the current critical situation where recapitalization of distressed companies has become of the essence.

3. Tax consequences of a sale of shares together with an assignment of claim

A company may both sell the shares of a distressed subsidiary and assign a claim against it. If a claim is assigned for its face-value amount, the operation is tax neutral for the seller. However, if it is assigned for a discounted price, the seller will generally be entitled to deduct the related loss. In this respect, assigning of claim at a discounted price than face-value may be a better way to go than waiving a debt as a debt-waiver may not be deductible.

For the distressed company, the transfer of its debt from seller to buyer does not have any tax consequence as long as the seller has properly informed it of the assignment to the buyer[24].

For the buyer, taxation will depend on what is done with the claim. If it is kept as such – i.e. the buyer has a claim against the newly acquired distressed company – there is no ensuing tax. If it is contributed to the capital of the latter though, taxation may occur.

Where a claim is assigned to the buyer at a discounted price rather than face-value, and the buyer makes a cash contribution to the distressed company by way of converting its claim, a potential profit is entered in books. It is made up of the difference between the discounted purchase price of the claim and the par value (that is a not-discounted value) of the shares resulting from the conversion of the claim into equity. This potential profit may be partially or fully neutralized for tax purposes under specific circumstances[25] : the buyer is subject to corporate tax, the cash contribution is made by way of converting a definite, liquidated and payable claim and is compensated with shares for the buyer, the seller is not closely related either to the distressed company or the buyer[26]. As regards the last requirement and according to the Finance bill for 2021, the potential profit derived from the contribution of a claim might be neutralized where the seller is closely related to a distressed company under business rescue proceedings – the absence of ties between seller and buyer would still be required in order to prevent artificial arrangements[27]. If those legal requirements are met, the taxable profit is made up of the difference between the fair market value (and not the par value) of the shares and the discounted purchase price of the contributed claim.

Let’s take an example in which we’ll consider that legal requirements are met: a buyer purchases a claim for 75 where face-value is 100. This claim is contributed to the distressed company.  The fair market value of the buyer’s new shares is 80. In books, profit resulting from the contribution of the claim is 25 (100 – 75) whereas taxable profit is 5 (80 – 75). 20 potential profit is then neutralized for tax purposes.


The Covid-19 pandemic certainly creates new considerations that must be layered on top of considerations that always come with a decision to rescue a distressed company. Strategies may vary according to multiple factors such as the reality (or the lack of) of business ties between creditor and debtor, exiting legal constraints as regards share capital, contractual demands from a buyer, existing business rescue proceedings or a shareholder’s wish to withdraw sooner than later. More than ever, skilful structuring and thorough due diligence will be crucial to alleviate tax costs. Finally, let’s pin our hopes on the tax authorities’ lenience in response to the current economic upheaval.

[1] Articles 39, 1, 3° and 212, I of the French tax code (FTC)

[2] French administrative supreme court (Conseil d’Etat – CE), 10 July 2019, no 429426 and 429428, SAS Wheelabrator

[3] Paris administrative court of appeal (Cour administrative d’appel – CAA) 22 October 2020, no18PA01026, Sté Studialis and CAA Paris 20 September 2020, no 20PA00585, SAS Willink

[5] Article 212 bis, I and II FTC

[6] Article 212 bis, VII FTC

[7] Article 39, 13 FTC

[8] For example, CE 9 Octobre 1991, nos 67642 and 69503

[9] For example, CE 30 September 1987, no 50157

[10] For example, CE 19 December 1988, no 55655

[11] Article 39, 1, 8° FTC

[12] See note 5

[13] For example, CE 30 April 1980, no 16253

[14] See note 5

[15] French tax authorities’ guidelines BOI-BIC-BASE-50-20-10 no60

[16] Article 209, I FTC

[17] Article 145 FTC

[18] Article 216 A FTC

[19] Article 39, 1, 9° FTC

[20] Finance bill for 2021, article 43 sexdecies

[21] Article 38, 2 CGI

[22] Article 39 quaterdecies 2 bis FTC

[23] Finance bill for 2021, article 43 quinquies