Transfer of deficits in the event of a merger: a scope broader than expected

In its recent comments on the mechanism of transfer without ruling to an acquiring company of the tax losses of an acquired company, the French tax administration adopts a flexible and welcome interpretation of the rules resulting from the 2020 Finance Law.

During a merger-acquisition transaction, the acquired company frequently accumulated tax losses representing potential tax savings that the acquiring company could use if it obtained the transfer thereof. This transfer may be legitimate when it supports the effort made by the acquiring company to take over and restructure the activities of the acquired company which generated these losses. This transfer may also represent, in whole or in part, a purely financial opportunity.

In order to reserve the benefit to transactions deemed economically relevant, the legislator has historically subjected the transfer of losses to a ruling of the tax administration, which must be requested prior to the transaction and is generally granted only several months after the completion of the transaction. The conditions of the ruling have tightened over time, following the general trend of national and international legislation that is more demanding in respect of the allocation of tax benefits and has more extensive anti-abuse mechanisms.

In this context, the legislator wanted to unclog the administration by simplifying the transfer for transactions presenting more limited issues and risks. Article 53 of the 2020 Finance Law (Law No. 2012-1479 of 28 December 2019) thus provided under certain conditions that the losses of an acquired company may be transferred without ruling to the acquiring company. This option extends to deferrals of financial expenses not deducted and unused deduction capacities under the so-called “ATAD” mechanism (Article 212 bis of the French Tax Code), which establishes a ceiling for the deduction of net financial expenses incurred by companies or groups.

This automatic transfer mechanism codified in Article 209, II of the French Tax Code applies to transactions carried out under the neutral tax regime of mergers of Article 210 A of the French Tax Code, when:

• the cumulative amount of the transferred deferrals is less than €200,000;
• the aggregates that may be transferred do not come from the management of movable assets by companies whose assets are mainly composed of financial interests in other companies or similar groups or from the management of real estate assets;
• during the period during which these aggregates were recorded, the acquired company did not sell or cease to operate a business or establishment.

A similar transfer mechanism provided for in Article 223 I, 6 of the French Tax Code applies to losses, financial expenses and deduction capacities of tax consolidation groups, when the ultimate controlling company is acquired by a company outside the scope which constitutes a new group with subsidiaries of the acquired company. The transfer then relates to aggregates from the acquired company or from the initial group companies that have been selected for the allocation mechanism on a broader basis.

In an update of the Bofip database dated 13 April, the administration provided several clarifications on this mechanism, some of which indicate a welcome spirit of openness.

Welcome details of the amount of the acquired company’s deferrals

After having reminded that the mechanism applies to transactions carried out as of 1 January 2020, the administration thus proposes a logical but favourable interpretation by indicating that the date of completion of the transaction corresponds to that of the legal effect, and not the tax effect if it is earlier (BOI-IS-FUS-10-60-10 no. 100).

The transactions concerned are mergers with or without exchange of securities, as well as transactions of dissolution without liquidation falling within the remit of Article 1844-5 of the Civil Code (BOI no. 30). The automatic transfer is possible under certain conditions in the event of cross-border or foreign mergers (BOI no. 70). However, the mechanism does not apply to demergers or partial contributions of assets (BOI no. 30).

The most constructive clarification relates to the condition relating to the amount of losses, net financial expenses and unused deduction capacities of the acquired company. The drafting of the statutory provision left open the question of whether a company acquired with more than €200,000 in deferrals was outside the scope of the mechanism, or whether the €200,000 limit only concerned the amount of the transfer authorised without ruling. The administration chooses this second option, specifying that the acquiring company may proceed with the transfer without ruling of a share of losses equal to €199,999, the surplus being then definitively lost (BOI-IS-FUS-10-60-20 no. 40 and 50). However, the transfer cannot, in terms of the same transaction, be carried out for a portion exempt from a ruling (up to €199,999) and for another portion in terms of the ruling procedure.

This interpretation nevertheless clearly extends the scope of possibilities, leaving the choice to the acquiring company, for the acquisition of a company with more than €200,000 in deferrals, either to claim the automatic transfer of €199,999, or to file an application for a ruling for a higher amount. It also allows for the automatic transfer of transactions for which the ruling could not have been obtained: the conditions of the ruling indeed imply a stability of the activity causing losses before and after the merger, that the departments issuing the approvals sometimes assess strictly and which the automatic transfer does not require.

Furthermore, the acquired company often has limited amounts of deferrable losses, but potentially generating genuine tax savings, and significant unused deduction capacities, but with no actual use for the acquiring company. In this case, the acquiring company may of course favour the transfer of losses, and waive without adverse consequences the transfer of the unused deduction capacities.

This flexibility of interpretation is reflected in the transfer mechanism provided for tax consolidation groups. The administration reminds that in the event that, before the acquisition of a consolidating parent company by a company that creates a new integrated group with the subsidiaries of the group that ceased, a subsidiary of the first group has exited it (for example because it was sold outside the group), the fraction of the overall loss attributable to this subsidiary cannot be transferred to the acquiring company (unless the exit of the subsidiary results from its merger into a neutral tax regime by another company of the first group). Therefore, if the reduction in the overall loss, by reason of the cancellation of the share of loss relating to the subsidiary exiting the group, leads to the overall loss being less than €200,000, the transfer of the loss is likely to benefit from the automatic transfer mechanism (BOI cited above no. 100).

Some less favourable interpretations

While the administration shows flexibility on the amount of the deferrals, it remains stricter on other conditions of application of the mechanism.

The same applies to the condition relating to the absence of assignment or cessation of operation of a business or establishment in the period during which losses, financial expenses and unused deduction capacities are recorded, which, as specified by the administration, is between the first financial year recording aggregates to be transferred and the completion of the transaction. Any assignment or cessation carried out during the aforementioned period shall entail the obligation to request a ruling, even when the business or establishment sold or having ceased its operation is not the source of the amounts to be transferred (BOI cited above no. 70 and 80).

In the same vein, in the case of the acquisition of the parent company of a tax group by a company which constitutes a new group, the administration specifies that the condition relating to the origin of losses and interest likely to be transferred to the acquiring company (which should not originate from either the management of movable assets or the management of real estate assets), is assessed at the level of each group company (i.e. subsidiary by subsidiary) and not at the level of the parent company alone (BOI cited above no. 60). However, the administration does not specify whether the condition of absence of transfer or cessation of operation is assessed exclusively at the level of the parent company acquired, or must also be verified at the level of each subsidiary concerned.