23 July 2018

Market rates on shareholder loans: impossible proof?

In a ruling dating from January 18th 2018 (1), the Paris Administrative Court confirmed the administration’s reconsideration of the deductibility of interest in majority shareholder loans granted during an LBO. This decision confirms the administration’s strict position in which it systematically requires a preliminary and hard loan offer from a bank to justify that the applied interest rate is a market rate as defined by Article 212-I of the General Tax Code.

As a reminder, this article states that the market rate is the rate “that the borrowing company could obtain from independent institutions or financial agencies in similar conditions”. The question of how to put forward such proof is legitimate given the current lack of legal detail.

In a specific case, a company named Studialis had a number of congruent elements to support the claim that the rate applied was a market rate: a preliminary offer (not a hard offer) for instruments with identical characteristics from the bank that agreed to a Senior loan, a statement from another bank confirming that they would have made a loan offer at a comparable or superior rate, and a report drafted by an independent expert as well as a benchmark confirming that the applied rate was lower than market rates at the same period.

The Administrative Court, however, confirmed the administration’s decision by stating that the company “did not provide any certain proof of the rate the company would have been granted by a credit institution or independent agency including, especially, an actual loan offer tailored to current operations and specific characteristics”.

This decision appears to contradict certain past rulings on the same topic (2), that specified that companies are free to provide any proof of market rates and can, using precise, detail and tangible elements, prove the deduction of interest applied to shareholder loans.

To truly measure the impact of this ruling, we recommend waiting for the ruling of the Court of Appeal or the State Council.

On this note, we hope that the ruling will be in line with the former version of Article 212-I of the General Tax Code (3): the ruling stated that the normal or abnormal character of applied rates for loans between related companies should be considered based on the compensation that the borrower would need to pay to an unrelated financial institution and if they were to borrow, in similar conditions, an equivalent amount. In this context, the High Jurisdiction confirmed the rate applied by the taxpayer without demanding a hard offer from a financial institution.

In the current situation, the ruling of the Paris Administrative Court denies the dialectic process that should be implemented when facing the administrative judge and adds a new condition to the current law by systematically requiring a preliminary and hard offer from a bank to secure deduction of interests in majority shareholder loans. This type of proof is nearly impossible to provide given that it requires negotiating with banks up until their credit committee meeting while knowing that the offer will be rejected by the company.

  1. Paris AC, January 18 2018, n° 1717553/1-2, Studialis
  2. Bordeaux AC, November 13 2014, n°1302599, SNC Siblu – see CAA Bordeaux, April 4 2017, n°15BX01177; Montreuil AC, March 30 2017, n° 1506904, BSA
  3. State Council, June 19 2017, n°392543, General Electric France and General Electric Capital