Participating interests: it’s the intention that matters

In a judgment of 29 May 2019 (CE 3rd-8th ch. 29 May 2019, No. 411209, Montisambert), the French Council of State (“Conseil d’Etat”) confirmed that securities may qualify as participating interests, resulting in the near-total exemption from corporate tax of the capital gain accruing on their disposal, to the extent that the acquiring company intended, at the time of the acquisition, to exert influence over the investee company, and that there was no need to demonstrate that such influence was actually exerted over the period in which the securities were held.

The facts:

The case concerned a holding company, SARL Montisambert, which, in 2007, acquired a 5.17% stake in Sarenza. As part of the acquisition, the manager and sole shareholder of the holding company was appointed as one of the five members of Sarenza’s Supervisory Board. It was not demonstrated that the powers conferred by this mandate were actually exercised.

Four years later, at the time this investment (reduced to less than 5% following a capital increase in which the holding company did not participate) was disposed of, Montisambert claimed an (almost full) exemption from any resulting capital gains liability under the long-term capital gains regime applicable to the disposal of participating interests.

The dispute relates to the definition of participating interests.

The inability to benefit from the irrefutable presumption that the shares were participating interests:

In the case at hand, the acquiring company could not benefit from this presumption, since the 5% threshold in terms of share capital and voting rights was not met on the date of the transfer (CE, 26 January 2018 no. 408219, EBM).

The intention to exert influence and the means of exerting influence over the target company, required for the shares to constitute participating interests:

From a tax point of view, the definition of participating interests follows the accounting definition. They are shares the long-term ownership of which is deemed valuable to the company’s business, in particular because the holding of such shares allows the company to exert influence over, or control, the investee company.

Ownership is valuable “if the conditions in which the shares in question were purchased demonstrate the purchaser’s intention to exert influence over the investee company and provide it with the means of exerting such influence” (CE 20 October 2010 no. 214248, CE 12 March 2012, no. 342295, and CE 20 May 2016 no. 392527).

Influence can be demonstrated through involvement in the target company’s management and financial policy and may take the form of representation on the company’s management or supervisory bodies.

The date of which influence is to be assessed:

In its decision of 29 May 2019, the French Council of State confirmed that the intention to exert influence, as well as the means to exercise influence, is assessed in light of the conditions at the time the shares are purchased, i.e. on the date on which the shares are purchased without there being any need to demonstrate that such influence has actually been exerted over the course of the period during which the shares are held.