French Court Upholds EU Freedom Of Establishment

by Ulrika Lomas, for LawAndTax-News.com, Brussels

11 August 2004

Normally it is the European Court of Justice which strikes down national rules as incompatible with EU law, but it has recently been reported that the French have used the ECJ's standby 'freedom of establishment' principle to rule that French thin capitalisation rules are incompatible with Article 43 of the EC Treaty.

Article 43 of the EC Treaty generally prevents EU Member States from restricting the creation of subsidiaries by EU companies by enacting conditions which are different from those applying to their own nationals.

The French Conseil d’Etat said that a tax measure which is intended to treat companies or branches differently depending on whether their parent company is seated in France or not, must be analysed as restricting the principle of freedom of establishment, in so far as both subsidiaries are objectively in the same situation with respect to French corporate income tax.

Using this principle, the Court upheld a decision of the Court of Appeal of Lyon that the French tax authorities were wrong to have disallowed the deduction of all the interest on loans paid by a French subsidiary to its German parent company where the debt equity ratio exceeded 1.5:1 (French tax law exempts national parent companies from this rule).

White and Case, who reported this decision, say that the French thin capitalisation rules can now only apply to situations involving a parent company situated in non-EU Member States which are either non-treaty protected, or whose treaty with France provides for a thin capitalisation rule to apply. It is unclear however whether France will extend the parent company exemption to qualifying foreign parent companies or abolish such an exemption altogether.

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