Since 2012, the French company SASU Alchimedics has been owned by Sinomed Holding Ltd, the holding company of a group of the same name set up by a Chinese resident domiciled in the British Virgin Islands. SASU Alchimedics was engaged in the manufacture and marketing of products using electro-grafting technology for biomedical applications and the licensing and assignment of patents in the field of electro-grafting technologies. SASU Alchimedics was subject to an audit for the financial years 2014 and 2015, as a result of which the tax authorities increased its income for the financial years ended 31 December 2013, 2014 and 2015 by the price of services not invoiced to Sinomed Holding Ltd. In addition, the non-invoicing of these services was considered to be a transfer of profits abroad within the meaning of Article 57 of the French General Tax Code and the amounts were therefore also subject to withholding tax. The tax authorities considered that SASU Alchimedics had committed an abnormal act of management by not re-invoicing to its parent company the services provided in connection with the “development and defence of patents”. The price of the services reintegrated as an indirect transfer of profits was determined by applying to the amount of the expenses recorded a cost plus 5%, considered to be a normal margin. These amounts were used as the basis for calculating the withholding tax, which is the only issue in this case. SASU Alchimedics appealed against the assessment and, by judgment of 2 December 2002, the Administrative Court rejected its application for a refund of the withholding tax. An appeal was then lodged with the Administrative Court of Appeal. Judgement of the Court The Administratibe Court of Appeal set aside the decision of the Administrative Court and decided in favor of SASU Alchimedics. Excerpts in English “… 6. In order to justify the existence of an advantage to the company, constituting an indirect transfer of profits, granted to Sinomed Holding Ltd, the tax authorities note that SASU Alchimedics is the owner of patents attached to a business acquired in 2007, and of an exclusive licence on patents and other intangible rights acquired, the same year, from the French Atomic Energy Commission (CEA) and that it entered into an agreement, on 1 June 2007, with Sinomed Holding Ltd, which will become its parent company, and Beijing Sun Technologie Inc, a company incorporated under Chinese law, owned by Sinomed Holding Ltd, which will become its sister company, a patent licence and sub-licence agreement granting them a perpetual licence for the techniques developed by Sinomed Holding Ltd in return for a one-off payment of 9,530,000 euros. The French tax authorities argued that it was not normal for SASU Alchimedics, following the technology transfer agreement of 1 April 2007, to bear the cost of registering and maintaining the patents and licences alone, without any “financial guarantee in the event of successful marketing of the related products, particularly on the European and American markets”, whereas Sinomed Holding Ltd, which now controls the strategy of the companies it owns, stands to benefit from any future successes and is in a position to prevent it from transferring its assets to a third party. It deduced that by not re-invoicing its parent company, Sinomed Holding Ltd, for services provided in relation to “the development and defence of patents”, despite the fact that it had always been in a loss-making position, SASU Alchimedics had granted an undue advantage to its parent company, constituting an abnormal management practice and an indirect transfer of profits abroad. 7. However, the tax authorities do not dispute that, as SASU Alchimedics points out on appeal, the costs of maintaining and protecting the patents, which were expensed, were its responsibility under the terms of the contract entered into in 2007, which it does not claim was no longer in force. Nor does it dispute that the research expenses invoiced by Beyond and Université Paris-Diderot, and the overheads deducted as expenses, were incurred in the interests of SASU Alchimedics. The fact that this company has a chronic deficit does not, in itself, justify the increase in operating income, nor does the fact that an asset is insufficiently profitable constitute, in itself, an abnormal act of management. The tax authorities have failed to identify the “patent valuation and defence” service that they claim to have identified for the benefit of Sinomed Holding Ltd and the exact nature of the advantage that they intend to impose, and have failed to demonstrate under what obligation SASU Alchimedics should have re-invoiced this company for these expenses. The fact that SASU Alchimedics does not have control over its strategy is not, in itself, a decisive argument proving the reality of services provided for the benefit of Sinomed Holding Ltd. Moreover, the contract concluded with this company and with the company that was to become its sister company was signed in 2007 at a time when it is not alleged that SASU Alchimedics was dependent on Sinomed Holding Ltd, and the investigation shows that SASU Alchimedics did in fact benefit from the patent concessions and sub-concessions, which were remunerated in the form of a single payment in 2007. Lastly, although the French tax authorities invoke the prospect of marketing in Europe and the United States the products already developed by the Sinomed group, and in particular by the Chinese company Sino Medical, under the contract concluded in 2007, during the period in dispute there was nothing to require SASU Alchimedics to have signed a contract with its parent company to have the latter bear the costs of maintaining, registering and defending the patents and licences of which it remained the owner and which are not yet used on its continents, where they were not registered. 8. In these circumstances, the French tax authorities have not established the existence of an advantage granted by SASU Alchimedics to Sinomed Holding Ltd and, consequently, of a practice falling within the scope of Article 57 of the French General Tax Code ...

In this case, A. S.A. had granted interest free loans to an affiliate company – Poiana Ciucas S.A. The tax authorities issued an assessment of non-realised income from loans granted. The tax authorities established that the average interest rates charged for comparable loans granted by credit institutions in Romania ranged from 5.45% to 19.39%. The court of first instance decided in favor of the tax authorities. An appeal against this decision was lodged by S S.A. According to S S.A. “The legal act concluded between the two companies should have been regarded as a contribution to the share capital of Poiana CiucaÈ™ S.A. However, even if it were considered that a genuine loan contract (with 0% interest) had been concluded, it cannot be held that the company lacked the capacity to conclude such an act, since, even if the purpose of any company is to make a profit, the interdependence of economic operations requires a distinction to be made between the immediate purpose and the intermediate purpose of a commercial activity, both of which are the cause of any legal act. Since company A. S.A. is the majority shareholder in Poiana CiucaÈ™ S.A., the grant of a sum of money to the latter, at a time when it was unable to secure financing, is intended to safeguard the economic activity and, implicitly, to obtain subsequent benefits for the company.” “The essential legal issue in this case is that for the period prior to 14 May 2010 (when the tax legislation changed) there was no legal basis for reconsidering the records of the Romanian related persons. Art. 11 para. (1) sentence 1 of the Tax Code cannot be considered as applicable in this case, as it refers to the right of the tax authority to disregard a fictitious/unrealistic transaction, which is not the case of the operation analysed during the tax inspection, which took place between companies A. and Poiana CiucaÈ™. Thus, the second sentence of Art. 11 para. (1) of the Tax Code, relating to the reclassification of the form of a transaction, becomes fully applicable to the factual situation at issue, as the tax authority considered the transaction between the two companies to be a genuine loan and not a contribution to the share capital.” Judgement of Supreme Court The Court set aside the appealed judgment, and refer the case back to the court of first instance. Excerpts “Consequently, the High Court finds that the objection of limitation of the authority’s right to determine tax liabilities for 2008 is well founded, since the decision of the court of first instance rejecting that objection was handed down with the incorrect application of the relevant provisions of substantive law, a ground for annulment provided for in Article 488(2) of the EC Treaty. (At the same time, from an analysis of the documents in the case-file, it is not possible to determine the amount of the sums withheld from the applicant company by the contested acts, representing corporation tax for 2008, interest and late payment penalties relating to that tax liability for the year in question, so that the Court of Appeal cannot determine with certainty the amount of those sums.” “As regards the appellant’s criticisms concerning the contract between it and Poiana CiucaÈ™ S.A., the judgment under appeal reflects the correct interpretation and application of the provisions of Articles 11 and 19(1)(b) of the Civil Service Code. (5) of Law No 571/2003 on the Fiscal Code, as in force at the relevant time, the provisions of Article 1266 of the Civil Code, Article 1 of Law No 31/1990 and point 1.65 of the OECD Transfer Pricing Guidelines. Thus, in analysing the applicant’s claims concerning the classification of the contract concluded between A. S.A. and Poiana CiucaÈ™ S.A. as representing a contribution to the share capital, the Court of First Instance correctly held that those claims were unfounded, having regard to the provisions of Articles 1266 and 1267 of the Civil Code and the content of the contractual clauses contained in the contract in question. From an interpretation of the extrinsic and intrinsic elements of the contract, it cannot be held that the legal act between the contracting parties which occurred approximately eight years after the conclusion of the contract and the making available of the initial funds constitutes an element indicating that those funds represent a contribution to the share capital and that that was the original and real intention of the parties. In accordance with the view expressed by the judge hearing the case, it is held that the obligation to repay the sum granted by way of a loan was extinguished between the contracting parties by a new expression of will which took place between 2015 and 2016 and which cannot have retroactive effect from the date of conclusion of the contract (1 January 2007). That conclusion of the Court of First Instance, with which the Court of First Instance agrees, is not the result of a strictly grammatical analysis of the contractual clauses stipulated by the two parties, but is based on an analysis of the legal act which subsequently arose between the parties, taking into account the entire factual context in which it was concluded, in relation to the clauses of the loan agreement, the content of which was examined in a relevant manner by the court, holding that those clauses cannot be interpreted in the sense asserted by the applicant as regards the nature of the contract. A further argument in support of the above conclusion also derives from the manner in which the contractual terms were performed, the subsequent conduct of the lender, which did not receive any repayment of the sum paid and did not charge any interest, being relevant in that regard. The Court of First Instance examined the lender’s conduct both in the light of the defining features of the loan agreement and in the light of the terms of the contract at issue, finding that that conduct fully complied with the ...

Two Swiss investors had established a structure for the management of a private equity fund in the form of a Swiss “Investment Advisor” AG and a Jersey “Investment Mananger” Ltd. They each held 50% of the shares in the Swiss AG and 50% of the shares in the Jersey Ltd. Swiss AG and Jersey Ltd then entered an investment advisory agreement whereby the Swiss AG carried out all advisory activities on behalf of Jersey Ltd and Jersey Ltd assumed all the risk of the investments. Both investors were employed by Swiss AG and Jersey Ltd had no employees execpt two directors who each received a yearly payment of CFH 15,000. According to the investment advisory agreement Jersey Ltd would remunerate the Swiss AG with 66% of the gross fee income. The Swiss AG would carry out all relevant functions related to investment advisory and recommend to Jersey Ltd acquisition targets which the latter would then evaluate and subsequently decides on and assume the risk of. For provision of the advisory functions two-thirds of the total fees (of 2.25% on Assets under Management) would go to the Swiss AG, and the remaining one-third would go to the Jersey Ltd. The Swiss AG had prepared a benchmarking analysis confirming that independent private equity fund of funds (Dachfonds) earned management fees of between 0.75% and 1% on Assets under Management, which was in line with the 0.75% attributed to the Jersey Ltd. The Swiss Tax Authorities regarded the two Swiss investors employed by the Swiss AG as the only two entrepreneurs in the structure that could have possibly taken any significant decisions. On that basis the tax authorities claimed that the 66/34 profit sharing was artificial and inconsistent with the substance of the arrangements. They argued that the Jersey Ltd should only be remunerated with a cost plus 10%. This assessment was brought to the first instance of the tax appelant court and then to the administrative court. Both courts ruled that the set-up was artificial and not in line with OECD standards, after applying a substance-over-form approach. Click here for translation ...

Lender S.A had granted a loan to a related entity but had not collected the agreed interest payments and not added the interest to its taxable income. The tax authorities stated that granting an interest-bearing loan to a related entity but not collecting the interest still results in taxable revenue. The reason Lender S.A. did not collect interest on the loan was due to the group relationship. Lender S.A. filed an appeal where it argued that since the interest was not received, it could not be taxed. Judgement of the Court The Supreme Administrative Court stated that the arm’s length principle applies to agreements concluded on arm’s length terms, where these are not implemented in accordance with there wording. Hence, the arm’s length standard also applies when the parties do not follow the agreement. Click here for English translation Click here for other translation ...