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Unquote
  • France

French presidential election spells bad news for PE industry

Socialist party candidate Francois Hollande plans to limit the tax deductibility mechanism for interest payments on acquisition debt if elected
  • Greg Gille
  • Greg Gille
  • @unquotenews
  • 06 February 2012
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The regulatory landscape is getting tougher across Europe for private equity - but French players might have more to worry about than most, as presidential candidates unveil measures that could affect the industry. Greg Gille reports

Francois Hollande, the Socialist party candidate and current poll favourite in the upcoming presidential election, unveiled on January 26 a series of fiscal measures he would introduce if elected. Among those are new limitations on the tax deductibility mechanism for interest payments on acquisition debt - a move that could significantly affect the French PE community.

French fiscal law allows a holding company, assuming specific requirements are met, to offset interest payments from its tax base when acquiring a business in an LBO transaction. This fiscal advantage was already dented at the end of 2011 - the French parliament adopted a new measure preventing a France-based holding company from offsetting the payments if it is merely an acquisition vehicle controlled by foreign shareholders.

The Socialist Party expects the measure to bring up to €4bn a year in additional tax revenues. Although Hollande has yet to disclose full details on this measure, industry trade body AFIC understands that interest payments wouldn't be deductible if they exceed 30% of a group's EBITDA. "This measure would negatively impact the economy as a whole, and not only LBO transactions," warns Louis Godron, partner at mid-market firm Argos Soditic and chairman of the AFIC's LBO Committee. "It would penalise businesses which, given the nature of their activity or the pace of their growth, have heavy financing requirement. This of course includes companies in the industrial sector, which is odd at a time when there is a consensus to promote job creation in French industry."

Godron adds that the measure would be ill-advised given the current economic environment: "The proposition's other pitfall is its pro-cyclical nature. In a downturn, financial charges remain largely the same whereas EBITDA is likely to go down: struggling businesses would be hit twice as reduced profits would trigger higher taxes."

The proposition could also send wrong signals to the business community, by stifling ambitious investment programmes and entrepreneurship. "We fear this could discourage businesses from making heavy investments; these generally result in a short-term drop in profit and generate higher financial charges, which again would risk triggering the non-deductibility mechanism. In a nutshell, does France need a law that hits industry, hampers fast-growing businesses and deters from launching any bold initiative ?" notes Godron. He nevertheless adds that fiscal integration's modest contribution to overall returns means that French private equity funds should remain attractive to investors.

Meanwhile incumbent President Nicolas Sarkozy decided in late January to push forward with the introduction of a tax on financial transactions, without waiting for a Europe-wide consensus. The 0.1% tax would be applied to all share transactions for Paris-listed businesses - it would therefore only affect PE activity with regards to PIPE investments, take-private transactions and IPOs. The measure would take effect on August 1 this year, but its limited scope leaves the AFIC unfazed: "We don't think having a 0.1% tax levied on public market transactions will fundamentally upset our industry - which is not focused on public markets - therefore the AFIC remains quite neutral on this issue," says Godron.

Easy target

The extent to which post-election reforms will affect the private equity community remains unclear, as candidates are still fine-tuning their program's delicate fiscal balancing act. Looming elections notwithstanding, France's increasingly strained public finances make private equity an easy target to replenish the coffers - especially at a time when the financial sector is not exactly winning the battle for public opinion.

In December, Parliament scrapped the €5,000 cap on the transfer tax that applies to the acquisition of shares in unlisted companies. The acquisition price of the shares is now generally subject to a 0.5% levy, with a 3% rate applying for the part of the price below €200,000 and 0.25% above €500m. Godron reckons that the tax's overall rate leaves PE investments relatively safe: "While not welcome news, this measure is also unlikely to deeply impact our business model."

But between the recently introduced measures and the ones that could follow the election, many in the industry feel that private equity is getting the short end of the stick: "I fail to see why punitive measures have to be taken against LBOs," laments Godron. "The perception shared by many politicians and the public in general is that private equity destroys jobs. But the French PE industry has for years adopted a model based on the growth of portfolio companies. For instance, the 625 buyouts monitored by the AFIC created 17,200 jobs in 2010 whereas unemployment in general went up by 80,000 people. Private equity is beneficial both for the companies it invests in, and for the millions of citizens whose savings are generating higher returns - French private equity has returned 8.6% annually over 10 years, while the stock market only returned 0.8%."

Although the association is busy promoting private equity ownership's more positive aspects - notably through regular research into the industry's contribution to the economy - Godron highlights that much work remains to be done: "Explaining that a financial industry can be beneficial to society is not an easy task, which is why we have to spend much time and effort detailing what private equity actually does."

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