French LBOs: foreign buyers beware?

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. But just weeks ago, the French parliament adopted a new measure that prevents a France-based holding company from doing so if it is merely an acquisition vehicle controlled by foreign shareholders. The holding will have to prove it is acquiring the shares on its own behalf and that it will control them from its home turf (France).

The legislator was originally targeting foreign corporate buyers acquiring businesses in other countries via subsidiaries based in France and with the use of debt, in order to benefit from the fiscal integration mechanism. "Eventually, the scope of this measure will be much wider in practice," warns Vincent Renoux from law firm Stehlin & Associés.

Indeed, this could potentially mean that LBOs of French companies backed by private equity funds based in Luxembourg, Guernsey or the Caymans could be impacted by the new regulation. Given that foreign buyout houses contributed to a sizeable part of French LBOs in 2011, is this bad news for the country's PE activity?

"At first glance, things shouldn't change too much for French LBOs," explains Renoux. "Advisers always recommend that buyers ‘activate' the holding prior to an acquisition by appointing managers that can act as decision-makers – notably in order to offset VAT borne on expenses related to the buyout. But it remains to be seen whether this will be sufficient proof for the tax administration."

Renoux adds that less sensible requirements could be put in place. For instance, the newco could have to prove it can sell the shares whenever it pleases – doing so prior to the shares actually being sold could prove very complex. Depending on the administration's stance on the matter, buyout firms could therefore breathe a sigh of relief, or think hard about potential loopholes to avoid a measure that didn't specifically target them in the first place.

In any case, this does little to simplify the already complex French fiscal landscape as Renoux points out: "The legislator often doesn't properly take into account the existing framework, which is exactly what is happening in this case. There is an existing belief that all of the interest payments can be deduced from the company's tax base under the fiscal integration mechanism – but France already has complex thin capitalisation rules that limit this deductibility in many instances. Once again we end up with a hastily drafted measure, the unforeseen effects of which only add more uncertainty."

It also remains to be seen whether the measure's patriotic subtext will sit well with the international community. "I am not sure this measure could be upheld given the existing French fiscal conventions and, perhaps more importantly, free-trade rules both at the international and EU levels," notes Renoux.

The tax administration should issue guidance documents shortly, which could clarify the requirements and help alleviate uncertainty. If "activating" the holding is sufficient, business should remain unaffected for most PE houses. If a less sensible approach is taken, foreign funds will have to wait for the first contentious cases to set precedents and assess whether pursuing French targets is worth the price of admission.

To read more about the increased fiscal pressure on private equity across Europe, click here.

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• Topics
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• Buyouts
• France