French tax law combines the pass-through approach and the entity approach of a partnership.
Like many other tax systems, although to a different extent, the French tax regime of partnership combines a look-through approach and a certain personality of the partnership.
French partnerships are not liable to either income tax or corporation tax on their income that is allocated to their partners, who in turn include their share of partnership profit in their taxable income. Losses made by a partnership may be deducted by the partners from their taxable income. Profits from a partnership may be sheltered by each partner’s losses. In a chain of partnerships, there is no limitation to the number of partnerships through which taxable income (or deduction) would flow to the first taxable person. In the author’s opinion, French partnerships are similar to many look-through entities in other jurisdictions and should not be regarded as a tax subject for income taxation.
However, French tax authorities and courts constantly state as principles that entities governed by article 8 of the French General Tax Code have a legal or tax personality distinct from that of their members and they carry out - or are deemed to carry out - their own activities; although, in many situations, partnerships are a means to carry out a business or profession in common or to pool the results of their members’ activities.
From these principles or assumptions it is sometimes assumed that such entities are tax subjects. In practice, both propositions are combined as follows.
Determination of partnership income
Transactions between the entity and any of its members are recognised and taxed as such. When a member contributes an asset (in exchange for an interest in the partnership), or sells a good or performs a service to the partnership for a price or another consideration, a gain, profit or loss is recognised and included in the individual taxable basis of the relevant partner. Conversely, the price paid or owed by the partnership to its partner in consideration for the asset, good or service provided by him or her is deductible (or amortisable) from the partnership’s income. It is not uncommon for partners in a French partnership to lend money or lease an asset to the partnership. Interests on the loan or lease payments are recognised for tax purposes; they are not deemed a supplementary allocation of partnership income. The only major exceptions relate to employment income of an individual partner (which is not deductible) or his or her spouse or tax-recognised companion (which is deductible only up to a very low amount).
Similarly, where the partnership transfers an asset or delivers a service to a partner, the price or fair market value, whichever is higher, is an element of the partnership income and could be deductible expense for the acquiring partner.
Where a partnership is the vehicle under which individual partners or some of them carry on their business or profession, their interest in the partnership is a professional asset, Accordingly, the acquisition costs of such interest, and the cost of acquisition financing, incurred by each individual partner are deductible from the professional partner’s income (ie, his or her share of partnership income even though those costs are not borne by the partnership or shared with the other partners). A similar solution applies to certain professional expenses, such as partners’ social security contributions and other costs, borne by each partner instead of being mutualised among the partners while being recorded as professional expenses of the partnership. All these costs and expenses are reported in the partnership’s tax return with the allocation of net income of the partnership to each partner.
Each individual or corporate partner reports its net share of partnership income as a single amount in its own income or corporation tax returns and does not file a special tax return for its share of profits in the partnership.
Partners’ shares in profit and losses of partnerships are aggregated into their net taxable income. Net losses of each partner may be brought forward or carried back, including where they derive from various partnerships.
Accounting and tax obligations: audit procedures
Accounting and tax filing obligations bear on the partnership. As a result, it was held that a reserve for litigation risk must be booked and reported by the partnership in order to enable the partners to deduct their portion of reserve from their taxable basis and only a reserve booked by a taxable partner would be disallowed.
A French partnership does not file a single tax return but as many tax returns as it has different tax categories of partners, namely:
- individual resident persons;
- corporations or other entities liable to corporation tax in France (even if only on their share of partnership income);
- non-resident partners (occasionally with a further distinction between non-resident individuals and non-resident entities); and
- tax-exempt institutions.
Generally, each partner must also file a tax return reporting his or her (or its) share of partnership income as part of his or her (or its) overall taxable income. As a result, non-resident partners in a French partnership carrying out activities in France must file the usual income or corporation tax returns in France, even where such returns report a single entry, namely the share in the partnership’s income that year.
The tax audit procedure is carried out with the partnership (article L 53 of the tax procedure code) and is an integral part of the tax procedure that ends with the taxation of each partner. The partnership’s manager has the power to answer questions and to discuss reassessments notified to the partnership, but it has no power to challenge them; partners only are entitled to challenge their own ensuing taxation.
Accordingly, even in compliance and procedural matters, the tax personality of French partnerships is more uncertain that it would have seemed.
Gains or losses made upon the disposal of a partnership interest
Pointing towards the personality of the partnership, French tax law does not treat a partnership interest as a share in the assets and liabilities of the partnership but rather as an element of intangible property like any other share in a company or corporation.
However, because the partners include their share of partnership profits in their taxable income, irrespective of whether these profits are distributed, French tax courts have consistently held that the tax basis for the partnership interest must be adjusted by an amount equal to the net sum of undistributed profits and uncovered losses of the partnership attributed to the partner. In effect, this solution may result in a tax-free step-up in basis where a property is acquired through the acquisition of shares or interest in a partnership hold such property.
French courts also hold that no depreciation of a partner’s interest in, or debt on, a partnership may be deducted for French income tax purposes, at least to the extent that depreciation corresponds to past or future losses of the partnership.
Here again, we find a combination of the look-through approach and the distinct personality of the partnership.
Tax exemptions in a partnership context
Exemptions generally apply on a flow-through basis. Partners may enjoy personal exemptions on the sale of real estate by a partnership. They may also enjoy exemptions that apply to the activity carried on by the partnership. The only notable exception related to the exemption of agricultural cooperatives that was denied on their share of profits in a GIE but, as a result of a legislative change, it is the author’s view that this solution may have been superseded.
Strangely enough, the major exemptions where the flow-through approach of partnerships is denied relate to intra-group financial flows and result in two situations of economic double taxation, even in a domestic context: (i) the dividend-received deduction has traditionally been denied with respect to qualifying shareholdings held by a French corporation through a partnership being either a French GIE or a foreign partnership; and (ii) thin-capitalisation rules apply to partnerships with corporate partners who are also partnership lenders (ie, interests are taxed to the corporate partner or lender, while interest deduction may be denied or delayed in the partnership).
Partnerships as paying agents on passive income
As far as passive income is concerned, the French system is more straightforward. Both for purposes of the EU Savings Directive and reporting and withholding under French domestic law, partnerships are mere paying agents. As a result, they are deemed to pay to their partners the interest, dividend, capital gains on real estate and other passive income at the same time they receive them. Where a partnership only owns a portfolio of securities or receivables, it is not required to file any income tax return and may file only paying-agent statements.
Taxation of foreign partners in French partnerships
Foreign partners - like domestic partners - are liable to income or corporation tax on their income, including their share of income or profit in the partnership as if they would have realised it themselves.
Business profits attributable to the activity of the partnership in France are taxable at standard income and corporation tax rates. The ‘branch tax’ should not apply to foreign corporate partners. Where a reduced rate applies to long-term capital gains - or royalties from patent and agricultural specialty - it applies equally to both domestic and foreign partners. Net losses arising from the operations of French partnerships may be brought forward or carried back by foreign corporate partners under the same rules as apply to French corporations.
Dividend, interest, real estate income and capital gains, and other passive income from French sources, are taxed by way of withholding tax where applicable, to foreign partners in the same manners and at the same rates as if they would have been realised directly by them. No withholding tax applies on interest or portfolio capital gains under French domestic law (except at the deterring rate of 75 per cent where paid to a blacklisted non-cooperative state or territory).
Foreign tax-exempt partners should benefit from the same exemptions as would apply to similar French tax-exempt partners.
Third-country source income (triangular situations)
Subject to (undefined and accordingly uncertain) abusive situations, business profits from foreign sources should not be taxable to foreign partners even though they would be realised through a French partnership. Where corporate partners are involved, this is a result of the French territorial scope of corporation tax, even towards domestic corporate partners. There is no law on the same point for foreign individual partners, but the practice seems well established with multinational partnerships organised under French law that have their main office in France, and other offices and partners in various other jurisdictions. French resident partners are liable to income tax on their share of worldwide income of the partnership. Non-resident partners are liable to income tax in France on the partnership business or professional income from French sources only.
The only controversial point relates to the taxation of foreign partners’ shares in the passive income from foreign sources flowing through a French partnership. Normally, no French taxation should apply provided the foreign partner does not hold his or her partnership interest through a PE in France. The French partnership would not normally be deemed a PE of the foreign partner and would merely be a paying agent.
The current legislative and regulatory environment would segregate passive income flowing through a partnership from business income of the partnership. A foreign partner should have no tax exposure in France on passive income from foreign sources of a French partnership, except where the perception of passive income results from carrying out a business through a PE in France of the partnership, in which case the business profit allocation rule should apply.
Back to top