Under treasury agreements, cash loans between related companies are common.
Interests paid between related companies are normally deductible up to the limit of the annual average of the average effective rates charged by credit institutions for variable-rate loans granted to companies. However, interests may be deducted based on the rate, if it is higher, that the borrowing company could have obtained from independent financial institutions or organisations under similar conditions. It is then up to the borrowing company to justify this rate by any means.
Since 10 July 2019, the French Supreme Court had softened the burden of proof by allowing companies to use bond benchmarks to demonstrate the arm’s-length nature of an intra-group interest rate if issuing bonds is a realistic alternative to an intra-group loan. Subsequently, the Administrative Court ruled that the company demonstrated that the interest rate was not excessive in relation to the yield on bonds issued by companies in comparable economic conditions (SAS Wheelabrator Group, 6 December 2019) by stating that the Supreme Court referred to OECD principles.
However, the Court does not provide any details on the notions of “comparable economic conditions” or a “realistic alternative to an intra-group loan”, so the probative force of the comparable presented by the companies is examined on a case-by-case basis.
Thus, the Paris Administrative Court of Appeal (Apex Tool Group, 10 March 2020) refused to deduct interests on a loan between related companies when the credit rating assigned to the loan did not correspond to the intrinsic situation of the borrowing company. The Court maintained that the grade took into account the aggregated financial statements of the sub-group that this company formed with four of its subsidiaries and sub-subsidiaries. In other words, it is allowed to refer to companies provided they have “comparable economic conditions”. However, this condition cannot be regarded as fulfilled for the companies where it is only explained, on the one hand, that they have credit ratings close to those attributed to the borrowing company’s loan, and, on the other hand, that they have gone to the bond market for transactions with the same duration and maturity.
Recently, the Paris Administrative Court of Appeal also rejected the comparable used (Willink, 23 September 2020) since the level of risk used as a comparison tool was based on a statistical model that took into consideration some historical quantitative data from companies that are not representative of the market - with defaulting companies being over-represented - and was determined on the basis of only around ten pieces of financial data.
Thus, for deducting interests paid to affiliated entities, the French company must prove that the interest rate it pays is the one that it could have obtained from independent financial institutions or organisations. The company can succeed in proving that the rate is not excessive by using the yield on bonds issued by companies in comparable economic conditions.
As can be seen from the case law mentioned above, lower Court judges maintain a very narrow interpretation regarding the evidence that the borrowing company must furnish so as to justify the market rate of its intra-group loans. However, the French Supreme Court seems to have a more flexible position on this matter.
On 11 December 2020, the French Supreme Court ruled a case in which the company BSA presented 3 different supporting documents justifying that the intra-group rates applied did not exceed the average effective rates applied by the banks. Indeed, the rates applied were the result of the addition of three elements: the fixed rate resulting from an interest rate swap contract based on the variable rate that constitutes the lender’s cost of funds – produced by the company Bloomberg – (i), the cancellation premium rate, which is the counterpart of the right to prepayment with which the loans were associated (ii), and the credit line – produced with the Riskcalc software developed by the rating agency Moody’s – (iii).
The French Supreme Court annulled the Court of Appeal’s judgment because it considered that the Court of Appeal had rejected the supporting documents submitted to it without providing sufficient justification for said rejection.
This recent decision demonstrates a more flexible position of the French Supreme Court, which reminds the lower Courts that when rejecting supporting documents presented to them, they must substantiate their rejections.
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