Legislation on prices transferring between international groups is a complex and important subject in the business world. This legislation aims to prevent predatory pricing practices, where companies within the same group set artificially low or high prices to shift profits to low-tax countries. These practices can result in a loss of tax revenue for the countries concerned.
To combat this, many countries, including France, have put in place regulations to govern transfer pricing and ensure that they are established in a fair and transparent manner. It is therefore essential for international companies to comply with the regulations that we will outline below.
I – Territoriality of corporate tax in France
We briefly present below the French principles of corporation tax territoriality.
1 – Taxation of businesses operated in France
The profits liable to corporate tax in France are determined by taking into account only those made in companies operated in France and, possibly, those whose taxation is attributed to France by an international tax convention relating to double taxation.
Thus, only expenses incurred which relate to an activity carried out in France are likely to be deducted.
Companies whose head office are located outside France are, whatever their nationality, taxable in France due to the profits derived from their operations in France.
The notion of a company operated in France (or outside France) is important because it determines whether or not companies are taxed in France. However, it will be different depending on whether or not an international convention applies.
2 – Concept of business operated in France in the absence of a tax treaty
The notion of business operated in France is not defined by the legislator. According to case law, it means the usual exercise of a commercial activity.
Foreign companies are in principle considered taxable in France:
- who operate an establishment in France;
- who, without having an establishment in France, nevertheless use the assistance of representatives considered as real employees carrying out an activity in our country on behalf of the foreign company;
- or who, without having an establishment or qualified representative in France, carries out operations there forming a complete commercial cycle.
3 – Principles of taxation in France in the presence of a convention
An international tax convention may modify the scope of French tax law. The rules of the convention take precedence, in French law, over a provision of a domestic law.
Bilateral tax treaties only apply to persons who are residents of one or both contracting states. Their purpose is essentially to distribute taxing rights between the two States and to avoid double taxation. This distribution is made by referring mainly to the notions of “residence” and “permanent establishment”.
The principles usually used to tax profits in a state are:
- benefit of a permanent establishment => exclusive taxation in the State where the permanent establishment is located, this taxation being calculated in accordance with the legislation of that State;
- profits not linked to a permanent establishment => exclusive taxation in the State of residence of the legal entity, the liquidation being carried out in accordance with the legislation of this State.
The rule stated above, however, has exceptions. Thus, real estate incomes are always taxed at the location of the buildings.
II – Determination of transfer prices
1 – Definition of transfer prices
As we have seen above, in matters of international taxation, each entity of the same group is treated independently of its parent, its sisters and its subsidiaries or branches. Transfer pricing can become a preferred tool for tax evasion.
Companies are concerned, not only for sales of goods and merchandise, but also for all intra-group services: sharing of certain common costs between several companies in the group, provision of people or goods, concession fees for patents or trademarks, etc.
OECD documentation on transfer pricing:
The OECD has published a book entitled “Transfer Pricing Principles for Multinational Enterprises and Tax Administrations 2022”.
“Arm’s length prices”: in order to ensure that the tax bases of each country are as fair as possible, to avoid conflicts between different tax administrations and distortions of competition between companies, member countries of the OECD have adopted the principle of “arm’s length pricing” for intra-group transactions. This means that the price charged between dependent companies must be the same as that which would have been charged on the market between two independent companies.
This principle appears in most tax conventions signed by France.
To determine a price consistent with the arm’s length principle, one method must be selected if-possible from the following:
- The comparable free market price method => This consists of comparing prices to those charged for identical transactions between independent companies.
- The resale price minus method => It consists of retaining the final selling price to the independent customer (outside the group), or determining the arm’s length margin or subtracting this margin from the final selling price to the independent customer in order to obtain the transfer price.
- The cost-plus method => The company determines the cost price of the good or service sold or supplied to a related company and adds an arm’s length profit margin, obtained using a comparable to that practiced by the company.
- The profit-sharing method => This consists of determining the consolidated result for the group on all operations, involving different related companies, to then share it between these same companies according to relevant criteria in order to obtain an allocation-profits comparable to that which would have been obtained in an arm’s length situation.
- The transactional net margin method => Its principle is to determine, based on appropriate data (e.g.: expenses, turnover, value of assets, etc.), the net profit margin that a company achieves within the framework of an intra-group transaction, and to compare it to that which an independent company would carry out for a comparable transaction.
2 – Verification of the conformity of the transfer price with the arm’s length principle
The company must analyze the functions it performs and the risks it assumes (functional analysis), and identify the assets and means used. It must then determine the method and price of intra-group transactions. Finally, it must ensure that the pricing chosen is consistent with the arm’s length price.
The company must choose the most suitable method to remunerate the activity: to avoid any tax risk, the company must ensure that this price is consistent with the arm’s length price.
The company must finally be able to trace the process of determining its transfer prices which it will make available to the administration in the event of an audit (functional analysis, choice of method, pricing, etc.).
Any method used by the company can be considered admissible provided that it is justified, consistent with the functions performed and the risks assumed, and that the remuneration complies with the arm’s length principle. The choice of method and the importance of the supporting documents provided must be adapted to the issues, the use of a sophisticated methodology and the establishment of elaborate documentation may be reserved for re-invoicing of a significant amount.
The company must also search for and select comparable companies; the search takes place at two levels:
- Internal => the company concerned, or another company in the same group, carries out an identical or similar transaction;
- External => an independent company carries out an identical or similar transaction with another independent company. This information is most easily discovered by consulting a commercial database.
The search and selection of comparable companies requires proceeding in several stages:
- examination of the characteristics of the goods or services and search for companies operating in the same sector of activity as the company concerned;
- selection of companies that perform the same function as that of the company concerned;
- selection of an “independence” indicator. It represents the degree of independence of a company from its shareholders;
- examination of the available financial data of the selected companies in order to retain only those with the same profile;
- selection, when the sample of comparable companies is made up, of a relevant ratio, taking into account the function and risks to be remunerated as well as the remuneration method chosen to assess arm’s length profitability.
3 – Prior agreement procedures on transfer pricing
French or foreign companies have the possibility of obtaining from the tax administration an agreement on the method of determining transfer prices which will apply to their future intra-group transactions. The objective of the prior agreement procedure is to constitute an instrument of legal certainty.
Indeed, no tax increase can be made when the administration has concluded a prior agreement relating to the method of determining transfer prices, either with the competent authority designated by a bilateral tax convention, or with the taxpayer.
Below are the types of existing agreements:
- Bilateral agreement: The bilateral prior agreement is concluded between two States by the competent authorities, within the legal framework of the amicable procedure provided for by tax conventions. Given its bilateral nature, the prior agreement eliminates the risks of double taxation while preserving the tax base of the States parties to the agreement.
Agreements can only be concluded with states with which France has signed a tax convention.
The agreement concerns the method to be used and not the setting of transfer prices as such within the multinational group. Depending on the taxpayer’s request, the agreement may concern a segment of activity, a function, a single product, or even a single type of transaction. - Unilateral agreement: The prior agreement on transfer prices gives companies the possibility of obtaining a formal position from the administration on the method of valuing future transfer prices applied to one or more transactions. This agreement guarantees the plaintiff company that the prices practiced in its intra-group industrial, commercial or financial relations do not enter into the forecast of a transfer of profits.
Unlike a bilateral agreement, the unilateral agreement is not negotiated with the foreign administrative authority concerned.
A unilateral price agreement may be requested in the following cases:
- no prior price agreement procedure exists in the other State concerned;
- transactions concern a large number of countries;
- transactions relate to particular subjects or of limited complexity but are a recurring source of differences of assessment;
- the company is a small or medium-sized enterprise (SME).
No unilateral prior agreement procedure may be initiated for existing transactions with companies located in countries with which no tax treaty has been concluded if they have a privileged tax regime (within the meaning of article 238 A of the CGI).
- Simplified agreement procedure for SME: The simplified prior price agreement procedure benefits SME that meet the following cumulative conditions:
- employ fewer than 250 employees;
- either have achieved an annual turnover of less than €50 million during the financial year, or have a balance sheet total of less than €43 million;
- have capital or voting rights not held at 25% or more by a company or by several companies not meeting the above conditions.
For this type of companies, the documentation on its transfer pricing policy is limited to the following documents:
- the group’s organizational chart;
- the list of transactions and their method of remuneration between related companies;
- functional analysis;
- description and justification of the chosen pricing method;
- the tax returns of the French and foreign companies concerned.
The SME must also justify by all means that the pricing policy applied complies with the arm’s length principle.
III – The consequences of the agreement and tax obligations
1 – Request for transfer pricing justifications during a tax audit
In certain cases, as part of the audit of a company’s accounts, the administration may request various information on the methods by which the price of transactions between a company and companies located abroad was defined.
When the company responds insufficiently, the administration sends it a formal notice to complete its response within 30 days. In the absence of a response within the deadline, the administration evaluates the tax bases concerned by the request based on the elements available to it. In the absence of precise elements to make adjustments, taxable income is determined by comparison with that of similar businesses operated normally.
The company is also subject to a fixed tax fine of €10,000 for each financial year covered by the initial request.
2 – Documentary and reporting obligations regarding transfer prices
2.1 – Annual transfer pricing declaration
Legal entities established in France must submit a declaration relating to their transfer prices when they satisfy one of the following conditions:
- their annual turnover excluding tax or the gross assets appearing on the balance sheet is greater than or equal to €50 million;
- they hold at the end of the financial year, directly or indirectly, more than half of the capital or voting rights of a legal entity satisfying one of the conditions mentioned in 1;
- or more than half of their capital or voting rights is held at the end of the financial year, directly or indirectly, by a legal entity satisfying one of the conditions mentioned in 1;
- or they belong to a group covered by the tax consolidation regime when this group includes at least one legal entity satisfying one of the conditions 1 to 3 mentioned above.
Are however exempt from this declaration:
- companies that do not carry out any transactions with related entities established abroad;
- companies which carry out transactions with related entities established abroad for an amount less than €100,000 per nature of transaction.
The declaration must be filed within 6 months following the deadline for filing the declaration of results by submitting form 2257-SD electronically. This declaration includes two main chapters:
- General information on the group of “associated companies” => In the first frame of page 1 of declaration 2257-SD, the company must identify the main activities of the group as well as the nature and location of the intangible rights exploited. These intangible assets must have a main character for the group and be related to the reporting company. The main character of an intangible asset is assessed with regard to the importance of its contribution to the group’s activity.
The company must, at the end of this first part, provide a general description of the group’s transfer pricing policy and the changes that occurred during the financial year. - Specific information regarding the reporting company => In the second part of the declaration (pages 2 and 3), the reporting company must provide a description of the activity carried out, including the changes that occurred during the financial year. The changes which concern the French company, both in terms of pricing policy and the nature and location of assets must be informed and briefly developed.
This description is supplemented by a summary statement of transactions carried out with other “associated companies”, when the amount of the transactions exceeds €100,000.
2.2 – Documentation to be kept available to the administration
This documentation must be made available to the administration on the date of initiation of a general, one-off or simple accounting audit. It does not replace the justifications relating to each transaction.
The legal entities covered by the documentary obligation regarding transfer pricing are the following:
- whose annual turnover excluding taxes or gross assets appearing on the balance sheet is greater than or equal to €150 million (since January 1st 2024);
- or, holding at the end of the financial year, directly or indirectly, more than half of the capital or voting rights of a legal entity satisfying one of the conditions mentioned in 1;
- or, of which more than half of the capital or voting rights is held, at the end of the financial year, directly or indirectly, by a legal entity satisfying one of the conditions mentioned in 1;
- or, belonging to an integrated group, when it includes at least one legal entity satisfying one of the conditions mentioned above (in 1, 2 or 3).
Objectives of the documentation: It must make it possible to justify the transfer pricing policy practiced in the context of transactions of all kinds carried out with associated companies established or incorporated outside France.
Structure of the documentation: It must be presented in an electronic format, it consists of two parts:
- The first part constitutes the main file and includes information on the group of associated companies.
This file has five sections in the following order:- organizational structure;
- description of the area(s) of the multinational group;
- intangible assets of the multinational group;
- inter-company financial activities of the multinational group;
- financial and tax situation of the multinational group.
- The second part constitutes the local file and includes information on the verified company.
It is presented in the form of three sections in the following order:- entity in France;
- controlled transactions;
- financial informations.
This documentation must be established or updated in such a way as to enable the companies concerned to ensure, from the moment they set their transfer prices, that these prices comply with the arm’s length principle. Correspondingly, comparable studies must favor the most recent information available on the date of invoicing of the transactions. When the conditions for carrying out the activity remain unchanged, the comparable studies can be updated every three years.
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