The exclusion of certain earn-outs from the benefit of tax deduction for the holding period, with regard to capital gains on transferable securities, is unconstitutional.

February 5th 2016

The agreements for the transfer of securities or social rights often provide for the payment, in addition to the transfer price, of an additional price or earn out.

This earn-out shall be subject to tax for the year in which it is received.

Until December 31, 2012, the tax treatment for the earn-out was the same as that of the capital gains made from the transfer price. It was subject to tax, in the same conditions, at the proportional rate applicable for the year in which it was collected.

Since January 1, 2013, the capital gains and the earn-outs are subject to tax at the progressive rate of income tax. In order to mitigate the effects of the progressivity, the legislator also set up a tax deduction mechanism according to the duration for holding the securities.

In this regard, paragraph 3 of 1., of Article 150-0 D of the French General Tax Code sets forth that “the earn-out provided in paragraph 2, I, of Article 150-0 A, relating to transfers of shares, rights or interests mentioned in the second paragraph of section I, shall be reduced by the deduction provided in the same paragraph and applied during this transfer”.

Discrepancies arose from the application of this provision between the tax Administration and the transferors.

The tax Administration considered that an earn-out that was received after January 1, 2013, but relating to a transfer registered prior to January 1, 2013, could not benefit from a deduction for the duration of holding the securities insofar as the rules applicable on the date of transfer did not allow for the application of the deduction.

This interpretation of the text was quite surprising. Indeed, it is undisputable, upon reading the parliamentary works, that the setup of a tax deduction for the duration of holding the securities was the direct offset of the taxation of the capital gains on transferable securities on a progressive scale. Therefore, a literal interpretation has been given to the text which is in total contradiction with the legislator’s intent.

The third paragraph of 1. of Article 150-0 D of the
aforementioned French General Tax Code was introduced so that the perception of an earn-out did not result in the application of a deduction for the duration of holding the securities that was longer than that applied to capital gains, but not to deprive an earn-out relating to a transfer prior to 2013 from the benefit of a tax deduction for the duration of holding the securities.

The French Conseil Constitutionnel was referred to on October 14, 2015 by the Conseil d’État (French Administrative Supreme Court) (decision no. 392257 on the same date) for a priority ruling on constitutionality (PRC) based on the words “and applied during this transfer” listed in the third paragraph of 1 of Article 150-0 D of the French General Tax Code.

In a PRC decision no. 2015-515 of January 14, 2016, the Conseil Constitutionnel confirmed that by adopting the disputed provisions, the legislator had intended to ensure, in all circumstances, that the duration of holding securities offering right to a tax deduction be appreciated on the date of transfer of the securities.

Nevertheless, the disputed provisions could not prevent the application of the tax deduction for the duration of holding the securities, without creating a severance from the principle of equality before the public charges, when, on the date of transferring the securities, the condition of duration for holding the securities was met, either because this transfer was carried out prior to January 1, 2013, or that it had not incurred any capital gains.

Therefore, the Conseil Constitutionnel made a reservation on the interpretation, obliging the tax Administration to review its position.

Claire Lachaux