Braxton Consulting

Braxton client case French Subsidiary

USA CO. is an American company that has recently established a new subsidiary in France (FRANCE CO.). USA CO. manufactures a line of food quite popular in the US market. But in the French market are not currently selling very well. The parent company sells the food products to FRANCE CO., which is responsible for marketing and distribution. The overhead expenses of the subsidiary are greater than the current
sales revenue and serious cash-flow problems exist in France. These problems can
be addressed as follows:

Advance of capital
USA CO. may loan the funds required to finance the short-term needs of the subsidiary and collect interest on that loan. This is acceptable unless the amount of debt owed by FRANCE CO. is sufficiently greater than the equity of the subsidiary that the local tax authority can argue that the subsidiary is thinly capitalised. In these situations, the tax authority may recharacterise all or part of the loans as if they were equity. In this case the parent is taxed at the subsidiary level as if it did not receive interest for use of those funds, but rather inter-company dividends in respect of equity capital. This recharacterisation will mean that no tax relief is obtained by FRANCE CO. on the ‘interest’.

Furthermore, the tax treatment of interest is often different from dividends as respects withholding taxes/imputation, tax credits, etc.

Inter-company payables and receivables
The parent company may invoice FRANCE CO. for the food products but not collect the receivable until the subsidiary can afford to make the payment. If the period of time involved is short (no longer than the payment terms ordinarily granted to distributors in this industry), this is an acceptable way of financing the receivable. However, in many countries (the US in particular), an inter-company receivable outstanding for a
longer period of time than is commercially appropriate will be reclassified as a loan and deemed interest will accrue on it.

Parent guaranteed bank loans
USA may guarantee a loan, which is granted to the subsidiary by a third party, e.g. a bank. A loan guarantee fee may be required to be paid by the subsidiary to the parent for having provided the guarantee. The loan itself is primarily the responsibility of the subsidiary and must be repaid by the subsidiary. This may potentially cause a thin capitalisation problem for the subsidiary, if it could not have
obtained the loan without the parent’s guarantee, although in practice the risk of tax authority attack is generally much less than where the loan is made directly from the parent company to the subsidiary.

Braxton presented several solutions and made only one recommendation, which were followed by the client.