International taxation of royalties, a cluster of double taxation
The differences of interpretation between France and certain African States on the scope of application of royalties (as defined by tax treaties, authorizing the State of source to make a withholding) create a risk of double taxation for French companies which may correlatively find themselves challenged in their right to allocate in France the withholding taxes levied abroad.
The key points
The concept of royalties (which may be subject to withholding tax in the client's State even if the service provider is not established there) is often the subject of divergent interpretations between France and certain African States.
The resulting risk of double taxation may affect the competitiveness of French companies, particularly in their responses to international calls for tender.
This risk can be mitigated by a precise breakdown of the services provided and particular attention to the wording used in contracts.
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While tax treaties grant only the State of the service provider the right to tax services falling under the category of business profits, those which can be classified as royalties within the meaning of the tax treaty may be subject to withholding tax locally in the State of the client.
The differences in qualifications between States relating to the concept of royalties can give rise to double taxation, with France contesting the right to recover as a tax credit the deductions made abroad when it considers (sometimes wrongly) that they are not in accordance with the provisions of tax treaties.
On the French side, a strict and sometimes restrictive interpretation of the notion of royalties: the example of software maintenance
In a recent case, a French software publishing company invoiced its Moroccan clients for software maintenance services, which were treated in Morocco as royalties for which the tax treaty authorizes the collection of a withholding tax.
The French tax judge considered, on the contrary, that these remunerations should be qualified as simple business profits within the meaning of the convention, not subject to withholding tax in Morocco and therefore not giving rise to the imputation of a tax credit in France (CAA Versailles, June 4, 2019, n°17VE01685, SA Sopra Steria Group).
In rejecting the classification of royalties, the Court noted that the purpose of the maintenance service "is not to grant or extend a copyright", nor to provide "technical studies" (assimilated to the royalty regime by the Franco-Moroccan convention), but simply to provide, separately from the software license and optionally, a service falling under "technical assistance" within the framework of the corrective and evolutionary maintenance of said software.
The reasoning followed by the Court has the disadvantage of not drawing the consequences of the sub-distinction which can be made between corrective and evolutionary maintenance services.
Corrective maintenance is limited to correcting errors present in the software, whereas evolutionary maintenance involves improvements that are not necessary for its operation. Consequently, evolutionary maintenance would probably have deserved to be covered by the royalty regime (the wording of the contract nevertheless plays a key role in this matter). An appeal having been filed with the Council of State, this issue deserves to be followed up.
On the side of African States, an often extensive interpretation of the notion of royalties
Some African states have a broad view of the scope of royalties, sometimes supporting almost systematic withholding tax policies. Companies are even more inclined to pay withholding taxes in the presence of strict foreign exchange regulations that require them to provide proof of tax payment before being able to repatriate the amounts collected.
This problem is a source of legal uncertainty for French companies, which are then exposed to the risk of seeing these deductions declared non-compliant with the contractual provisions and therefore not chargeable in France.
In a recent case judged by the French Council of State, withholding taxes made in respect of trading and rental services of drilling equipment carried out by a French company in Algeria, Cameroon and Congo resulted in the rejection, in France, of their allocation as a tax credit on the grounds that the remuneration did not constitute royalties but business profits exclusively taxable in France. The tax judge ultimately allowed the deduction of these wrongly made withholding taxes (Council of State, 9th – 10th ch., October 12, 2018, 407903, Smith International France).
The special case of technical studies
Several tax treaties concluded with African countries include technical studies in the scope of royalties, which also gives rise to differences of assessment between States.
In the absence of an express definition, some tax administrations consider that "internal" studies or analyses of the service provider, required by the work it has undertaken to carry out (but for which it prepares reports for the client), constitute technical studies that may be subject to withholding tax. However, in France, these "studies" not provided for the client's operating needs will be treated as simple business profits that do not give rise to the right to deduct the irregularly withheld tax as a tax credit.
In order to limit qualification conflicts, an exchange of letters concluded on January 21, 2019 between France and Morocco clarified the notion of technical studies, defining them as "any specific analysis or research of a technical nature" during which the service provider "uses its specific knowledge in connection with a project and allows the other party to have access to it independently. The technical study is distinguished from technical assistance, the remuneration for which falls within the scope of Article 10 of the agreement. The lessee, if it chooses to carry out this project on the basis of this study, can carry it out alone […]".
Amicable procedure or simple deductible charge, insufficient remedies
Tax treaties allow taxpayers to seek an amicable settlement between the relevant administrations, which must then endeavor to find a solution to any potential conflict of qualifications. The outcome of such a procedure, which is also very lengthy, remains highly uncertain.
As for the possibility of deducting withholding tax from the taxable base of French corporate tax, now accepted in France while the French administration contested the principle (see above), it may appear to be little consolation for the company (even if a deductible expense can sometimes prove more interesting than a tax credit that cannot be attributed in the absence of profits and cannot be carried forward).
Vigilance in drafting service contracts
These difficulties require great care in drafting contracts. Although the legal reality of the transactions should in principle prevail, an unambiguous wording of the services can sometimes help avoid a delicate debate.
