Those initiating in covert activities under French tax law are in a very awkward position with regard to the tax authorities.

They shall be subject to taxation without any prior formal notice (Article L 68 of the French General Tax Code), with an intervention period extended to ten years (Article L 169 of the French General Tax Code) and the application of an increase of 80% of the rights recalled (Article 1728 of the French General Tax Code).

These rules are not surprising when they are applied to persons who intentionally concealed an economic activity which they knew was subject to French taxation.

Yet, often, the difficulty is found when you dig deeper into the details and an activity may be subject to taxation by its very nature or by its localization in France, for reasons that are sufficiently ingenious not to have been perceived as such by the person carrying out such activity.

The danger zone for companies

In the business world, it is cross-border relations which shall cause risks in this regard due to the complexity of the qualification criteria for permanent company establishments or registered offices.

Yet, Article L 169 of the French General Tax Code sets forth that: “Covert activity is considered to have taken place when the tax payer or the legal entity mentioned in the first phrase of this paragraph has not submitted the declarations within the statutory period which he was obliged to do and either has not provided information on its activity to a company registration center or the court registry of the Commercial Court, or has been taking part in a covert activity.”

Article L 68 of the French General Tax Code makes reference to this definition and Article 1728 of the French General Tax Code simply uses the term “covert“, but the consistency of the French Tax Code justifies that the tax authorities may use the same definition for the interpretation of this Article.

It is evident that the persons considering that they exercise their activity in a tax jurisdiction other than France, shall not submit a declaration in France and shall not register with the registry of trade and companies or the business formalities center and are particularly exposed to the implementation of these measures in their regard if they still have material elements that bind them to France.

The extent of the risk

The issue which has been raised since the beginning of these texts, and which was only recently “partially” resolved by the French Council of State, is the authority to be given to the aforementioned definition: lack of tax declaration and/or lack of identification with the Business Formalities Center or the Registry of Trade and Companies.

This definition is formulated as instituting an irrefutable presumption of the covert activity, resulting in all the detrimental consequences already mentioned, if and only if, its objective conditions are established, whereas the term “covert” includes the idea of an intentional concealment.

Yet, it appears to be evidently inequitable to consider the tax payer deceptive, who has committed an error on the taxable nature of his activity or the localization of his activity, given the rules of territoriality of taxations insofar as this activity was duly declared in another country, in particular, if the latter is a member State of the European Union.

The circumspect evolution of the nature of the “covertness” presumption

The irrefutable presumption, which prevents the admissibility of any evidence to the contrary, is evidently a radical impediment to the right of defense which was nonetheless recognized as a constitutional principle which was applicable even in the absence of any law (French Constitutional Council decision 389 DC dated April 22, 1997. §32).

The French Constitutional Council applied this principle to limit the effects of a legislation instituting a presumption of income (Decision no. 2010-88 QPC dated January 21, 2011, on the evaluation of the lifestyle evolution; Decision no. 2014-437 QPC dated January 20, 2015 on the operations made with the member States or non-cooperative territories).

With regard to presumed covert activities, the French Council of State was very cautious in this regard, in particular for the admission of an error with regard to the determination of the tax territoriality for an activity, whilst ensuring that the tax payer provide evidence of the unintentional nature of his error.

In its first decision on this issue, rendered in plenary assembly, the French Council of State provided criteria for the admission of evidence to the contrary which could be admissible and relevant “with regard to a tax payer who asserted that he had met all its tax obligations in a member State other than France, the justification of the error committed must be appreciated taking into consideration both the level of taxation in this other member State and the means of exchange of information between the tax administrations of both States”. (French Council of State, December 7, 2015, plenary assembly, no.368227, Frutas).

Yet, in this case, the French Supreme Administrative Court did not justify its error.

A refusal was rendered at the beginning of 2019, taken under the same motivations, yet the French Council of State emphasized that it had reached its decision in the context of the Franco-Luxembourg tax treaty prior to the treaty entered into force on October 29, 2010, which enhanced the intensity of the discussions between the administrations of these countries (French Council of State, March 18, 2019, no.410573, point 6), which would have let it be assumed that for the period subsequent to its entry into force, the situation would be more favorable.

These decisions, even although they were disappointing for the tax payers in question, had the advantage of recognizing that the “covertness” presumption was not irrefutable.

The ambiguity of the notion of evidence

The presumption of “covertness” is an onerous presumption which may only be dismissed by the tax payer if he can provide evidence of a legitimate error, whereas as the notion of error relates to a psychological element, it is very difficult to produce such evidence.

Most fortunately, in a decision dated December 4, 2019, the French Council of State confirmed the principles provided by accepting the evidence of a legitimate error in circumstances excusing the tax payer’s conduct, with such circumstances being explicitly mentioned:

“the tax payer justified that the absence of subscription to a declaration should be considered as an error justifying the fact that he has not settled his obligations insofar as it is only after the years of taxation under dispute that the case law and tax administration explicitly estimated that such profits were, under certain conditions, subject to income tax“ (French Council of State, December 4, 2019, no. 420488, point 4).

This position is reassuring when it is specified that the activity concerned a poker player, and it is very surprising insofar as it mitigates the principle pursuant to which no one is deemed ignorant of the law, whereas the law includes, implicitly, but inevitably, the interpretation given by case law.

It places the appreciation of the error, for an undeclared activity, on a level playing field with that of “intentional negligence” for any other insufficient declaration under Article 1729 of the French General Tax Code.

With regard to Article 1729, it should be recalled that, in the context of linguistic hesitance which generalizes the term, this Article 1729 successively used the qualifications of “bad faith“, then “lack of bad faith” and finally “intentional negligence” to designate the same conduct and institute the same sanction.

Yet, the burden of proof of the “intentional” nature of the breach and the resulting bad faith, have always been assumed by the administration.

This being said, the intentional negligence and error are two sides of a sword relating to the same issue: did the tax payer have clear awareness of its tax obligations, which is an intellectual and not a material issue, the evidence of which may only result from indices, which are finally subject to the judge’s discretion.

The evidence to be provided by the administration to establish the intentional negligence or by the tax payer to refute the covert nature of his activity shall only be constituted by indices of the tax payer’s awareness of the tax rules.

The benchmarks abroad

In this dialectic of evidence, the fact that the French Council of State accepts that a new case law solution may be legitimately ignored by the tax payer, is a reasonable solution and is not contrary to the principle of the awareness of the law. It shall not prevent the application of the French tax law per se but shall influence the appreciation of the tax payer’s conduct.

This latest decision clarifies the position of the French Administrative Supreme Court concerning the issue of territorial attachment for which it considers that “the error committed must be appreciated by taking into account both the level of taxation in this other member State and the means of exchange of information between the tax administrations of both member States“ as these circumstances render less likely the tax payer’s intention for covert activity.

From this latter point of view, the enhancement of the provisions concerning the inter-administrative exchanges in most of the tax treaties signed by France, and the entry into force of the Directive 2011/16/EU of the European Council dated February 15, 2011 relating to the administrative cooperation in the tax sector in the European Union, consider the incorrect choice of territorial attachment in Europe as an “excusable” error.

Based on the freedom of establishment principle, in the event of an activity carried out in a member State that is different to that of the company’s registered office, the Court of Justice of the European Union censored the obligation to keep the accounts regularly updated in the country of exercise of such activity to benefit from a local tax benefit. (ECJ 1997-05-15, C-250-95, Futura Participation, point nos. 23-26). Accordingly, is the criticism of the lack of account keeping in France able to be challenged on the basis of this case law?

A precautionary conclusion

In practice, the tax administration investigation authorities have an unfortunate tendency to quickly label a covert activity, insofar as an activity is developed abroad by a person who has ties with France, and without really distinguishing the particularities of the relations between our country and that of the disputed activity.

Caution should be taken, and besides a careful analysis of French law, which is always necessary, the law of the European Union, in this domain, like in many others, provides elements of security and moderation which should also be used as benchmarks.