Summary:

“Tax substance” has become a central concept in international taxation. Yet in French tax law, the concept does not exist as a clearly defined legal requirement.

Instead, substance operates as a practical analytical tool used by tax authorities and courts to assess whether a taxpayer is legitimately entitled to a tax benefit. Rather than being examined in isolation, substance is considered only when it may influence the tax outcome of a situation — for instance by denying access to a tax regime, disregarding an intermediary entity, or reallocating taxing rights.

In practice, the notion has been shaped primarily by case law and audit practice, which rely on a set of factual indicators to evaluate whether a structure reflects genuine economic reality.

Substance issues typically arise in cross-border situations involving holding companies, intermediary entities or passive intra-group flows, particularly when tax benefits depend on the identity or location of the recipient of income. Examples include:

• withholding tax exemptions on dividends under EU law,
• beneficial ownership under tax treaties,
• the determination of a company’s place of effective management.

A structured analytical approach developed by French courts

Over time, French case law has developed three complementary analytical tests to assess substance.

The first is the reality test, which focuses on the actual location and management of the entity. The key question is where strategic decisions are genuinely taken. Authorities typically analyse the role of directors, the location of decision-makers, and the presence of operational resources such as premises, personnel and costs.

The second is the rationality test, which examines why the entity exists. Tax authorities will assess whether the interposition of an entity is justified by valid non-tax reasons such as financing needs, organizational efficiency, governance considerations or investment structuring.

Finally, the effectiveness test focuses on how the entity actually operates within a transaction. Increasingly, courts examine the entity’s real role in specific operations, asking who makes decisions, controls risks and ultimately determines the outcome of the transaction.

An important implication of this approach is that substance may be assessed dynamically. An entity may possess sufficient substance at a general level but still be disregarded for a particular flow if it does not genuinely intervene in that specific transaction.

A contextual and pragmatic concept

From a French perspective, tax substance is therefore not a checklist, nor a predefined minimum threshold. It is a contextual concept, applied pragmatically depending on the tax issue at stake and the potential tax benefit involved.

In practice, the decisive question is whether the legal structure used by the taxpayer corresponds to the underlying economic reality and whether it genuinely justifies the tax outcome claimed.

Understanding how tax authorities approach this analysis is therefore essential for designing cross-border structures that are both operationally sound and resilient from a tax perspective.

Author and firm:

Germain Raillat is a tax lawyer at PEREN Avocats, a Paris-based business law firm. He advises French and international groups on corporate taxation, with a particular focus on restructuring operations, private equity transactions and cross-border tax issues. He also assists companies in their dealings with the French tax authorities, including advance rulings, approvals and tax controversy matters.

Germain Raillat – Counsel

+33 6 37 83 09 03 | g.raillat@peren-avocats.com

PEREN Avocats is an independent French business law firm based in Paris. The firm brings together complementary expertise in tax law, corporate/M&A and employment law, allowing it to provide integrated support to companies, investors and executives. Its tax team advises clients on domestic and international taxation, transactional tax matters, real estate operations and tax audits and litigation.