However, there are limits to this autonomy, particularly when certain management decisions result in impoverishment without economic justification.Companies have substantial freedom in managing their affairs. This principle is based on the idea that each manager is free to make strategic decisions tailored to the company’s specific needs, without the obligation to systematically maximize profits.
However, there are limits to this autonomy, particularly when certain management decisions result in impoverishment without economic justification.
During tax audits, authorities may assess whether a company has deviated from “normal” management practices. This may lead to the reclassification of management actions as “abnormal acts of management,” resulting in the disallowance of certain deductions or the inclusion of unreported income in taxable profits.
This concept, derived from case law, is a powerful tool for French tax authorities.
Freedom in management and its limits
Management decisions are the sole responsibility of the company’s directors. The tax authorities cannot criticize these decisions as long as they are in the company’s interest, as the Conseil d’Etat has affirmed in numerous decisions (notably: CE December 20, 1963, n°52308).
However, this freedom is circumscribed, and the authorities may intervene when a management action appears to be manifestly contrary to the company’s interests, particularly in cases of unrequited impoverishment.
For example, in the Sté Croë Suisse ruling (CE plén., December 21, 2018, no. 402006), a company had sold an asset at a price well below its market value. In this case, the Conseil d’Etat ruled that, in the absence of sufficient economic justification, this transaction constituted an abnormal act of management, resulting in the impoverishment of the company without sufficient consideration. To prevent such reclassification, it would have been necessary to demonstrate that the transaction served a compelling interest, such as financial difficulty, or offered some other form of equivalent benefit.
The end of the “excessive risk theory”
Until 2015, tax authorities challenged management decisions by invoking the excessive risk theory, reclassifying an act as abnormal if the risks taken by the company were deemed disproportionate. This approach was widely criticized for limiting the freedom of companies to make strategic choices. The Ferrari ruling (CE November 9, 2015, n°369814) put an end to this practice by affirming that as long as risks were taken in the normal course of economic activity, they could not be considered abnormal.
This development was confirmed by the Monte Paschi Banque ruling (CE December 16, 2016, no. 395732), which clarified that significant risks could be justified by a legitimate economic interest.
Henceforth, the administration can no longer question the excessive nature of the risks taken by a company in its management decisions to justify the rejection of a charge, for example.
Abnormal acts of management and VAT
Although the theory of abnormal acts of management is applied to corporate income tax (IS) and industrial and commercial profits (BIC), it does not apply to value-added tax (VAT).
This principle is based on the nature of VAT itself, which is a tax on consumption. Unlike other taxes, VAT is calculated on the basis of commercial transactions themselves, not on a company’s profitability or internal management choices.
Thus, even if a transaction may be deemed abnormal in terms of taxable profits, this has no impact on VAT. The neutrality of this tax excludes any consideration of the economic purpose of the transactions carried out by the company.
Compliance with the corporate purpose and abnormal acts
The fact that an act complies with the company’s corporate purpose is not sufficient to prevent it from being reclassified as an abnormal act of management. It is entirely possible for an act to be consistent with the company’s corporate purpose yet reclassified as abnormal for tax purposes if it leads to unjustified impoverishment.
This was made clear by the Conseil d’Etat in its ruling on Sté Phoenix Union Co (CE July 22, 2022, no. 444942), which held that a waiver of revenue, even when expressly provided for in the company’s corporate purpose, could constitute an abnormal act of management. The mere fact that an act is provided for in the bylaws is therefore not sufficient to justify its economic interest.
Burden of proof
When the tax authorities base a tax reassessment on the theory of an abnormal act of management, the burden of proof lies, in principle, with the tax authorities. In its rectification proposal, it must demonstrate that the disputed act was not carried out in the company’s interest.
In certain cases, such as an ex officio tax assessment, the burden of proof may be reversed, in which case it is up to the taxpayer to prove that the management decision was justified.
Penalties for abnormal management acts
When the tax authorities reclassify a management decision, the financial consequences for the company can be severe. Non-deductible expenses or unrecorded income may be added back to taxable income.
This may also result in the taxation of distributed income in the hands of the beneficiary or a fine for failure to designate the beneficiary (rate: 100%). In an international context, this may also trigger a withholding tax reminder.
Finally, penalties may be applied, up to 40% (deliberate non-compliance), or even 80% (fraudulent maneuvers). In the most serious cases, criminal proceedings may even be initiated.
Distinguishing abuse of rights from abnormal management
“Abus de droit” and abnormal acts of management are two distinct concepts.
Abuse of rights implies a deliberate intention to circumvent tax law through fictitious or devious acts, with the aim of obtaining a tax advantage. On the other hand, an abnormal act of management is based on the absence of economic justification for an act that impoverishes the company.
In practice, abnormal management acts are much more commonly used by tax authorities than the procedure for penalizing abuse of rights, which is more complex to implement.
To mitigate reclassification risks, companies must document their management decisions and demonstrate the economic interest of each transaction. Particular attention must be paid to relationships between related companies or to agreements between the company and its directors.
In the event of a tax audit in France, contact Qualifisc without delay. We are recognized experts in French corporate tax law and regularly assist companies and international groups in managing disputes involving abnormal management acts. Our in-depth knowledge of tax procedures and case law enables us to secure your position and protect your interests at every stage of the audit.
