We would like to ensure that you are still receiving content that you find useful – please confirm that you would like to continue to receive ILO newsletters.
08 October 2012
Groups of companies commonly set up organisational structures of varying complexity in order to segregate their activities along sectoral, service or geographical lines. These group structures can also result from financing structures that are put in place when a group is acquired or obtains outside financing. The operating subsidiaries within such groups are often placed under the same common management, under the ultimate control of the holding entity, so as to ensure effective management and standardise management processes across the group.
French companies have adopted the practice, developed in Anglo-Saxon jurisdictions, of organising the management of operating subsidiaries through management agreements with the parent company. For example, a holding company under the terms of such a management agreement would provide management services to its operating subsidiaries. The legal representatives of an operating subsidiary would generally also be employees of the holding company. These individuals would usually be remunerated as employees of the holding company, but not in their capacity as legal representatives of the operating subsidiary. The holding company would charge management fees to the subsidiary (which would cover the salary of the managers, plus a margin).
This type of arrangement accommodates the basic rule that the same person cannot both hold the function of legal representative – who has the power to act on behalf of the company – and be an employee of that company, which derives from the corporate governance principle that the legal representative of a company is independent and should not be subordinated to any other person - except, ultimately, the shareholders.
From a tax standpoint, this set-up is transparent at the level of the holding company where the salary could potentially be deducted from taxable income; and also at the level of the operating subsidiary, which could potentially deduct the management fees from its taxable income.
From a labour law perspective, managers have an employment agreement with the holding company, which gives them greater security than they have in their capacity as legal representative of the operating subsidiary. Managers are increasingly reluctant to accept the relatively precarious status of legal representative of an operating subsidiary - who can usually be dismissed without reason or notice - without the security of also being employed by the holding company, which gives them the full protection of French labour law in terms of dismissal procedures and indemnities.
This arrangement would appear at first sight to be ideal, as it provides flexibility in the organisation of the management of the various operating subsidiaries. However, labour, tax and corporate law issues must all be considered.
The reasons that can justify the dismissal of a legal representative at the level of the subsidiary may not constitute valid grounds for terminating the employment agreement between that person and the holding company.
In 2003 the Court of Cassation held that the employment agreement between an employee and the holding company is independent from that employee's function as legal representative of an operating subsidiary. The employment relationship co-exists with the employee's mandate as legal representative.
The court held in this case, regardless of whether the employee's sole role under the employment agreement with the holding company was to fulfil the function of general manager of the subsidiary, that the manager was subordinated to the holding company in his capacity as employee, and both capacities (employee and legal representative) could co-exist independently from the other. Accordingly, the employment agreement with the holding company remained in place and did not come to an end as a result of the employee being dismissed as general manager of the subsidiary.
This decision has important financial consequences for an employer, as the termination of an employment agreement without cause gives rise to damages of at least six months' salary, in addition to the contractual notice period and indemnities provided by law and any applicable bargaining agreements, provided that the employee has been in place for at least two years.
The tax authorities consider that the payment of management fees is an 'abnormal act of management' if the management services provided by the holding company cannot be distinguished from the services that are provided by the legal representative of the operational subsidiary, regardless of whether the legal representative is remunerated. As such, the management fees (which would include the salary of the legal representative of the subsidiary, as an employee of the holding company) are not tax deductible.
The administrative courts have ruled in two cases that the fees charged by a holding company to its operational subsidiary for management services (frais de présidence and frais de siège) were not justified, on the grounds that the services provided by the legal representative of the operating subsidiary, who was employed and remunerated by the holding company, were identical to those provided by the holding company. The result was that the fees paid to the holding company by the operational subsidiary, together with value-added tax, were not deductible from the taxable income of the subsidiary.
No penalties were applied in these cases, although in one case the scheme was qualified as an 'abnormal act of management', which normally carries a penalty amounting to 40% of the tax reassessment amount. Some commentators have even claimed that in certain cases such schemes could constitute a fraud which is subject to a penalty amounting to 80% of the tax reassessment amount.
This case law does not, however, prevent a holding company from providing other types of service to its operational subsidiary that are different from those provided by the subsidiary's legal representative, in order to pool certain costs. For example, administrative, IT, financial or legal services can be rendered legitimately to the operating subsidiary, provided that these services are substantiated. In other words, the subsidiary must not have adequate internal resources to provide these services and the holding company must have the required expertise, resources and personnel, over and above the legal representative of the subsidiary, if such person is an employee of the holding company.
The management agreement may be held null and void on the grounds that the services rendered by the holding company are already being rendered by the legal representative of the subsidiary.
The most recent Court of Cassation decision on this question, issued in September 2010, brings corporate law into line with tax law. In this case, two companies concluded a management agreement whereby Company B provided management services to Company A through the secondment to Company A of an employee of Company B to serve as general manager of Company A. Company B was remunerated for this service. Company A stopped paying Company B, claiming that the agreement was null and void and that the amounts paid by Company A should be reimbursed by Company B.
Company B argued that the management agreement was valid and had been authorised by Company A's board of directors.
The court found in favour of Company A for two reasons. First, it considered that the management agreement lacked a valid cause (being a ground for rescission of a contract under French civil law), in that the services provided by Company B under the agreement were the same as those rendered by the general manager of Company A, in his capacity as general manager and independently from the management agreement. In other words, the management of Company A could not be undertaken simultaneously by both Company B and the general manager of Company A. Second, the court considered that regardless of whether the management agreement had been authorised by Company A's board of directors, the remuneration of the general manager of Company A was a matter that lay solely with Company A's board of directors and could not be determined under the terms of an agreement with a third party, even if this agreement was approved through the process for the approval of 'related party' agreements (ie, those concluded between companies that have managers in common).
Management agreements have become a useful tool for the effective organisation of management structures within group companies. However, their implementation is far from risk free. The most sensitive area is the provision by the holding company of core executive management functions, such as general leadership, supervision and strategy, as opposed to more technical or accessory functions, such as finance, IT, legal or human resources.
Careful planning at the pre-implementation stage will help companies to avoid unforeseen tax and employment liabilities, and ensure that their intra-group management arrangements are effective and watertight.
For example, the risks can be circumvented if the operating subsidiary is a simplified joint stock company ( société par actions simplifiée). Unlike the legal representative of a public limited company or a private limited company (société anonyme or société à responsabilitée limitée), who must be a natural person, the legal representative of a simplified joint stock company can be a legal entity. It is therefore possible to appoint the holding company as president of the operating subsidiary (if it is a simplified joint stock company) and remunerate the holding company for this service. The legal representative of the holding company can then delegate to one of its employees the power to act on its behalf with respect to its role as legal representative of the operating subsidiary. The drawback is that the holding company becomes directly liable for the management of the operating subsidiary. The corporate veil between the two entities, which would otherwise shield the holding company from liability in most cases, is effectively lifted.
For further information on this topic please contact Rhidian David or Cyrille Gaucher at Cabinet Hughes Hubbard & Reed by telephone (+33 1 44 05 80 00), fax (+33 1 44 05 80 54) or email (email@example.com or firstname.lastname@example.org).
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
ILO is a premium online legal update service for major companies and law firms worldwide. In-house corporate counsel and other users of legal services, as well as law firm partners, qualify for a free subscription.