Tax litigation · Ground of reassessment

The abnormal act of management, defending the company

Are you being reassessed on the ground of an abnormal act of management? The tax authorities argue that your company has impoverished itself in an interest foreign to its own. This is one of the most frequent grounds of audit for companies and their directors. Yet the principle of non-interference in management and the rules governing the burden of proof offer real lines of defence. The firm challenges the characterisation, the base and the penalties.

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— In brief
Concept
An act by which the company impoverishes itself for purposes foreign to its interest
Legal basis
French Tax Code art. 38 and 39 (expenses incurred in the company's interest)
Case law
CE Plén. 27 July 1988 no. 50020 ; CE 21 December 2018 no. 402006
Burden of proof
In principle on the tax authorities, with adjustments depending on the accounting entry
Key principle
Non-interference: the tax authorities do not judge the appropriateness of a management decision
01

What is an abnormal act of management?

An abnormal act of management is one by which a company decides to impoverish itself for purposes foreign to its interest. An expense is deductible only if it is incurred in the interest of the business (French Tax Code art. 39); income cannot be reduced without consideration. Failing this, the tax authorities reinstate the expense or increase the income.

This theory, of case-law origin, is subject to one essential limit: the principle of non-interference. The tax authorities are not to judge the appropriateness or the wisdom of a management decision; they may only sanction an act contrary to the company's interest, not a management choice that turns out, after the fact, to have been ill-advised (CE 21 December 2018 no. 402006).

02

Typical grounds of reassessment

Grounds of reassessment based on the abnormal act of management regularly arise in the same areas:

  • Advances, loans or debt waivers without consideration or interest;
  • Excessive remuneration or benefits granted to directors or shareholders;
  • Rents, management fees or intra-group prices that are not justified;
  • Waiver of income (sales at reduced prices, free-of-charge services);
  • Assumption of expenses that fall to a third party.

The reassessment is often accompanied by a characterisation as deemed distributed income in the hands of the beneficiary and by penalties, which are argued separately.

03

The burden of proof, a decisive battleground

In principle, it is for the tax authorities to establish the facts characterising the abnormal act of management (CE Plenary, 27 July 1988, no. 50020). However, case law adjusts this burden according to the nature of the accounting entry: for certain expenses, the tax authorities are deemed to discharge the burden of proof where the taxpayer fails to justify, in principle and in amount, the accuracy of the entry.

Mastering this allocation is often what tips the case one way or the other. Documenting the consideration, the commercial interest and the economic reality of the operation is the central line of defence.

04

Not to be confused: abnormal act, abuse of law, management decision

The success of a defence often rests on a correct characterisation. Several related concepts are regularly confused, even though their regime, the burden of proof and the penalties differ.

  • Management decision: a choice falling within the company's freedom. By virtue of non-interference, the tax authorities may not call it into question on the sole ground that it turned out to be unprofitable;
  • Accounting error: an involuntary inaccuracy, correctable, to be distinguished from the management decision which, for its part, is in principle enforceable against the taxpayer;
  • Abnormal act of management: an impoverishment agreed to in an interest foreign to the company (French Tax Code art. 39). The burden of proof lies in principle on the tax authorities;
  • Abuse of law (Tax Procedure Code art. L. 64 and L. 64 A): a fictitious act or an act with a mainly tax-driven purpose. Specific procedure and safeguards, surcharges of 40% or 80%;
  • Gratuitous transfer: a transfer without consideration revealing an intention to make a gift, often reclassified as distributed income in the hands of the beneficiary.

The tax authorities must rely on the correct legal basis and satisfy the conditions specific to it. A poorly chosen characterisation, or a shift from the abnormal act of management towards abuse of law without complying with its procedure, is in itself a ground for challenge.

05

Our lines of defence

The firm builds the defence on several fronts: demonstrating the company's own interest in the operation (commercial, financial or strategic consideration); invoking the principle of non-interference where the tax authorities are in reality challenging the appropriateness of a management choice; arguing the burden of proof and the probative value of the evidence relied on; challenging the base of the reassessment and the correlative characterisation of distributed income; and arguing the penalties (deliberate breach), the proof of which lies on the tax authorities.

Frequently asked questions

Abnormal act of management: your questions

May the tax authorities criticise my management choices?

No. By virtue of the principle of non-interference, the tax authorities do not judge the appropriateness of a management decision. They may only sanction an act that impoverishes the company in an interest foreign to its own, not a choice that merely turns out to be unprofitable.

Who must prove that the act is abnormal?

In principle the tax authorities (CE Plenary, 27 July 1988, no. 50020). Case law does, however, adjust this burden according to the nature of the accounting entry: hence the importance of being able to justify the principle and the amount of each operation.

Is an interest-free advance to my subsidiary an abnormal act of management?

Not necessarily. An advance granted in the parent company's own interest (support of a strategic subsidiary, commercial interest) may fall within normal management. Everything depends on the consideration and its documentation.

Does the reassessment give rise to taxation in the hands of the beneficiary?

Often: the sum regarded as abnormally transferred may be characterised as deemed distributed income and taxed in the hands of the director or the shareholder. This aspect is challenged separately.

Why call on a tax lawyer?

Because the defence turns on the characterisation, the burden of proof and the economic documentation. Exchanges with the lawyer are covered by professional secrecy, and the lawyer carries the dispute all the way to the tax court if necessary.

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A reassessment on the ground of the abnormal act of management?

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François Ouairy, avocat associé

Written by

Me François Ouairy, avocat associé en charge du bureau de Paris, expert en fiscalité immobilière, fiducie et fiscalité financière.

This page presents the concept of the abnormal act of management for information purposes; each case calls for a specific analysis. References to the French Tax Code and to the case law of the Conseil d'État in force at the date of drafting.