Tax deduction for payment of US punitive damages recognized by administrative court

This article was first published on Tax@Hand, and is reproduced on this blog with the authorization of its authors.

 

France’s administrative court of appeals in Versailles (Cour administrative d’appel de Versaillesruled on 5 October 2021 that punitive damages paid by a French company are deductible from its taxable income (CAA de Versailles, 1re chambre, 05 octobre 2021, 20VE00034). Such damages are distinct from non-deductible penalties and fines described in article 39.2 of the French Tax Code (FTC).

Background

For the determination of taxable income, article 39.2 of the FTC prohibits the tax deduction of monetary sanctions and penalties of any kind imposed on violators of legal obligations, and in particular tax increases, fines, seizures, and penalties resulting from the failure to comply with tax, customs, social, labor, competition, or price laws.

In the case at hand, the question arose as to whether this prohibition also applies to punitive damages, given their particular nature. Under certain common law legislation, punitive damages are awarded by a court to punish intentional unlawful conduct, in particular bad faith or disregard of a duty of care, when compensatory monetary damages seem insufficient.

Facts of the case

As a result of commercial litigation with a former American subcontractor, a French company had been ordered by the District Court of Kansas to pay punitive damages to the subcontracor. The expense had been deducted by the French company from its FY 2011 taxable result.

Following a tax audit, the French tax authorities challenged the deduction of the punitive damages, considering them part of the non-deductible monetary sanctions listed in article 39.2 of the FTC.

Decision of the Versailles administrative court of appeals

In light of the parliamentary work on article 39.2 of the FTC, the court overturned the position of the French tax authorities, considering the fact that punitive damages are not collected by a public authority but rather are awarded in private claims. Therefore, punitive damages do not fall within the scope of article 39.2 of the FTC and are tax deductible.

This decision could still be overruled by the French supreme administrative court (Conseil d’État), which could reject the Versailles court’s legal approach and be more moralist, to be in line with the “punitive” objective of such damages in the US.

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