President Sarkozy has announced his intention to radically reform the controversial business tax, the taxe professionnelle.

The taxe professionnelle can best be described as the French version of business rates that are applied in the UK, and in many other countries.

It is an immensely controversial tax, introduced by Jacques Chirac in 1975 when he was Prime Minister under President Mitterand. Soon after it was introduced, the socialist President described the tax as "imbecile" because of the adverse impact it had on the competitiveness of French companies in the world economy.

This is because, broadly speaking, the tax is levied on the value of the fixed asset base of the company, their property and capital equipment. Accordingly, it actually penalises investment (and thereby attempts to improve productivity), for any increase in the value of the balance sheet through new investment leads to an increase in the tax.

For this reason, it also tends to impact more heavily on those companies in the industrial, energy and transport sectors, who pay around two-thirds of the total revenues generated by the tax, despite the fact that they account for only around one-third of the profits generated by French companies. In an attempt to try and equalise the incidence of taxation to all companies, certain services based companies are also taxed on a proportion of their turnover, but the inequalities remain.

Such has been the impact of the tax that, progressively, the government have been forced to make concessions to certain types of business, and to a relaxation of the tax in development areas. Thus, artisans and farmers, in particular, are exempt from the tax, and there are also exemptions in rural and urban development zones. More recently, the government have introduced an exemption for new capital investment, and there is a cap on any increase each year in the tax for larger companies.

As a result, the computation and application of the tax has now become as complex as it is controversial.

It seems that the President is not proposing the abolish the tax entirely. The element that applies to the capital value of the property will continue to remain in place, which accounts, on average, for around 20% of the total bill.

The taxe professionnelle is one of three local taxes that fund local government services in France. The other two are the property ownership tax called the taxe foncière, and the residence tax, called the taxe d’habitation.

The tax generates a huge level of revenue each year. In 2007 it produced €28 billion in public revenues, with the taxe d’habitation producing around €15 billion and the taxe foncière producing €20 billion.

The main recipients of the taxe professionnelle are the local communes, who receive €17 billion of the €28 billion. Around €8.5 billion goes to the departments, and the remaining €2.5 billion to the regions.

As might be imagined, the local councils have something of a love-hate relationship with the tax. Whilst they like the cash it generates, they also realise it threatens the competitiveness of their local companies. Unlike income or corporation tax, the taxe professionnelle is unforgiving in it`s treatment of companies, who all have the pay the full amount of the tax, whatever the state of their business.

No details of a replacement tax have been announced, although President Sarkozy did suggest that a carbon tax is his preferred replacement.

However, few commentators believe that sufficient revenue could be generated from such a tax, and there is also concern that the tax would lack any territorial basis; it would simply become another national tax, with local authorities then funded on a per capita basis by the central government. There will be huge resistance from the local authorities if they feel they are losing control over local finances.

There will also be other local councils glad to see the abolition of the tax, not because it sits too heavily on the shoulders of local employers, but because it is self-evidently weighed in favour of those councils with the strongest local economies. In some communes it accounts for up to 80% of their total revenues. Rural areas where there is no strong economic infrastructure are forced to rely more on the property taxes for their revenues. Alternatively, they simply manage with less, with the result that public service provision in these areas is weaker.

The reform may well be introduced in tandem with the reorganisation of local government that is proposed to take place, with President Sarkozy, in particular, keen to abolish the departmental level of local government in France. A commission under former Prime Minister Edouard Balladur is due to make its recommendations later this month. Their recommendations are eagerly awaited, and we shall be reporting on them in a future Newsletter.