The French Parliament adopted on 6 July 2011 a major reform of wealth taxation (Finance Act for 2011). Some deputies made a claim in front of the Constitutional Council considering that some articles were against the principle of equality of the taxpayers. However the Constitutional Council decided that the law did not contain any provisions against the Constitution.
The new law dated 29 July has been officially published on the 30th July and is now in force.
This reform constitutes an important change of taxation of private assets in France and will have big impacts on non-resident individuals. Indeed if the new law certainly represents good news in the shape of a revised wealth tax, its effects on non-residents may be less than welcome…
Streamlined wealth tax
The wealth tax threshold has been increased from 800,000 euros to 1,300,000 euros.
The actual progressive rates from 0.55 %t to 1.8 % have been decreased to a new rate of 0.25 % from the 1st euro (for a net value of assets over 1.3m euros) and of 0.5 % from the 1st euro (for a net value of assets over 3m euros).
This means that non-residents owning French property for a net value between 800.000 euros to 1,300,000 euros will no longer be subject to wealth tax. This should constitute an
important decrease of wealth tax exposure for high net worth individuals investing in France. For example, a UK resident owning a €5,000,000 (net value) property in France will have to pay an amount of wealth tax of 25,000 euros compared to 40,000 euros under the current tax rates.
The new law provides also with a mechanism to reduce the thresholds’ effect for taxpayers a net value of their assets between €1,300,000 and €1,400,000 and between €3,000,000 and 3,200,000.
The deadline for filing the wealth tax return for 2011 has been postponed to 30 September 2011.
The new law should apply from 2012. Nevertheless from 2011 taxpayers with a net value of their assets below €1,300,000 are fully exempted from wealth tax; and the taxpayers with a net value of their assets below the threshold of 3 million euros will no longer have to file a wealth tax return and will just have to declare the net value of their assets in their income tax return.
20% tax on secondary homes removed…
The French Government proposed to introduce a new annual tax of 20% of the rental cadastral value of the property (that is, on the same basis value as for the taxe foncière). This tax would have applied if the non-residents did not rent out the property, so if it was available for their own use.
President Sarkozy since announced his intention to withdraw this tax on French real estate owned by non-residents. It was indeed likely to be challenged under European law, since in practice it would have discriminated against foreign owners of holiday homes. Foreign owners of second homes in France already pay local property tax – taxe fonciere – and council tax - taxe d’habitation.
The final draft of the tax reform has definitively removed this 20% tax.
Investments through real estate companies (such as SCI)
Non-residents have frequently invested in real estate in France through SCI (French real estate Company) for patrimonial reasons.
In order to reduce their wealth tax exposure, the non-residents have lent money to their SCI (financed through their shareholders current account) to reduce the net value of their shares for wealth tax purposes. As non-residents are exempted from wealth tax on their financial investments, valuation of the shares subject to wealth tax took into account the debts toward its shareholders, whereas the corresponding receivable was not subject to taxation.
From tax year 2012, debts based on shareholder current account of real estate companies (held through one or several companies) will not be deductible for French wealth tax purposes. Only commercial loans will remain tax deductible to reduce the net value of the French assets. Non-residents would have to revisit their financing strategy...
Life insurance contracts
Under the current regime, payments made to beneficiaries of a life insurance contract are exempted from inheritance tax and are subject instead to a specific withholding tax of 20% up to the premium paid before the 70th birthday of the policy holder. Also, there is a particular advantage for non-resident individuals to set up a life insurance contract before their return to France. Indeed the beneficiaries of this contract are fully exempted from the 20% withholding tax (for the premium paid before the 70th birthday of the policy holder) even if the policy holder has become French resident at the date of his death.
From now, the rate of this specific withholding tax will be increased to 25% for the part of the premium exceeding €902,838.
Also, beneficiaries of life insurance contract are subject to the withholding tax of 20% or 25% if:
- The beneficiary is a French tax resident at the time of the death of the policy holder and has been a French tax resident during the last 6 years; or
- If the policy holder was French tax resident at the time of his death, even if the contract was set up while he was not French tax resident.
New taxation regime of foreign Trusts
If the concept of Trust does not exist under French law, French courts have always recognized the effects of foreign Trusts in France.
However, this is the first time that the French government introduces a legal definition of Trust and lays down specific tax legislation.
The new provisions confirm that income (but not capitalized income) received by a French beneficiary are subject to income tax.
Gift tax and inheritance tax
At the creation of a Trust (revocable or irrevocable), gift tax would apply with an applicable gift tax rate depending on the relationship between the settlor and the beneficiaries. In the same way, inheritance tax will apply at the death of the settlor if the assets are distributed to the beneficiaries. This is the recognition of the transparency of the Trust.
Also, even if the assets of the Trust are not distributed, inheritance tax will apply in the following way at the death of the settlor:
- If the beneficiaries and their share in the Trust assets are identified, inheritance tax will apply with an applicable tax rate depending on the relationship between the settlor and the beneficiaries;
- If the beneficiaries or their share in the Trust assets are not identified, then inheritance tax at the rate of 60% will automatically apply. The only exception is if the beneficiaries are collectively descendants of settlor where the higher rate of gift tax (45%) will apply;
- In addition, a specific disposition punishes the use of Trusts by French resident settlors as the rate of 60% applies in any case (for Trusts set up after 11 May 2011). This is also the case if the Trustees are subject to the law of a non-cooperative State.
These new provisions are now in force since the publication of the legislation (30 July 2011).
Until now, and based on case laws, settlor and beneficiaries of an irrevocable and discretionary Trusts were exempted from wealth tax. However, under the new regime, the settlor, or if he is already deceased, the beneficiaries, are subject to wealth tax on the Trust assets. If neither the settlor nor beneficiaries are residents in France, the settlor (or the beneficiary) is subject to wealth tax on the French assets or French rights only. The new law does not make any distinction between discretionary or non-discretionary Trusts, so it should apply to any foreign Trusts.
In addition, in the case where the trust assets have not been taxed in the settlor’s wealth, a special tax of 0.5% (sui generis wealth tax) would have to be paid by the Trustees (even if the taxpayer is the settlor). This would apply whether the settlor or any of the beneficiaries are residents of France, or if the Trustees hold a French asset or right such as shares in a real estate company. The Trustees would be responsible for the filing and payment of this 0.5% specific tax. Settlor and beneficiaries will be jointly liable with the trustees for the payment.
This 0.5% withholding tax will however not be due if the assets have been reported by the settlor (and subject to wealth tax) and the above disclosure obligations have been complied with.
These provisions will be applicable from 1 January 2012.
Please note that an exception will apply if the Trust is a discretionary pension Trust or Charity Trust. In this case, there would be neither wealth tax nor 0.5% withholding tax.
The new law creates an obligation for the Trustees to disclose information in respect of the existence, modification or extinction of the Trust, the specifications of the Trusts and the Trust assets. This disclosure information must be made if the settlor or a beneficiary is French tax resident, or if a Trust asset is located in France. If the Trustees do not comply with this disclosure information, they are liable for a penalty of 5% of the Trust assets. The settlor and beneficiaries are jointly liable for the payment of this fine. Non-compliance could also trigger the application of the specific withholding tax of 0.5%.
This new finance bill includes also other important measures of interests to non-residents, such as:
• The end of the “tax shield” (bouclier fiscal) to prevent a taxpayer to pay more than 50% of tax on his worldwide income;
• Increase of the gift tax and inheritance tax rate up to 45% (instead of actual rate of 40%);
• The reductions of gift tax rate based on the age of the donor do no longer apply;
• Introduction of an exit tax for French resident transferring their residence outside of France. This exit tax applies to individuals with a substantial interest in a French or a non-French company (more than 1% of the share capital of a company or a value in excess of 1,300,000 euros). These individuals will be subject to capital gain tax at a rate of 31.3% (including social contributions) on their unrealized capital gains. However, deferral of payment will apply automatically for transfer of residence in an EU country (or in a country with a relevant tax treaty with France). This exit tax applies retroactively from 3 March 2011.
This Finance bill includes some major changes in the French legislation of taxation of private assets. If it includes some good news in terms of wealth tax, it introduces a series of penalizing measures for non-residents. Especially the new treatment of foreign Trusts constitutes a real earthquake in the tax planning of foreign investors in France.
1st August 2011
A version of this article is due to appear in the October edition of Trusts and Estates Law & Tax Journal.
This article is for general information only and is not intended to provide legal advice
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