Harsh regime

  • Author : Pierre Dedieu
  • Author : Adea Meidani
  • Date : August 2011
ABOUT THE AUTHORS: Pierre Dedieu is a Partner and Adea Meidani is an Associate in the International tax department at CMS Bureau Francis Lefebvre

Following the publication of a series of reports and discussions over the past three years, France is about to introduce a new set of rules providing for the tax treatment of trusts under French law. The new provisions are included in the Draft Rectified Finance Act 2011 (the Draft), which is to be enacted by the end of July 2011.

The new regime introduces a definition of ‘trusts’ in the French tax code (FTC) and completes the existing legislative framework on the tax treatment of income deriving from trusts, with further provisions on gift and inheritance taxes on the one hand, and wealth tax on the other.

Definition of trusts

The term describes the body of legal relationships that arises in the law of a foreign state that is not France, when a person (the settlor), transfers through a settlement between living persons (intra vivos) or upon death certain assets or rights to an administrator (trustee), for the benefit of one or more beneficiaries or for the accomplishment of a defined purpose (Article 792-0 bis).

Interestingly, the Draft will introduce a general definition of trusts, even though such entities do not exist under French law. It is worth mentioning that France has signed but not adopted the Hague Convention on the Law Applicable to Trusts and on Their Recognition. However, practitioners agree that French law recognises the validity of trusts settled outside France according to the laws applicable in the state in which they were settled, provided that the trust provisions are not contrary to French law and public policy, which includes, most notably, the forced heirship rules.

‘French death taxes may be reiterated, as after the death of the initial settlor the beneficiaries existing at the time of the death are deemed to be the new settlors’
Gift and inheritance taxes

Under the new provisions, French gift or death taxes may apply on the estate of the trust provided that the territoriality test is met, irrespective of whether the assets are actually remitted to the beneficiaries.

In accordance with previous case law, the transfer of assets into a trust will follow the French territoriality rules. French inheritance and gift taxes will apply to assets held in the trust if the settlor and/or beneficiaries are French residents. Conversely, they will apply on assets located in France, if the settlor or the beneficiaries are residents abroad.

Should these territoriality rules conflict with the double tax treaties concluded with France, the latter provisions should prevail as the new taxation is still qualified as gift or death tax under French law. Consequently, the real issues will arise where the settlor is, at the time of their death, a resident of France or of a state that has not entered into a double tax treaty with France.

Gift taxes are likely to apply where an asset is effectively remitted to a beneficiary or, theoretically, where some assets are definitively allocated to a beneficiary under the trust.

Death taxes will be triggered upon the death of the settlor, irrespective of whether assets have been effectively remitted to the beneficiaries. French death taxes may, however, be reiterated, as after the death of the initial settlor, the beneficiaries existing at the time of the death are deemed to be the new settlors.

The death tax rates applicable upon death of the settlor will depend mostly on the beneficiaries:

aIf the share of the assets attributable to a beneficiary can be determined, the Draft provides for the application of the standard progressive death rates, depending on the parental bounds between the settlor and the beneficiary.bIf the share of each beneficiary cannot be identified, but the beneficiaries are globally the descendants of the settlor, the rate of 45 per cent will apply.cIn all other cases, the rate of 60 per cent will apply.

Moreover, if the trustee is located in a non-cooperative state or territory, or the settlor is a French resident when the trust is set up (for trusts created after 11 May 2011), the tax rate will be 60 per cent even in (a) and (b) described above.

In (b) and (c) the trustee will be liable for the payment of the tax, with joint liability of settlor and beneficiaries if the trustee is located in a non-cooperative jurisdiction or a jurisdiction that has not entered into a tax recovery agreement with France.

No death or gift tax applies where the exclusive beneficiary of the trust is a charitable entity, which would be exempt on direct gifts or estates.

The new provisions will apply to gifts or death taking place from the enactment of the Draft (July 2011).

Wealth tax

In France, individuals are subject to progressive wealth tax on a yearly basis if their net assets exceed EUR800,000. Under the Draft, wealth tax will apply at 0.25 per cent for individuals with a net asset value between EUR1.3 million and EUR3 million and 0.5 per cent for individuals with a net asset value of EUR3 million or more.

A special levy of 0.5 per cent will be due on a yearly basis from the settlors or the beneficiaries of a trust who are French residents for tax purposes, on the market value of their share of the assets of the trust. The special levy will also apply on the French assets of a trust (other than financial investments), irrespective of the tax residence of the settlors and the beneficiaries.

The special levy will have to be paid by the trustee, with a joint liability of the settlor and the beneficiaries.

The special levy will not be due to the extent that the assets were included in the wealth tax return filed by the beneficiary or the trustee. Under the Draft, wealth tax will be due by the settlor.

The special levy rate of 0.5 per cent corresponds to the maximum wealth tax rate. However, the tax base will not be the same, as none of the usual wealth tax exemptions should apply with the special levy. Moreover, wealth tax provisions of double tax treaties will, in principle, not apply to the special levy. Consequently, it will often be preferable to file the wealth tax return.

The new provisions will apply from 1 January 2012.

Income tax

Under the Draft, proceeds distributed by a trust are regarded as taxable income subject to French income tax (progressive rates to a maximum of 41 per cent) and to social contributions at the global rate of 12.3 per cent for 2011.

By so amending Article 120-9 of the FTC, the tax authorities have partially clarified the former provisions, but the uncertainty related to the term ‘proceeds’ remains (some fear that this term might include capital as well as income). The Draft only adds the word ‘distributed’ to the former provisions, which confirms that accumulated income will not be taxable until distributed.

There is also an important anti-abuse rule (Article 123 bis of the FTC), pursuant to which French individuals holding rights in an entity located in a privileged tax regime may be subject to income tax on 125 per cent of the profits of the entity, irrespective of their distribution. This anti-abuse rule remains unchanged and consequently does not expressly refer to trusts.

Trustees’ liability

In addition to the tax payment obligations mentioned above, the Draft introduces certain reporting and filing obligations that will be borne by the trustees. Subject to a territoriality test, the trustee will have to declare:

  • the trust settlement, its termination and any potential modification to the trust, as well as any change in its terms; and
  • on an annual basis, the consistency and the value of the trust assets, rights and accumulations as recorded on 1 January.

Failure to comply with any of those obligations will result in a penalty due by the trustee (with a joint liability of the settlor and the beneficiaries) equal to the higher of either EUR10,000 or 5 per cent of the trust assets or accumulations. The total liability could therefore be equal to 30 per cent of the value of the assets of the trust if the proper information has not been filed for six years.

In practice, trustees will have to choose between the devil and the deep blue sea, i.e. to face criminal or civil liability under local rules if they disclose information or to face huge tax penalties in France if they don’t.

‘The new regime can be perceived as harsh and unfair, as beneficiaries may be subject to tax on assets that they will never own’

The new regime can be perceived as harsh and unfair, as pursuant to its rules beneficiaries may be subject to tax on assets that they will never own, and settlors on assets they no longer own. And if they do not pay the tax promptly, the consequences will affect the assets of the trust itself and consequently be borne jointly by the whole family.

Trustees will seriously have to ponder whether they should keep their mandate with respect to trusts involving French residents or French assets. If they keep their functions, the contractual terms of the trustee agreement should be carefully checked and amended in order to allow disclosure by the trustee, and the possibility to levy the taxes and penalties on the assets of the trust.

Although the Draft was intended to clarify the situation, the absence of flexibility and the failure to take into consideration the specific nature of trusts (revocable/irrevocable, discretionary or not) will give rise to increasing litigation before the French courts, as parties will have no other choice. Moreover, this regime will probably have a deterrent effect on trust beneficiaries or settlors who have moved to France for personal or professional reasons or who contemplated doing so in the near future.


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