3. Tax System: General Concepts

A. Income Tax And Capital Gains Tax

Individual residents in France are taxed on their worldwide income, while non-resident individuals are only taxed on their French-source income. In 2011, rates varied from 0 per cent to a maximum of 41 per cent (plus 12.3 per cent for social contributions in respect of French tax residents). Individuals are also taxed on certain capital gains (e.g. gains arising from the sale of buildings and land or the sale of shares).

B. Gift And Inheritance Tax

Tax is not imposed on the donor or on the estate of the deceased, but on each beneficiary, based on what that beneficiary receives. Tax is due on worldwide assets when either the deceased or the beneficiary is domiciled in France, but only on French assets when both the deceased and the beneficiary are domiciled outside France. The rate of taxation is dictated by the degree of relationship to the deceased. A child is taxed at rates ranging from 5 per cent to 45 per cent, collateral relations are taxed at rates ranging from 35 per cent to 45 per cent, while for unrelated beneficiaries the rate is 60 per cent. Surviving spouses and civil partners are fully exempt from inheritance tax (but not from gift tax).

C. Wealth Tax

This tax is payable by all physical persons whose net assets are EUR1.3 million or more on 1 January 2011. For a French resident, worldwide assets are taken into consideration. A non-resident, however, is subject only to wealth tax on French assets. Such assets include, among others, real property situated in France, shares in property investment companies, debts owed by debtors established in France and personal property situated in France. Financial investments by non-residents are, however, expressly exempt from wealth tax. In addition, debts relating to the estate subject to wealth tax are allowed as deductions in determining the tax base. The rate of wealth tax varies from 0.55 per cent to 1.8 per cent depending on the net taxable value of the assets. From 1 January 2012, assets worth between EUR1.3 million and EUR2,999,999 will be taxed at 0.25 per cent and assets with a value exceeding or equal to 3 million will be taxed at 0.5 per cent.

D. Taxation Of Trusts

I. Income Tax And Capital Gains Tax

When property is transferred to a trust, the income derived from it ceases to be that of the settlor and instead becomes that of the trustee. Assuming the trustee is not a French resident, any French-source income received is subject to French tax according to the rules applying to non-resident individuals or companies. As a general rule, French resident beneficiaries are subject only to income tax when they receive an income distribution.

The question arises as to whether French resident beneficiaries are subject to the anti-avoidance (CFC) provisions of article 123 bis of the French Tax Code (FTC). Under these provisions, French residents are subject to income tax on income derived from financial assets held through an intermediary structure set up in low-tax countries, even if the income is not distributed to them. The ambit of article 123 bis of the FTC is extremely wide, as the structures covered include legal entities, fiducies and comparable institutions or organisations. For the provision to apply, it suffices that there be a direct or indirect holding of at least 10 per cent in the structure concerned. Where the foreign structure is set up or established in a state or territory that does not have a tax treaty with France, the taxable income of the individual is a notional income. The majority of practitioners believe that beneficiaries of an irrevocable discretionary trust, who have no rights in the assets held in trust, do not come within the ambit of article 123 bis of the FTC.

Ii. Inheritance And Gift Tax

The new regime introduced by the Amended Finance Law 2011 officially confirms that the transfer of assets to a trust is not subject to gift tax or inheritance tax, but that these are payable on distribution of the trust assets to the beneficiaries. As from 31 July 2011, these taxes apply at the time of the transfer of trust assets to the beneficiaries or, if earlier, on the death of the settlor. The beneficiaries are liable for the payment of tax, which is assessed on the value of the trust assets at the time. The tax rate is determined in accordance with the relationship between the settlor and the beneficiary as though the trust were transparent (assuming that the relationship can be substantiated).

If, however, it is not possible to ascertain the shares of the beneficiaries in the trust fund upon the death of the settlor, the trustee and the beneficiaries are jointly liable for the payment of tax. A 45 per cent rate applies if the class of beneficiaries only contains descendants of the settlor, while a 60 per cent rate otherwise applies. In any event, the 60 per cent rate applies if the trust is governed by the law of an uncooperative jurisdiction or if the trust was settled by a French resident after 11 May 2011. The other provisions apply to any settlement or capital distribution occurring after 31 July 2011.

Iii. Wealth Tax

The new law provides that assets held in any kind of trust, including an irrevocable discretionary trust, are taxable on the settlor (or on the beneficiaries following the death of the settlor) for French wealth tax purposes if the settlor/beneficiary is a French resident or the trust fund contains taxable French assets. However, the assets held by a trust whose beneficiaries are all qualified charitable organisations under article 795 of the FTC are not subject to wealth tax.

A specific wealth tax for trusts is also being introduced at a rate of 0.5 per cent. Indeed, a catch-all provision specifies that the trustee is liable for this tax jointly with the settlor and the beneficiaries, either if the trust assets are not included in the settlor's or the beneficiaries' estates for wealth tax purposes, or if the trust has not been disclosed to the tax authorities (where the taxpayer was not liable to wealth tax). As a departure from this principle, trusts whose beneficiaries are all qualified charitable organisations and trusts settled by French residents specifically for retirement purposes are not subject to this tax. This provision will come into force in January 2012.

Iv. Reporting Requirements

If the settlor or one of the beneficiaries is resident in France or if the trust fund contains French assets, the trustee must disclose to the tax authorities the formation of the trust, any variation of its terms and its termination, as well as the market value of the trust assets each year.

Failure to comply with the reporting requirements will give rise to a heavy penalty equal to 5 per cent of the value of the trust fund.