How France can become an attractive onshore jurisdiction for High Net Worth Individuals
By: Cécile VILLACRES

Introduction

France is seldom seen as a low tax jurisdiction - which it can be, provided everything is correctly planned. When carefully structured there are several very interesting onshore solutions for high networth individuals under French tax law. Indeed, with careful structuring a marginal taxable income tax rate of around 50% can be reduced to between 0 - 10% of taxable income—a figure which is below the rate of Switzerland and the other countries of the European Union.

Inheritance tax and wealth tax issues are also of great importance for high net worth individuals. Therefore, it is interesting to explore the tax-planning tools that make France an interesting onshore jurisdiction. The purpose of this article is to detail several interesting aspects concerning individual taxation in France:

How to structure the purchase of property to a legal & fiscal advantage. I will discuss here the advantages of the French real estate company or the SCI and outline the main tax issues to be considered when purchasing a French-based property.

The lowering of taxation on unearned income by using an umbrella insurance fund. I will outline the tax advantages of life insurance under French tax law and its use as a tax planning tool for individuals taking up their residence in France

Reducing the tax on earned income by way of property investments. Finally, I will briefly explain the favorable tax aspects pertaining to the LMP (the professional renting of furnished property regime). This regime is especially adapted to clients who wish to become French tax resident as it allows them to reduce their income tax on other earned income taxable in France.

An efficient Real Estate Tax and Legal Planning Tool:
THE SOCIETE CIVILE IMMOBILIERE (SCI)

Two things that can be combined are of great interest when purchasing a French-based property ; the use of the SCI or French civil code-real estate company for inheritance law purposes and the use of loans to mitigate or cancel any wealth tax liability as well as inheritance tax law. The use of a back to back loan can be interesting as well. The use of an SCI can be interesting for inheritance law purposes. This concerns non-residents as well as French residents for tax purposes.

Purchasing a property directly without a SCI: General Principle

A property that is owned directly by residents or non-residents is subject to French inheritance law. If one of the spouses dies, the other will own the property jointly with their heirs (children or parents) according to the "French reserve". If the house was owned directly, any decision concerning the property will require the agreement of all the joint owners, that is to say, the surviving spouse and the children of the deceased. We suppose this situation would be ‘uncomfortable’ in the case of children from a previous marriage. However, if a non-resident purchases a property through an SCI, the French inheritance law will not be applicable as the SCI shares will be subject to the inheritance law of the last country of residence. For French-resident tax purposes, who purchase through SCI, the "French reserve" can be avoided upon the transfer of the shares to the surviving shareholder. The article of association can provide that 100% of the shares of the deceased will be transferred to the surviving spouse in case he is the co-owner of the shares. In addition, the SCI’s Memorandum allows that both spouses be appointed as the directors of the company.

Therefore, the surviving spouse will not need their heirs agreement for the running of the property. Even in the case where the children own part of the SCI shares in order to reduce future inheritance tax, we can arrange that the surviving spouse has the right to use the property and the control of the voting rights by having more that 50% of the shares. Finally, it is easier to divide the SCI shares than to split the ownership of a property and give assets protection facilities. Owning a French property through an SCI constitutes an efficient solution to protecting the surviving spouse against the rights of the children or the parents of the deceased. Indeed, in the absence of children, the parents have reserved right of ¼ each).

In conclusion, non-residents will not be, in any event, subject to the French inheritance law if they purchase the property through an SCI, and the property of residents, even if they are subject to French inheritance law, will be protected thanks to the SCI article of association provision.

TAX implications

An SCI Reduces the net worth for wealth and inheritance tax purposes by way of debt. (See below). The transfer duties in France amounts to 4,80%. Selling a property by the sale of the SCI shares might be less costly than selling the property directly.

First of all, the 4,80% transfer duties are applicable to the net value of the shares (taking into account an eventual loan). Property held individually with a mortgage is transferred at the full market value regardless of mortgages

Where there is borrowing in the company, including the shareholders’ loan accounts for non-residents, this substantially reduces its value for any future transfer of its shares, thereby economizing future transfer duties. This concerns also gift tax (subject to tax convention), and inheritance tax for non-residents (subject to tax convention)

Regarding additional transfer costs: If a property is sold directly, a notary must be appointed and the additional costs involved paid (this amounts to 6-7% including notary fees of 0.8%). On the other hand, if a property is sold directly by non-French resident, a French tax representative should be appointed.

To protect the client, often the management of the SCI is secured by an external office that acts as manager for an SCI, and can also domicile SCIs as well as manage the company.

Up-date on discussions with the UK Inland Revenue regarding their interpretation of an SCI. The UK Inland Revenue currently considers (in its bulletins no.50 and no.39) an SCI as opaque for UK tax purposes. This is clearly wrong and thanks to discussions we have had with the officials in charge on this issue, we hope, that their interpretation will change. Professor Anthony is personally corresponding with the UK Inland Revenue policy unit to explain that the SCI is a transparent entity that is supported by all the French civil code provisions as well as the French tax code provisions. There are also numerous solicitors in the UK that share Prof Anthony’s views. The issue is of importance as it could trigger tax consequences for British shareholders.

The French tax authorities currently view SCIs as a transparent entity, and its owners are taxed as individuals on their share of the profit. The UK Inland Revenue meanwhile interprets the SCI as a corporate entity. This may mean that the individual members of the SCI will become liable to additional tax arising from UK benefits legislation. This risk is, however, mitigated when the manager of the SCI is a third party or ourselves. We have agreed with the Revenue to hold all contentious issues since this matter is to be reviewed. After various correspondence with the Inland Revenue and according to Martin Brooks of Revenue Policy, International, "the Revenue is reconsidering its position on SCIs but the outcome of that review cannot be speculated upon at this stage and that it will be some time before a conclusion is reached." It is understood that the Revenue will be taking its own advice on the application of French law.

In order to avoid any fears that current French property owners may have, Professor Anthony is keen to point out that, "the Inland Revenue has agreed to halt any investigations into any disputes, although at this point the Revenue says it is not aware of any cases in dispute." Martin Brooks agrees that, "clearly this is an important potential difficulty that must be sorted out. If there are cases that are causing difficulties please let me know and I will ensure that enquiries are halted while the Revenue reconsiders its position."

We would like to see the issue clarified as soon as possible. We believe that the confusion surrounding an SCI status has, in some cases, led French notaries advise wrongly UK clients on the acquisition of a property. If, as a result of the advice it receives, the UK Inland Revenue ultimately changes or modifies its view in relation to French SCIs, then UK owners of French property will no longer be liable for benefits related taxation in the UK.

Taxes to consider when purchasing a property in France : Wealth tax, capital gain tax, income tax and death duty

What are the main tax issues to consider?

The 3% patrimonial tax on fair market value of properties

General principle: The 3% annual tax applies to French and foreign companies owning real estate properties in France. However, there are possibilities of exemptions of the 3% tax thanks to international tax treaties and also under conditions according to the French domestic tax law. First exemption: If a foreign company is resident in a tax treaty country, and provided that declarations are made (annually or declaration that undertakes to disclose information on the shareholders) the foreign company can be exempted from this 3% tax. Another exemption: notwithstanding the application of a tax treaty, a foreign company can be exempted from the 3% tax if more that 50% of its French-based assets (movable and immovable) are financial assets. It is a costly scheme and difficult to administrate on a long-term basis. In conclusion: It is recommended NOT to use an offshore company.

The tax on three times the rental value of a property

This tax is applicable to individuals having directly or indirectly the disposal of a French-based property and who are resident in a jurisdiction that has not signed a tax treaty with France. Non-French nationals residing in Monaco, for instance, should be liable for this tax by the French tax authorities. However there are many litigations with the tax authorities and a decision from the French Supreme tax court (the Conseil d’Etat) is expected soon and should be in favor of the taxpayers considering the tax as illegal when the taxpayers, while residing in Monaco, are nationals of a treaty country that has non-discrimination clause with France. The idea is to consider that the these nationals (e.g. a British national living in Monaco and owning a property in France) cannot be taxed more than French nationals in the same situation.

Wealth Tax (tax planning for some clients and the use of loan)

Principle: The owner of a property, whose net value is more than €,000 (the rate for the year 2002), whether by way of a company or directly as an individual is subject to wealth tax.

Indirect ownership of French-based property through foreign company

Under French law, a non-resident who owns a French property through a foreign company (not quoted to the stock exchange) is within the scope of French wealth tax if the assets of the foreign company is mainly constituted by French real estate assets or French real estate rights (article 750 ter 2 of the French General Tax Code).

Conventional provisions France have signed several tax conventions that include wealth tax provision (for example with Germany, Spain, Switzerland, Luxembourg, etc). If individuals indirectly hold a French-based property, for instance through a foreign company or a French real estate code company, then the relevant tax treaty’s provisions can avoid a wealth tax liability in France under certain conditions. Indeed, depending on the relevant tax treaty, company share owners whose main asset is a property rather than owning the property itself, can be exempted from wealth tax (for example, the French-Netherlands tax Treaty).

In conclusion, a review of one’s home country tax rules is necessary in order to obtain the right solution as well as the right analysis of the relevant international tax treaty.

Capital Gains Tax on French real estate properties

Capital gains tax is an issue which must be deeply analysed whether the client is resident or not, and whether one owns a French-based property directly or indirectly. The sale of a French-based property often triggers CGT issues and leads to a taxation in France. For non-residents individuals, three main cases must be distinguish:

The transfer of property directly by foreign companies (ex: British Ltd)

The transfer of property directly by French companies (ex: SCI)

The transfer of French companies shares by non-residents individuals

Before analysing these cases, it is important to outline the main features of a recent administrative note issued by the French tax authorities which reduce the scope of French withholding tax on transfer of French real estate: The administrative note dated 16 April 2002 According to this administrative note, there is no longer withholding tax on SCI Shareholders when the real property is directly sold by the SCI (administrative note of the 16 April 2002). The withholding tax is only applicable upon the sale of shares by the shareholders of a SCIs and other look-through entities based in France. Under this administrative note, the territoriality principle is maintained (that is, the capital gain is taxable in France), but the way the gains are taxed has been modified. The French tax code (section 244 bis and 244 bis A) provides that gains derived from sales of French real property by non-resident individuals or companies are subject to a 33.33 percent or 50 percent withholding tax. There are three cases to consider concerning CGT issues upon the purchase of a real property.

The transfer of property directly by foreign companies

If a French-based property is directly sold by foreign entities, they will usually be subject to capital gains tax in France. The tax rate is 1/3 of the gain realized and specific depreciation rules apply. Professional capital gain tax regime applies which leads to a compulsory depreciation of the real estate amounting to 2% per year which increase the latent capital gain each year. This is a major inconvenient and a potential tax liability. This is the main reason why we usually do not recommend to use a foreign corporation to own a French based property for private use.

From a conventional standpoint, there is only one tax treaty which provide that French capital gain taxation does not apply to the sale of a property owned by a foreign company: the Luxembourg – French tax convention. Under this convention a Luxembourg Soparfie which sale a French based property is not subject to French capital gain tax. Under a recent judicial decision of the Luxembourg court of Appeal dated 23rd April 2002 (Case law "Lacosta") the income generated from a French property by a Luxembourg company is not subject to tax in Luxembourg. These lead to a non-taxation of the gain realized. However the tax convention has been re-negotiated and this situation should changed. Finally, a tax representative would have to be appointed as a foreign company sells the real property.

The transfer of property directly by French companies

If a French-based property is owned by a French real estate company (SCI) whose shareholders are non-resident individuals in France, the treatment would be the following.

The SCI will be subject to capital gains tax, however as it is a translucid company, and since an administrative note dated April 16, 2002, the shareholders are subject to the standard rules for real estate capital gains applicable to individuals. Therefore, the standard French income tax rules would apply with a specific computation available to real estate capital gains realised by individuals. According to this regime, the individual benefit from an allowance on the gain realized of 5% per year from the second year of ownership. Please note that income tax rates go up to about 50% and that another 10 % needs to be added for CSG/CRDS Tax.

The transfer of property directly by non-residents individuals and the transfer of shares of companies by non-residents individuals

The French tax treatment is 1/3 of the net capital gains. However, the specific individual capital gains tax regime applies which includes an allowance of 5% per year after the second year of shareholding. Therefore, in practise, after 22 years, no capital gains will be taxable. A tax representative, needs however to be appointed.

Inheritance Taxes

Most of the time, there is no tax treaty between France and the country of tax residence of the client. French internal tax legislation is then applicable.

A non-French resident owning a French property directly or through an SCI is subject to French inheritance tax. A non-resident individual is considered to own such French based assets if he and his family own (directly or indirectly) more that 50% of the shares of a French or foreign company which own a French real estate (section 750 ter 2 of the French general tax code). There is no more the requirement that the company should owns more immovable assets than movable one. As for an example an English individual, resident and domiciled in the U.K. for tax purposes, there is a tax treaty for inheritance tax purposes between France and the United-Kingdom (tax treaty dated 21 June 1963). A French property directly or indirectly owned by English tax resident would therefore fall within the scope of section 750ter of the French tax code.

There is a tax planning for American clients due to the application of the inheritance tax treaty signed between France and the United States, dated 24 November 1978. Due to this treaty, the shares hold in a company which assets are mainly constituted by a French-based property, are not deemed immovable assets for inheritance tax purposes and as a consequence are not taxable in France. Under the Swiss- France tax convention, a Swiss resident is not subject to French inheritance tax if he owns the French property through an SCI and not directly.Therefore, under conditions, purchasing a property through a company such as an SCI, can be an interesting tax planning tool for American and Swiss individuals as it will not fall under the French inheritance tax law as it would be the case if the property is directly hold by American and Swiss clients.

Other tax aspects

Once a property has been acquired, various taxes fall due. "Taxe d' habitation" (residence tax) and "Taxe foncière" (property tax)--these are the annual taxes due to the local administration. There may also be rental taxes and these are determined according to whether the accommodation is furnished or non-furnished. Non-residents are also subject to these taxes. I would like to take this opportunity to briefly point out that in case a rental activity is performed in France a specific analyse should be organized before the purchase. This study should take into account the tax regime of these income and the tax implications on the future gain realized.

Being part of the French system is often a concern for clients. This concern is most of the timedue to a lack of understanding which may lead to declaring a tax residence outside of France. This often results in paying more tax than if correctly declaring a French tax residency!

An efficient tax-planning and financial tool: the French-approved life insurance policy.

The fiscal ability to use an insurance fund for investment tax planning in France.

A foreigner taking up residence in France and using a French approved insurance plan for their investments can make a considerable difference to the ultimate taxation on any withdrawals, gains and estate duty. We like to call this an "approved umbrella insurance investment policy". Ideally, it ought to be taken out prior to becoming resident in France.

The growth not drawn from the fund remains non taxable to income tax. The withdrawals are taxed only on the part of the growth withdrawn and the tax rate applicable decrease as much as you keep the investment. Finally, capital withdrawals are not taxed.

The potential French resident can subscribe to the fund before taking up residence. The total investments, together with growth, can be drawn from the policy at any time subject to the policy conditions. Some policies may allow the first 80% of the initial capital to be withdrawn tax free by paying the deferred income by way of bonuses at a later stage of the policy.

Estate planning

On the basis that the descendants are identified as beneficiaries by the insurance policy, no inheritance tax will be payable within the limits of € 152,500 per beneficiary (threshold from 2002). Estate duty in excess of this is at 20%. (Special rules apply for those over 70 years old.) In addition, there is a total freedom to appoint & change beneficiaries. Indeed, one may change beneficiaries at any time. (subject to the Napoleonic estate law under which one has to avoid being seen as deliberately disinheriting one’s heirs whilst French resident.) It can be an interesting estate planning tool in order to avoid forced ownership rules in case of 1st marriage children or in case of non married couple (where the inheritance tax rate can go up to 60%).

The investments can be structured in a flexible way offering new residents discretion on their investment portfolios. As usual, there is some disadvantages:

It requires an up-front capital investment.

Wealth tax will be payable on the portfolio value once residency is established. If the policy is subscribed before moving to France, there is no wealth tax because non resident are exempt from wealth tax. However, depending on family situation, we can tax plan these insurance policy in other that the subscribers are not subject to French wealth tax.

An initial commission is generally charged by the insurance company

The French government taxes this type of investment on the basis of growth withdrawn from the fund (article 125 OA of the French General Tax code). This is taxed at the following withholding tax rates: 45% on growth withdrawals in the first four (4) years 25% on growth withdrawals over the next four (4) years 17.5% on growth withdrawals thereafter (an allowance of 9 200 Euros per year is given for married couples on the growth withdrawn.)

As indicated above, the taxation of growth withdrawn can be avoided for the first 8 to 10 years in case the fund is invested in a deferred bonus investment. A beneficiary has the advantage of the first 152 500 Euros tax-free. Thereafter, all proceeds from the deceased’s policy incur tax at 20% according to section, 990-I of the French tax code. However, due to the fiscal instruction (Inst. 30 December 1999, 7 K-1-00, n° 16), the 20% withholding tax is applicable provided that the subscriber of the policy was resident in France for tax purposes. Therefore, the question is of great importance if the subscriber was a non-resident when subscribing the French policy. According to us, the 20% withholding tax after the first 152 500 Euros is not applicable.

The question was submitted to the French Minister of FINANCE, who was not able to give us a clear answer. We therefore think that non-residents can have a very important advantage comparing to French residents. This solution is supported by the fact that before the promulgation of section 990-I of the French tax code the exemption was total. Finally, we would like to point out that the 20% tax rate can be interesting for example if the beneficiary has no family link with the subscriber of the policy because under the normal regime the inheritance tax rate can go up to 60% in France. Special rules apply when someone is over the age of 70. Since November 20th, 1991, that part of all premiums paid by an insured aged over 70 which exceed 30,500 Euros are considered for tax purposes to be included in the insured estate and taxable to estate duty.

The ideal Plan

Generally speaking, the ideal situation is to draw from a policy at a lower rate than that of the growth. This will reduce the withholding tax rate payable on the policy. Living off this type of policy can reduce tax rates to much le ss than 10% per annum. Often, the tax payable is in fact negligible. It is advisable to provide a capital sum to live off for the first year or two and start drawing on a policy thereafter. This reduces the tax rate still further and avoids paying unnecessary commission on setting up the policy.

Beware of Luxembourg, the British Channel Islands and Trusts

In order to make this to work, it is extremely important to understand that an investment needs a French approved fiscal representative. Secrecy laws in Luxembourg do not permit the fiscal representative to be appointed, so a Luxembourg based policy loses its tax advantages. The withholding taxes only apply to French approved policies. As there is an attractive choice of companies, there is no need to look outside French fiscally approved policies. It is, of course protectionism, but does preclude many foreign insurance brokers from writing this type of policy.

Unfortunately, it has come to our notice that clients are still using policies issued in the British Channel Islands. These really do not work, as they do not comply with the E.U. ‘third directive’. The wish to keep one’s trust funds has also been expressed.

When a client is beneficiary of a trust, this could be looked through and taxed as income or on capital distributions taxed as gifts. Tax rates on this may reach 60 %. If a move to France is planned, a study of the tax implication in France of a family trust should be organised and a possible re-organisation could be necessary.

A sophisticated tax planning tool for resident or / and non resident: the professional rental activity (Location meublée professionelle).

When clients, retired in France have acquired directly or indirectly a property in France, have invested in an approved life insurance they may be taxable in FRANCE on their pensions for instance or any other earned income. This tax burden can be mitigate or cancelled by using another tax planning tool available to individuals who are resident in France for tax purposes.

The interests of the LMP are notably the followings:

to acquire a valuable property asset

to Facilitate an immediate reduction of one’s tax liability and lower one’s fiscal burden over successive years

to Receive tax-free income for 15 years and more

to Reduce inheritance taxes

to Control the level of wealth tax

No capital gains tax after 5 years

Concerned Taxpayers

This scheme is primarily for individuals who pay high rates of tax in France, those who are paying income tax at the highest rate of 50% or more and have a sound financial base. Considered as professional furnished property rentals, they will be renting, on a regular basis, furnished property, and as such are entitled to a significant reduction in income tax under the French tax code.

According to the paragraph 4 under article 151 of the French General Tax Code, one can become a "professional of furnished property rental income" if the following condition is fulfilled: Inscription with the register of commerce. This activity must bring in at least 23,000 € gross per year inclusive of VAT or these receipts have to represent more than 50% of the total income.

The tax system

If the above conditions are fulfilled, the lesser will benefit from numerous tax incentives or advantages as follows:

Deduction of net operating losses (NOL) on global taxable income

The professional lessor can deduct the deficit generated by the running costs of this type of activity, from their global revenues. These deficits are generated by both, the depreciation of the assets and the deduction of interest on bank loans. This creates fiscal benefits. The charges, which can be deducted, are as follows:

Financial charges associated with the purchase (interest on the loan, life insurance taken out on the loan etc … )

Fees for setting up the purchase Social charges associated with this commercial activity Management costs Maintenance and restoration costs.

VAT regime

According to the 1990 finance act, VAT at 19.60% payable on the purchase price of the property is recoverable immediately.

If the property is resold within a twenty-two year period, then the VAT due is calculated on a pro rata basis. It is definitively acquired prorata over the twenty two years of ownership. If the investment is held for 22 years, the VAT is not repayable on the sale. Tax exemption on capital gain tax upon the resale of the property (under conditions).

A property, which is held for more than five years, is not subject to capital gains tax in the event of re-sale. This exemption is valid for as long as the rental income does not exceed 152,600 €. This is one of the more interesting aspect of this regime as it can also be used by non French resident wishing to invest in France and perform a furnished rental activity. In this case, it could be interesting to purchase of a French property through a French commercial transparent company.

Wealth Tax exemption (under conditions)

The Financial Act of 1999 has cancelled the exemption on wealth tax for most landlords. However, according to the article 885 R of the French General Tax Code, professional renters can be exempted from wealth tax under certain conditions. As a conclusion, on the SCIs are specifically adapted to the management and ownership of French-based properties. Their shareholders can be resident or non-resident in France.

General conclusion

Correctly structured, retirement in France can be a pleasant experience from a taxation point of view. It is important to be advised on the correct structure and investment. Even an approved investment needs to be chosen carefully as it can effect the tax rate. In general, one should avoid exotic investment choices. Subject to the clients’ wishes, it is possible to retain one’s existing investment advisors. This depends on the sums involved and the management needs. In addition, as outlined previously it is advisable to restructure its assets before taking residency in France. Indeed, France has CFC legislation that aims at individuals who are resident in France for tax purposes.

There are onshore tax-planning tools for individuals in France that resident individuals and non-resident individuals can enjoy. Due to international trends, onshore solutions should be carefully analyzed. It does need to be repeated finally, that France is a good place to retire, not just for the sun, food, wine and health, but with carefully thought out tax planning, it can also be a tax haven!

Cécile VILLACRES
Head of International tax department
Anthony & CIE