"While the acquisition of a French property should not trigger residence, in all likelihood over the years the individual and his family will strengthen their ties with France"
The matrix in the frame shows the model underlying the easy guide on page 19 to tax and estate planning. An individual connected to Country A acquiring an asset connected to Country B should analyse the tax and estate implications for him and his family within the framework of the matrix. This case study looks at the tax and estate planning impacts of an individual acquiring a residential property in France.
The first impact is the potential for the individual and his family to become connected themselves with France by virtue of occupying the property. The connecting factors for individuals with France are:
• The family home (foyer) or principal place of residence (sejour principal). The foyer is the place where the individual's spouse and children live together and normally reside, irrespective of the period of effective residence of the taxpayer during the year. The sejour principal is that of effective presence, in other words, more than 183 days a year.
• Carrying on a professional activity, whether salaried or not, unless it can be shown that this activity is exercised in France only on an ancillary basis.
• The centre of economic interests, in other words, the place of the individual's principal investments, the place where they administer their assets or from where they draw a larger part of their income.
The definition is therefore wide and does not necessarily require any period of partial or full time physical presence to render an individual liable to French tax. The ownership of a second home in France where family visits are less than six months a year should not result in an individual becoming resident in France. For an individual who is resident in a country with a treaty with France, the treaty should avoid him becoming resident even if he triggers one of the connecting factors subject to the tie-breaker tests found in most treaties.
Although the individual can avoid becoming connected with France, the property's situs is in France. Any rentals arising from the property would therefore be subject to French income tax under the source doctrine. However, even if it not rented out, Article 164c of the French tax code provides that owners of French residential property who are not resident in France for French income tax purposes are subject to French income tax on deemed income from the property, calculated as three times the estimated annual rental value. To avoid this tax charge recourse must be had once again to a double tax treaty, either in respect of his residence or failing that his nationality.
Using a double tax treaty
An individual resident in a country with a double tax treaty with France can escape this tax if the treaty has the appropriate article. For instance, Article 24c of the UK-French treaty provides:
"A resident of a contracting state who maintains one or more places of abode in the other contracting state shall not be subject in that other state to an income tax according to an imputed income based on the rental value of the place or places of abode."
If the individual's country of residence either does not have a treaty with France or does not have an Article 24c equivalent then they must fall back on their nationality. Article 25(1) of the UK-French treaty provides:
"The nationals of a contracting state shall not be subjected in the other contracting state to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other state in the same circumstances are or may be connected."
It is therefore necessary to look at the treatment of non-resident French nationals under Article 164c. Under the article there is an exception to the charge for French nationals who can prove that they are subject, in the country in which they are resident for tax purposes, to income tax equal to two-thirds of the amount they would have had to pay in France on the same basis. A British national would therefore avoid the charge only if he is subject to a deemed income assessment equal to two-thirds of the amount they would have had to pay in France on the same basis. Residents of countries such as Dubai who owned French residential property for their own occupation would therefore have difficulty in avoiding the charge.
Other taxes affecting French property
In addition to the deemed income charge, the property can also be subject to capital gains tax and wealth, succession and gift duty and French forced heirship rules since it is sited in France. The property's connection with France can be broken by interposing a company and so potentially avoid these taxes. However, using a non-French resident company would trigger another deemed income charge equal to 3% of the value of the property. Normal practice therefore has been to use a French property company, a Societe Civile Immobilere (SCI). Since SCIs are treated as transparent for French tax purposes they would not avoid the Article 164c charge. However, as discussed above, individuals resident in the UK would avoid the charge.
Use of ownership vehicles
If the individual were resident in the UK there are no deemed income provisions if property is held in the individual's own name or through a nominee. However, if the property is owned through a company then the property could be within the charge to income tax on the grounds that the individual is a shadow director of the company and therefore subject to the benefits charge, since the property is made available for the individual's occupation by the company. The individual is treated as an employee and the use of the property regarded as a benefit-in-kind calculated at 5% of the cost of the property over £75,000. The Inland Revenue confirmed in its December 2000 Tax Bulletin that it considers an SCI to be opaque for UK tax purposes and so potentially within this charge. However, there are some compelling arguments against the Revenue's view and the Revenue has recently agreed to review the position and in the meantime is not pursuing any cases.
A means of avoiding this charge, if the Revenue eventually concludes that an SCI is opaque, would be to draw up an agreement whereby the French company holds the property as a nominee for the individual. In that way it is believed that the individual would be the beneficial owner for UK tax purposes and the company the owner for French inheritance purposes.
While the acquisition of a French property should not trigger residence, in all likelihood over the years the individual and his family will strengthen their ties with France. At some point his family may move to France and he may commute to the UK. Eventually the individual may retire to France and become domiciled there. Tax and inheritance planning must therefore be undertaken from the outset.
An individual who becomes or will become resident in France can use a French approved insurance linked investment bond to significantly reduce their liability for French taxes down to a taxable rate of only between 0% and 10% of taxable investment income on the gains arising from withdrawals from their investments. Because the tax benefits associated with qualifying bonds increase to a maximum over an eight-year period, the sooner a potential resident invests in a qualifying bond before becoming resident, the sooner they will benefit from the maximum tax advantage when they become resident in France. For a life assurance investment bond to work the bond must have a French approved fiscal representative. An offshore bond can be used so long as it is issued out of Dublin or Luxembourg or other EU member state and the life office has a French approved fiscal representative. The bond would be effective for UK tax purposes and achieve the tax planning goals of tax free roll up, taxation only on withdrawals and a discount/taper on deferred gains.
The problem with these tax and inheritance issues is that they will only emerge over time. For instance, CGT will emerge when the property is sold and will be enforced by the property agent who will not release the proceeds until he has seen proof that a return has been submitted to the French Inland Revenue. It is therefore essential to look at all of the issues prior to purchasing a property and to plan to mitigate tax and ensure that all compliance obligations will be met on time. The impact of penalties on tax being paid several years late can double the liability. Oh, and there is also an exit charge in France when an individual becomes non-resident after a period of residence.
Once the property has been purchased the French Revenue has only to sit and wait for the plot of the french connection to unfold.
Capital gains tax can no longer be avoided
Brendan Harper is technical services consultant at Friends Provident International
For many years, certain tax planners used life insurance as a means of avoiding capital gains tax (CGT) on private company shares. Does a recent case drive a final nail in the coffin of this planning?
The basis of the planning was to use the tax efficient life wrapper to avoid CGT on the sale of a private company. Because the sale happened within the bond, no CGT was chargeable and the cash could remain in the bond until the policyholder was ready to take the benefits. In addition to this, some bonds would be set up in the ownership of an offshore company. The thinking here was that, due to the time apportionment relief formula, the gains could not be charged to UK tax as the policyholder never became UK resident. There was no equivalent to the settlor charge in relation to bonds held in an offshore company, so the gains were totally tax free.
It was also possible to transfer the company into the structure without creating a CGT charge - very useful if a company had large inherent gains. This was done by setting up the bond, which owned an offshore holding company, which itself owned an onshore company. The 'target' company was then transferred to the UK company. This transaction qualified for holdover relief under s165 TCGA 1992. When a buyer was located for the company, the offshore company was sold within the bond, giving that magic tax-free gain.
These schemes fell out of use in 1998 due to a number of significant changes:
• Introduction of the PPB rules.
• Removing tax-free gains on bonds held by offshore companies.
• The abolition of s165 holdover relief.
• Introduction of business assets taper relief.
The Revenue has also attacked past schemes, particularly in denying holdover relief on the transfer of the private company. That was the subject of a recent case heard at the Special Commissioners. The case involved a typical scheme incorporating all the steps outlined above. The Revenue said that s167(2)(b), which restricts the relief in the case of gifts to companies, applied because the life company was connected to the client through s286(7), as they acted together to secure control of the underlying company.
The issue was whether the client continued to exercise their former role as shareholder to secure control of the underlying company together with the actual shareholder, the life company. The Special Commissioner said that the legal position created by the scheme was that, despite the life company being the legal and beneficial owner of the underlying company, the bondholder held contractual rather than ownership rights representing the value of the shares. Under the scheme, the appellants changed from being owners of the shares to life tenants of the settlements, which held contractual rights worth the value of the shares. Thus the life company had no real economic interest in the shares. The only reason the underlying company was acquired was to enable the client's scheme to be completed by the gift of the shares. In this, the client acted with the life company to secure control of the underlying company.
The Special Commissioner found that the client's actions were far beyond those of a director negotiating a sale. He made all the decisions relating to the sale, while the life company made none. Therefore, the appellants and the life company were connected persons and s167(2) prevented holdover relief applying to the gift of shares.
Life policies have traditionally been used to avoid CGT on private company shares. Sale of shares took place in the bond, so no CGT on proceeds and cash stays in bond until drawn down.
Many of these schemes fell out of use in 1998 but some still remain.
Recent case by the Special Commissioners has reduced the tax reliefs due in one case of company shares held via a bond.
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