"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"
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.
EU Savings Tax Directive
Brendan Harper is technical services consultant at Friends Provident International
Almost 18 years since the idea was first mooted, EU member states are finally beginning to exchange information on savings income payments from institutions resident in one EU state to individuals resident in another. The provisions are also being adhered to by certain non-EU states such as Switzerland, the Isle of Man and the Channel Islands.
The non-EU jurisdictions, along with Austria, Belgium and Luxembourg, have opted for a withholding tax regime. The withholding tax will be levied at a rate of 15% for the first three years, and 20% for the following four years. After the seven-year period, the tax will rise to 35%. This will be the default position but clients will be allowed to opt for exchange of information if they wish.
The directive covers all interest payments - this is widely defined to include debt interest, including capitalised interest from zero coupon bonds - beneficially owned by individuals. The directive does not cover non-interest payments, such as dividends and life policy benefits.
Interest distributed by collective investments is also covered but there is an option to ignore such distributions if the fund holds less than 15% of its assets in debt instruments. The redemption proceeds of funds are also included where 40% or more if the fund's assets are in other income producing funds. This threshold reduces to 25% in 2011.
For those institutions affected by the directive, there are minimum requirements for establishing the identity and residence of the beneficial owner, which differ depending on when the contractual relations were entered into. Perhaps the most onerous of those is where relations commence after 1 January 2004. In these cases, where an EU passport holder claims residence in a non-EU country, the paying agent must establish proof by requesting a certificate of residence or tax identification number from the tax authorities of the country in which the client claims to be resident. Not many people seem to appreciate that this will catch, for example, a British passport holder resident in Hong Kong who has a bank account or fund in a jurisdiction affected by the directive.
It may not be easy to get the certificate from the tax authorities so these clients could find that withholding tax is deducted from their interest. It might even be impossible, for example, if a client resides in a jurisdiction where there are no personal taxes - Dubai, for example. Advisers should therefore be reviewing their clients to ensure they are aware of these provisions and to take action before it is too late.
Longer term, perhaps the directive will encourage more individuals to think twice about not disclosing their wealth - particularly when withholding tax rates rise to 35%. It will also encourage individuals to structure their wealth in the most tax efficient way possible using legitimate planning techniques, so will provide good opportunities for financial advisers.
Non-EU jusrisdictions, along with Austria, Belgium and Luxembourg have gone for a with-holding tax rather than comply with EU Savings Tax Directive.
With-holding tax starts at 15% but rises to 20% in four years' time and to 35% after seven.
EUSTD covers not just interest payments, including from debt, but also capitalised interest from zero coupon bonds.
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