A question of trust

Changes in French law means that those who are thinking about buying a French property through a trust might want to reconsider their options, as Sarah Walker explains

There has been a great deal of uncertainty surrounding French tax rules applying to foreign trusts for quite some time, with civil law not recognising the common law concept of trusts. The position was therefore governed in France by case law. The situation has now been clarified by a new French finance law adopted on 29 July 2011. This introduced brand new rules regarding the inheritance and gift tax, wealth tax and income tax treatment of any trusts with a French connection.

It is believed that the aim of the new regime is to discourage the use of trusts by French residents, as France has historically regarded trusts as a tax evasion tool. In fact under common law, although there may sometimes be tax advantages involved, this is frequently not the case and often the motivation for creating trusts stems from reasons such as ensuring assets are safeguarded to pass on to future generations.

The new law has introduced an obligation for trustees to declare to the French tax authorities the existence of any trust with a French connection, whether that be because the trust contains French assets or because any of the beneficiaries are French resident. These declarations must be made annually during the lifetime of a trust, and additional declarations must be made if the trust is modified or brought to an end. Fairly severe penalties apply if these obligations are not fulfilled.

For the purposes of the new rules, French law now provides its own definition of a trust, which has been very widely drawn. Using French terms, it covers broader concepts under English law meaning that, for example, trusts arising on death under a will or intestacy will be included within the scope of the new rules.

This article will focus on the inheritance and gift tax implications of the legislation, which is undoubtedly the most complex part of the new law, and is likely to be of most impact to many people. To reiterate, this new tax treatment will apply to trust assets if the settlor or any of the beneficiaries are French resident, or if any trust assets are situated in France.

A tax charge will be generated either by a gift or transfer by the trustees, or by the death of the settlor. This applies whether or not the assets are transferred to the beneficiaries at that time or they remain in trust. For example, if an individual settles property on trust, there will be a tax charge on his death and should the property remain in trust, there will be further tax charges on the death of each generation of beneficiaries.

How the trust is taxed will depend on whether the transfer may be regarded under the new rules as a ‘normal’ gift or succession. If it can be, the usual gift and inheritance tax rules will apply, and the rate of tax will be determined by the beneficiary’s relationship to the settlor. In order for a transfer qualify as a normal gift or succession, a ‘determined’ share must be passing to a ‘determined’ beneficiary. This is likely to apply where a trust comes to an end on a specific date and an identified share is passed out to each beneficiary, for example. However, is not entirely clear at this stage exactly what will be classified as a determined share and, given past difficulties with applying French civil law principles to trusts, it may be that the scope of this ‘normal’ regime may be limited in practice.

If this does not apply and the transfer cannot be treated as a ‘normal’ succession, a specific tax charge will be applied instead. This specific charge will be at one of two rates; if a ‘global’ share is passing to beneficiaries who are all descendants of the settlor, tax will be at a flat rate of 45%. An example of when this might apply could be where a certain portion of an estate is globally attributed to children in a testator’s will.

In all other cases the rate of tax will be 60%. In particular, it is worth noting that this may apply to a spouse whereas, if no trust were involved, there would be an exemption from inheritance tax. It should be borne in mind that in any event, if a French resident sets up a trust after 11 May 2011 the rate of tax will be 60%.

The double tax treaty applying between France and the UK may be of assistance in certain circumstances. If, for example, a UK domiciled person settles assets on trust and one of the beneficiaries is French resident, France will only be entitled to tax the immoveable assets situated in France. However it is important to remember that this will only applies to transfers occurring on death and not during a settlor’s lifetime.

It will be important to check whether these new rules may impact on you. In the event that you are the settlor, trustee or beneficiary of any trust with a French connection it is likely that they will. Similarly, it is likely that your estate will be affected on your death if you or any of your beneficiaries be French resident, or if you own French property, unless you have prepared a separate French will.

There may be scope for reducing this impact. For example, in the case of trusts created during lifetime, it may be appropriate to bring the trust to an end and appoint the property out to beneficiaries. This will however require careful consideration of the likely inheritance tax implications in both the UK and France, as well as capital gains tax and other factors. What possibilities may exist will depend upon the terms of the trust and therefore what options are available to the trustees.

In light of these new rules the importance of making a separate French will cannot be underestimated if you have French property or are resident in France. The definition of trust contained in the new law is wide enough to encompass English wills even where there are no ongoing trusts, by virtue of the fact that the assets will come to be under the control of the executors or administrators while the estate is being dealt with. By preparing a separate French will dealing with the French assets you are therefore likely to avoid a great deal of complication.

It will be important in future to think extremely carefully before settling any French property on trust, or before including any French resident individuals as beneficiaries. Additionally, in the event that a beneficiary of an existing trust should move to France, it may be appropriate to consider excluding them as a beneficiary. All things considered, it is probably sensible to avoid wherever possible constituting trusts with French connections. LF

www.ashtonkcj.com

This article is for general information purposes only and does not constitute legal or other professional advice. We would advise you to seek professional advice before acting on this information.