The rules not only affect trusts holding French assets, but more importantly, where the settlor or any beneficiary is French resident. The measures included in the 2011 Supplementary French Budget became fully effective from 1 Jan, 2012.
The scope of the new rules
France has generally recognised the validity of trusts created in other territories. However, its tax authorities have struggled to deal with them, as there is no direct equivalent structure in French law. This has lead to confusion over their tax treatment and scepticism of their use.
The new tax definition of a trust is widely drafted, and has led to problems for trusts created in the UK and other jurisdictions.
The definition does not distinguish the type of trust and the interests under it, and thus generally treats all trusts the same for tax purposes. Many trusts, particularly discretionary trusts, have a wide range of possible beneficiaries to provide flexibility when appointing benefits.
But even trusts where the settlor and the trustees are all UK resident can still be caught if just one of the potential beneficiaries is French resident.
The full scope and impact of the new rules can be illustrated in the following example.
Margaret is UK resident and has no intention of leaving the UK. She made a gift of £325,000 into a discretionary trust for her three adult children and their families. The trustees are Margaret’s two sons, who are both UK resident.
Margaret’s daughter, Claire, and her husband, Robert, moved to France six years ago with their children, and that branch of the family is now resident in France.
The trustees must disclose the value of the trust assets to the French tax authorities, as at 1 Jan each year, because Claire and her family are French resident beneficiaries.
There should be no French tax charge while Margaret (the settlor) remains UK resident, provided the trust does not hold any French assets.
But the penalty for failing to supply this valuation information by 15 June each year is the greater of €10,000, or 5% of the trust value. For example, if the trust’s value at 1 January is €400,000, that is a €20,000 charge if it fails to report.
The position becomes more complicated following Margaret’s death. Following the settlor’s death, any French resident beneficiaries are treated as the new settlors, for the purposes of these French rules.
The result is that the value of the trust is now aggregated with both Claire’s and Robert’s personal assets when calculating their annual French Wealth Tax liability. This is despite being discretionary beneficiaries, who may never actually benefit from the trust, and who may have no right to reclaim any tax payable from the trustees.
What is more, if they fail to disclose the trust on their wealth tax return, an additional 0.5% tax charge is applied.
Further tax would also be payable if trust assets are actually distributed to a French resident beneficiary.
These new tax measures can also affect UK trusts where the settlor, trustees and beneficiaries are all UK resident. Merely owning French situated assets will be sufficient to bring the trust within the need to disclose.
What next steps should be considered?
Affected trusts will need to make the necessary disclosures before the first filing date on 15 June, 2012, to avoid unwanted penalties. Valuations of trust assets as at 1 Jan will need to be acquired and submitted along with the trust provisions.
Trustees of discretionary trusts will need to check their knowledge of the country of residence of potential beneficiaries, which could be quite a task.
The trustees may need to take stock and consider whether the original purpose of the trust can be balanced against any reporting and tax issues faced. The new measures can make trust taxation more penal than personal taxation for French residents.
So is now the right time to wind-up the trust and appoint the capital to the beneficiaries? This is a big step, but for some trusts it might be the right decision.
A slightly less draconian step involves a deed of appointment to exclude French resident beneficiaries, to remove future French reporting obligations yet allow the trust to continue. There is a clear need for the trustees to take legal and tax advice.
The new French trust tax regime is harsh and unforgiving, with onerous reporting obligations. It appears to be retro-active in effect and its full scope and application is still being clarified. Action must be taken before 15 June for trusts where a settlor or (potential) beneficiary is French resident.
Julie Hutchison is head of international technical insight at Standard Life International