French Finance Act 2018 – Significant Changes for Individuals
The French Finance Act for 2018, which was adopted by the French Parliament on 21st December 2018, has been described by many commentators as a revolution for the taxation of individuals.
Purpose of this Article
To summarise the main changes coming out of the most recent French Finance Act which affect individuals either resident in France or owning assets in France.
The Finance Act
The most substantial reforms relate to the taxation of investment income, the overall review of the scope of wealth tax as well as the local taxe d’habitation. However, these tax reductions are compensated by a significant increase to French social contributions rates (CSG), which is likely to affect most UK residents with French income.
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- Social contributions: increase by 1.7%
The French social contributions are applicable to most French-sourced income, since 2012. They apply to all French investment income earned by non-French residents, such as French rental income, interest from French bank or saving accounts, French sourced dividends, and gains on the sale of a French holiday home.
Foreign investment income earned by a French resident taxpayer is also subject to French social contributions.
The cumulative rate of the various contributions, which was 15.5% until 2017, has risen to 17.2%.
The increase is to apply to all financial income received and capital gains crystallised from 01/01/2018. By exception, the increased rate is to apply to French property rental income received in 2017.
As a result, any UK tax resident who received French property rental income in 2017 will face a French tax liability of at least 37.20%, composed of:
- French income tax – minimum rate of 20%, and
- French social contributions – 17.20%.
One may consider that this increase of the social contributions rate will not affect higher rate UK taxpayers as it is absorbed by the foreign tax credit. However, under the France/UK double taxation convention, only French income tax is eligible for the Foreign Tax Credit to avoid double taxation. This restriction now leaves UK residents with French rental income with an unrelievable amount of French tax of 17.20%.
- Financial investments: the application of the flat tax
Until last year, financial investment income and gains (e.g. interest, dividends) were subject to the taxpayer’s marginal rate of French income tax. Certain income sources, such as dividends, were subject to a 40% rebate before tax. Some others, such as interest, were taxable on the gross amount received. In addition to income tax, social contributions applied at 15.5% in total
Since 1st January 2018, most financial income and gains are now subject to a flat tax – Prélèvement Forfaitaire Unique – at a rate of 30% on the gross amount of income or gain, composed of:
- Income tax – 12.80%
- Social contributions – 17.20%.
As the flat rate will disadvantage those taxpayers whose marginal rate of income tax is below 12.80%, it will be possible to opt out of the flat rate and remain subject to the income tax rates.
French residents with UK investment income will also be affected by this new flat rate, as it will apply to both French and foreign income.
Likewise, UK residents with French investment income will be affected when France keeps the right to tax under the France/UK double tax treaty, such as French sourced dividends. However, the double tax treaty limits the tax that France can withhold on dividends, to 15%. Therefore, any tax levied above 15% should be eligible for a refund.
Under the double tax treaty, France also loses the right to tax interest received by UK residents. Therefore, it is anticipated that any tax withheld at source by French banks on interest income will remain eligible to a refund claim by UK residents. France may however consider that only the income tax element of the flat rate is eligible for refund, hence limiting the refund to 12.80%.
The 30% flat tax has also been extended to gains made on life insurance policies, when the total amount of premium paid on the policies exceeds €150,000.
For policies below this threshold, any withdrawal made after 8 years will continue to benefit, on option, from the French income tax rate of 7.5% plus the social contributions at 17.20%, hence a total tax rate of 24.70%.
These new tax rules apply to all life-insurance policies or capitalisation contracts taken out by French residents in France or abroad.
For income and gains on French life insurance policies paid to non-residents, the 7.5% income tax rate will only apply to the gains relating to premiums paid before the publication of the draft Finance Act on 26 September 2017. Therefore, for non-residents, an apportionment will have to be made between:
- the gains relating to premiums paid on or before 26/09/2017, which may still benefit from the 7.5% preferential French income tax rate on option for contracts of over 8 years; and
- the gains relating to the premiums paid from 27/09/2017 for which the 30% flat tax will automatically apply, independently from the age of the policy. The taxpayer will however be entitled to claim the application of reduced the 7.5% rate for the part of the gain corresponding to premiums below €150,000.
Having said that, the double tax treaty provisions will continue to prevail over internal laws. As such, France should lose the right to tax any gains from French life-insurance policies when paid to a UK tax resident. Once again, France will still apply the social contributions at 17.20% and restrict any claim for refund of the flat tax to 12.8%.
- Taxe d’habitation: partial exemption or abolition?
The taxe d’habitation is a local tax paid by any owner or occupier of a property which is regarded as habitable.
The reform aims at exempting from the tax all households whose previous year’s base annual income does not exceed a given threshold (€28,000 for an individual; €45,000 for a married couple with no children). The exemption will straddle three years, so that a full exemption applies from 2020.
However, this exemption will only apply to the taxe d’habitation of the taxpayers’ main residence. UK residents who own a holiday home in France will continue to pay their taxe d’habitation as usual and will not be affected by the reform.
Having said that, President Macron, in his New Year’s speech, announced his intention to totally abolish the taxe d’habitation by 2020, which may bring some good news to owners of French secondary residences in the forthcoming years.
- Wealth tax: now restricted to properties
When I wrote my last January article on Wealth tax (French wealth tax: is it only for the wealthy?), Emmanuel Macron had not yet been elected as French President and we could not anticipate the considerable forthcoming changes to the French Impôt de Solidarité sur la Fortune (ISF).
The reform does not aim at abolishing wealth tax entirely, but it restricts its scope to immovable assets. The tax is consequently renamed as Impôt sur la Fortune Immobilière (IFI).
In practice, from 01/01/2018, all movable assets, whether tangible or intangible and wherever situated, are exempt from wealth tax, such as bank and saving accounts, bonds, SIPPs, financial investments, furniture, cars or yachts.
French residents are now taxed on their worldwide immovable assets, including UK-based properties. Non-French residents are taxed on their French property and land only.
Shareholdings are also exempt but so long as the company does not own French property or land which is not used for its business. Hence a UK resident who owns a French holiday property via a French company or a UK company, will be subject to wealth tax on the portion of its shareholding representing the market value of the French property.
With exception to the reporting obligations which are also simplified, most of the rules of computation of the tax remain otherwise unchanged:
- tax threshold – still € 1.3 million;
- tax rates – still range from 0.5 % for estates below €1.3 million to 1.5% for estate above €10 million;
- tax will be based on assets value on 1st January each calendar year;
- all previous exemptions remain applicable. Notably, a UK national who takes permanent residence in France will still benefit from the temporary newcomers’ exemption of foreign assets, hence will be subject to the IFI on his French immovable assets only for a period of 5 consecutive calendar years. His UK based properties will only become taxable from the 6th year following his arrival.
Mr Smith moved permanently to France in February 2017. Under the new IFI, Mr Smith’s position has changed as follows:
Mr Smith’s French and UK investments are now outside the scope of French wealth tax and therefore disregarded.
His UK property, worth €750,000, will only be subject to wealth tax from the 6th year following his installation in France, hence not before 2023.
Between 2018 and 2022, only his French immovable assets will be subject to wealth tax. So long as his French property’s value (€850,000) remains below the tax threshold, Mr Smith will not have any IFI liability to pay.
In 2023, Mr Smith’s worldwide immovable estate will be worth €1,345,000, (i.e. €750,000 for his UK property and €595,000 for his French flat after deduction of the main residence 30% relief). The corresponding French wealth tax will be about €2,725 per annum, reduced from €4,600 under the previous ISF rules, hence a tax saving of €1,875 per year.
Wealth tax remains applicable on the net value of assets. If Mr Smith had taken a mortgage to buy his properties, he could have deducted the capital outstanding on 1st January each calendar year until loan redemption, hence reducing further the net value of his immovable estate. Mr Smith will however not be able to use an interest-only mortgage to further postpone the payment of the French wealth tax, as the 2018 Finance Act now provides that taxpayers using interest-only mortgages should be placed in the same position as those contracting out classic mortgages and the loan capital deduction evenly spread over the loan period.
You will want to:
- identify your clients with French assets and/or income and consider the impact of the reform on their French tax liability for 2018;
- encourage clients to take prior advice on any withdrawal from French life-insurance policies and any possible claim for a refund of flat tax levied at source for withdrawals recently made;
- consider those clients who may benefit from wealth tax reform, but also those who may be penalised if they bought properties via an interest-only mortgage or via a French or a UK company.
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