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The law of 29 July 2011 defined the tax regime applicable in France to foreign trusts with respect to transfer taxes, income taxes and wealth taxes. While this legislative framework has had the merit of clarifying the tax treatment applicable to distributions made by a trust, some grey areas remain, including how to distinguish between the capital and the income of this capital when it is distributed to the beneficiaries of the trust. The question also arises at the time of filing an event declaration.
When the trust is set up, the settlor devests himself in favour of the trust by transferring capital into the trust, which can then generate income within the trust itself. Thus, during distributions, the beneficiary may receive capital or income generated by this capital. The importance of the distinction lies in the difference in the tax regime applicable to these two types of distribution.
The tax regime applicable to distributions of trust products to beneficiaries
In domestic law, Article 120-9° of the French Tax Code (FTC) stipulates that a beneficiary who is a French tax resident and who receives the proceeds of a trust is subject to income tax in the category of income from movable capital, regardless of the nature of the underlying income (property income, capital gains, etc.).
This article was modified by Article 14 of the amending finance law for 2011 dated July 29, 2011, so as to only cover products distributed by the trust.
Thus, products capitalized within the trust do not fall within the scope of Article 120-9° of the FTC. However, when the trust is subject to a privileged tax regime, Article 123 bis of the FTC is intended to prevent the accumulation of untaxed income within the trust. A recent decision of the Paris Administrative Court of Appeal1 clarified that it was impossible to apply Article 123 bis of the FTC to beneficiaries of a discretionary and irrevocable trust. In this regard, the parliamentary discussions of 2011 had already highlighted the difficulty of applying Article 123 bis to trusts2 .
Finally, it should be noted that even if the notion of "products" stricto sensu has not been specified by law, practitioners generally consider that only the distributions corresponding to the income generated by the capital allocated to the trust can be considered as income from foreign trust products. What happens when the trust's capital itself is allocated to the beneficiary?
Tax regime applicable to the remittance of a fraction of the trust's capital
Pursuant to Article 792-0 bis of the FTC, "the transfer by donation or succession of property or rights placed in a trust as well as the products that are capitalized therein is, for the net market value of the property, rights or products concerned on the date of transmission, subject to transfer duties depending on the family relationship existing between the settlor and the beneficiary”. Thus, the assets of the trust, including capitalized products, are subject to transfer duties in the event of a transfer by inter vivos or death.
Regarding, on the other hand, the products distributed, the administrative guidelines confirm that for products of a trust which are taxed under income tax rules upon their distribution, their exit from the trust does not in principle entail any transfer taxes3 , provided that the beneficiary or the administrator of the trust are able to justify the qualification of the products above mentioned.
Therefore, at the time of allocation, how is the portion that must be subject to income tax distinguished from the portion subject to transfer duties? How is the order of imputation determined when the trustee has discretionary power? Should we consider that we distribute income first and then capital? Or vice-versa? Should we consider that the trustee has decision-making power in this arbitration?
The difficulties of distinguishing between capital and products during a distribution
While the difference in the tax regime applicable to a remittance of capital and to a distribution of products seems clear, a certain number of practical difficulties remain in the distinction between what comes under the qualification of capital and products since the law and administrative guidelines remain silent on this point. To our knowledge, two case law decisions shed partial light on this question.
First, on September 6, 2012, the Bordeaux Administrative Court of Appeal4 ruled that the sums provided from transfers of capital of a British trust are not taxable under income tax rules. However, the Court did not draw the conclusion that the transfers were liable to transfer taxes as such, but also the latter was not questioned on this point. In this case though, the fact that the sums originated essentially from transfers of capital for the benefit of the beneficiary was not disputed by the French tax authorities. Then, on May 21, 2013, the administrative court of Cergy Pontoise5 ruled that a distinction must be made between the sums corresponding to the income generated by the capital allocated to a Canadian trust, and those resulting from the transfers of the capital itself to the beneficiaries. Only the former constitutes trust products subject to income tax in the category of income from movable capital. In this second case law, the taxpayer had a detailed statement of movements on the trust's capital, which indicated that the disputed sums reduced the beneficiaries’ share of the trust's capital as compensation and that the allocations of the trust's capital were higher than the disputed payments. The judge was also provided with a letter from the Canada Revenue Agency setting out the amounts paid into the capital of the trust since the origin and the distributions granted to the beneficiaries in the form of capital payments.
Thus, to be able to determine what falls under the capital or the products/income of a trust, we think that the trust's administrator keeping probative accounts is a first element of response, although in some cases this does not fall within the scope of any legal obligation in the country in which the trust is established. This approach implies a clear distinction between the “income” account and the “capital” account, even more so when the distributions correspond to discretionary distributions made up of both income and capital.
In this case, to make the accounting probative, does this distinction has to exist since the trust's creation? How should cases where the accounts are non-existent or impossible to reconstitute be handled? In the absence of any indication of the law or administrative guidelines, should an approach similar to life insurance contracts apply, in order to determine the share of capital and the part of income relating to each payment made by the trust? Again, this analogical analysis has no legal grounds today.
There is also the delicate question related to the capitalization and the tax treatment of these capitalized products/income. According to a strict reading of the law, capitalized products are integrated in the base of the transfer duties (art. 7920 bis of the FTC). Subsequently, how should this draft combine with Article 120-9° of the FTC?
Should it be considered that the income received by the trust and distributed before the enforceability of the transfer duties is subject to income taxes, while once the transfer duties are due, the capitalized income distributed would be subject to transfer duties?
To date, neither the law, nor the administrative guidelines, nor case law give clear answers on how to charge what comes under capital and what should be qualified as products generated by the capital at the time of a distribution. There is no doubt that the judges will have to decide on this thorny question in the years to come. In the meantime, a legislative intervention or new administrative guidelines would be welcome.
