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Irrevocable and discretionary trust and French anti-tax evasion

10 September 2020

Article 123 Bis of the French Tax Code (CGI)

Further to a case law of June 24, 2020, No. 19PA00458, from the Paris Administrative Court of Appeal, Article 123 Bis of the French Tax Code which is an anti-tax evasion legislation does not apply to an irrevocable and discretionary trust. This decision is important as there is little case law on trusts in France and particularly with respect to anti-evasion legislation.

In its Finance Act (hereafter referred to as “F.A.”) 1999 initial version, Article 123 Bis provided that if an individual, resident of France holds 10% of the shares, units, financial rights or voting rights in a legal person, body, foundation or trust established or constituted outside France and benefitting from to a preferential tax regime, the profits or positive income of that entity are deemed to be income from securities to the individual, irrespective a remittance or a distribution, prorata the shares, units or financial rights held directly or indirectly by that person if the assets of the entity consist principally of securities, claims, deposits or funds.

Article 123 Bis is worded in such a way that the test is for the individual to hold 10% in a legal person or a trust. However, an irrevocable and discretionary trust is an institution of Common law that cannot be held by anyone and this was the main question for the French Court.

In the case at hand, the French administration believed that it could rely on Article 123 Bis to tax for the years 2010 and 2011 the income deemed to be received by a taxpayer who had set up in 2004 and 2008 three irrevocable and discretionary trusts, governed by Bermuda law, to which he had transferred his assets.

The Paris Administrative Court of Appeal considered that because of the Parliament preparatory works for the 1999 F.A., Article 123 Bis was designed to be applicable to trusts governed by foreign law.

However, the Paris Court has decided that the taxpayer does not hold any shares or voting rights in such three trusts. While he may receive income from the trusts, the Court has noted that the decision to remit income to the beneficiary and the amount of the distributions are at the discretion of the trustee, in this particular case, a company not controlled by the taxpayer and his family. Accordingly, article 123 Bis cannot apply.

This decision is in line with the legal framework and the economy of irrevocable and discretionary trusts.

The case also contains an intentionally overabundant paragraph, introduced by the formula “in addition, and in any event”, according to which even if the taxpayer could be considered as holding rights in the trusts, they could avail themselves of the safe harbour clause resulting from constitutional case law (C. const., 1 March 2017, No. 2016-604 QPC). According to such constitutional case law, the taxpayer is allowed to demonstrate that the holding does not constitute an artificial arrangement which purpose is to circumvent French legislation. In the case of 24 June 2020, the Court decided that the three trusts were set up at a time where the taxpayer was not a tax resident of France, in the context of restructuring operations caused by a conflict with their partners, and whose main purpose was to protect  the family’s assets under the circumstances described.

Article 123 Bis in its current wording (resulting from the Amending 2017 F.A.) continues to require a 10% holding of "shares, units, financial rights or voting rights". It also provides that “the 10% holding requirement is presumed to be met when the individual has transferred assets or rights to a legal entity located in an uncooperative State or territory, as was already the case in the 1999 version.

The current wording also provides for a double safeguard clause:

  • The first one, applicable when the legal entity is established or constituted in a Member State of the European Union or another State or territory that has concluded with France an administrative assistance agreement to fight tax fraud and tax evasion and a mutual assistance agreement on recovery with a scope similar to that provided in the Directive 2010/24/EU of 16 March 2010 on mutual assistance for the recovery of claims relating to taxes, taxes, duties and other measures and which is not an uncooperative State or territory, if the operation of the business or the holding of shares, stocks, financial rights or voting rights of this legal entity by the person resident of France cannot be regarded as constituting an artificial arrangement whose purpose would be to circumvent French tax legislation;
  • The second one, applicable when the legal entity is established or constituted in a State or territory, if the person resident of France demonstrates that the operation of the business or the holding of the shares, units, financial rights or voting rights of this legal entity mainly has an object and effect other than to permit the localisation of profits or income in a State or territory where it is subject to a privileged tax regime.

Thus, even if Article 123 Bis was intended to apply to date to irrevocable and discretionary trusts set up in non-cooperative States and territories, its implementation can be neutralised by virtue of the safeguard clause.
This case law of 24 June 2020 was defended, with success by CMS Francis Lefebvre Avocats.

Authors

Picture of Pierre-Jean Douvier
Pierre-Jean Douvier
Partner
Paris
Picture of Arthur Vatinel
Arthur Vatinel
Associate
Paris