France: The difficulty of applying anti-avoidance rules to trusts
Nicolas Duboille of Sumerson looks at the decision in the Clive-Worms case, which confirms that anti-avoidance rules targeting undistributed profits realised in low-tax jurisdictions are not easily applicable to trusts.
French tax authorities have traditionally handled matters concerning trusts with caution, considering it as a typical international tax avoidance tool. Despite this, French case law concerning foreign trusts has not been too frequent. The decision rendered by the Paris Court of Appeal in June 2020 concerning the taxation of undistributed profits deriving from assets in a Bahamas trust evokes wider consideration.
Most French anti-avoidance rules that are designed to be applied to legal entities are also applicable to trusts, but the modalities of the application of such rules are not always well apprehended by the French legislator or the French tax authorities, as they often struggle to duly take into consideration the aspects or legal features of trusts. Among these rules, Article 123-bis of the French Tax Code (FTC) targets the undistributed profits realised by entities whose assets are mainly financial assets and that are established in low-tax jurisdictions (LTJs) by treating these profits as deemed distributed income at the level of the shareholders/beneficiaries who are French taxpayers.
The recent decision of the Administrative Court of Appeal of Paris, Clive-Worms (CAA Paris, 2nd ch., June 24 2020, No. 19PA00458) confirmed that this anti-avoidance rule is probably not properly designed to target undistributed profits deriving from many trust assets.
On one hand, the Paris Court of Appeal confirmed that the French Parliament, when voting on the Article 123-bis rule, intended to apply it to profits deriving from assets placed in trusts. On the other hand, the conditions provided by the Tax Code for the application of this measure have been designed for legal entities, especially companies. Thus, they do not seem to be well-tailored to the particular nature of trusts. This specific anti-avoidance rule applies only if the taxpayer holds at least 10% of the shares, units, financial rights or voting rights in the entity (this condition is assumed to be met when the entity is located in a non-cooperative state and territory (NCST)).
According to the Court of Appeal, this infers that for irrevocable and discretionary trusts, tax authorities must demonstrate that the French taxpayers have control over the trustee, so as to actually have the means to decide on the distribution of such income. When the trustee is an independent trust management service provider, as it was in the case at hand, there is in principle no control by the trust settlor or trust beneficiaries over the trustee, and thus, no holding of voting powers and financial interest ‘in the trust’, in the meaning of Article 123-bis FTC, as confirmed by the Court of Appeal.
Under this case law, profits or income deriving from assets held through an irrevocable and discretionary trust administered by an independent trustee should not trigger the application of the French 123-bis rule, except if the trust is ‘established’ or ‘constituted’ in a NCST. Again, the concept of place of ‘establishment’ and place of ‘constitution’, that was intended to apply to legal entities, may elicit some questions when applied to some trusts (i.e. whether these terms refer to the law governing the trust arrangement or/and the place where the trustee is established).
Moreover, even if the control over the trustee is demonstrated, or if the holding of the 10% voting rights/financial interests is presumed in case of a NCST location, some other difficulties should be overcome by the French tax authorities for efficiently applying Article 123-bis. For instance, it is necessary to determine the portion of profit to be taxed at the level of each beneficiary. Such apportionments could be in practice, in many cases, very difficult or impossible to perform, e.g. in case of several beneficiaries whose rights are determined with seniority rules, or with condition precedents, etc.
Finally, pursuant to a safeguard clause, the taxpayers are allowed to avoid the 123-bis taxation if the trust, ‘located’ in a state having concluded with France an administrative assistance agreement to fight against tax evasion and a mutual assistance agreement on tax collection, is not an artificial scheme in the aim of French tax avoidance. If the trust is not ‘located’ in such a state, the taxpayers can avoid the 123-bis taxation by demonstrating that the trust has a main object and effect other than the location of profits and income in an LTJ. In the case at hand, the Paris Court of Appeal judged that the taxpayers were entitled to benefit from such safeguard clause, as the trust was formed years before the beneficiaries and settlor became French tax residents, and was mainly motivated by the need to protect the family assets with respect to a commercial conflict faced by the settlor.
It is important to note that this decision is definitive, as the French tax authorities have opted not to bring this case to the French Supreme Court.
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