French homeowners need some savoir faire

Reforms to French tax laws have eased some headaches for the tens of thousands of Britons with second homes on the continent, but wealthy property owners still need to be wary of falling into international tax traps.

This warning comes from UK property lawyers who say there are still inconsistencies between the UK and France’s inheritance tax laws that could lead to substantial tax bills if estate planning is not undertaken.

The problem flares up when a Briton with property in France dies. The French home is subject to local estate tax, regardless of where the owner lives, and the owner is also subject to inheritance tax in his or her country of domicile.

A double taxation treaty between the UK and France irons out much of the liability in both locations, but lawyers say there are flaws in this deal. “The UK French tax treaty allows French tax arising from the same event to be set off against UK tax, but only in respect to the same taxable occasion,” explains Andrew Penny, a solicitor with Forsters, the Mayfair law firm.

“The difficulty occurs when there is a mismatch in the timing of IHT and droits de succession [the French equivalent of the UK’s IHT].”

Unlike the UK, where assets are passed automatically to the surviving spouse free of IHT, in France succession laws have traditionally favoured children who have an automatic right to a set percentage of their parent’s estate, regardless of their parent’s wishes. This legacy share is taxed.

But under reforms introduced in 2007, the surviving spouse no longer pays tax on the share, or life interest, which passes to them – a position now equivalent with that in the UK.

Children who receive a share now also pay less tax on this legacy slice, with their abattement , or nil rate band, also tripling to €150,000 in recent years.

Lawyers say that while, on the surface, these reforms looked positive for UK-based property owners, there are still snags that could expose some, particularly those with more valuable properties, to local IHT bills.

“There is no IHT on the survivor’s share on the first death of a couple because of the life interest or usufruit, qualifies for spouse exemption both in France and the UK,” says Penny.

“The children’s reversion [or legacy slice] will not be taxed in the UK but tax will apply in France because the nue propriété, or remainder, passing to the children is treated as a distinct taxable asset,” adds Penny.

Measures introduced by president Sarkozy to increase the abattement or nil rate band for legacy shares will reduce, if not eradicate, the tax bill for many children of British property owners.

But this won’t cover all estates. For example, a British family with a €700,000 (£650,000) French property with two children could still face a significant IHT bill, estimates Penny.

“In cases where there a significant amount of tax is payable on the death of the first to die, it may be worth investigating means of avoiding the discrepancy in timing by ensuring that the French tax arises on the same events as the occasion for the UK charge to IHT, i.e on the death of the second to die,” he adds.

One way this deferral can be achieved is by establishing a Communauté universelle, or a marriage property regime in France, much like the obsolete marriage settlement.

Under this arrangement, the property is owned jointly for the duration of the marriage and passed to the survivor and then on to the children on the second death. Crucially, says Penny, no French taxes are paid on the first death, and the burden falls, as in the UK, on the second death.

“The advantage of the Communauté universelle is that the charge, when it comes, can be fully offset against IHT,” he says.

However, couples who have remarried will find it difficult to implement these this arrangement as Communauté universelle are not possible where there are children from previous relationships. This is because the arrangement would deprive them of their legacy share and this is not possible under French law.