The Franco-British taxation of individuals
By Maître Cédric RIVIERE, tax lawyer in Périgueux, Dordogne
At a time when Brexit has taken an irrevocable turn, the many British citizens residing in France are asking many questions about their future in our country. Among these questions: their tax situation and the taxation of their British-source income. Taxation is not governed by European Union legislation but by a bilateral tax treaty, which is unlikely to be affected by the UK’s exit from Europe. Such treaties are agreed between nations and reviewed periodically; the last amendment to the UK/France treaty was some 7 years ago.
Replacing a previous treaty dating from 1963, the current Double Tax Agreement (DTA) “to avoid double taxation and prevent tax avoidance and evasion with respect to taxes on income and capital gains” between France and the United Kingdom, signed in London on June 19, 2008, came into force in France on December 18, 2009. It has begun to apply to French income from January 1st, 2010. This agreement is based on the model established by the Organization for Economic Co-operation and Development (OECD).
For British residents in France, it is first necessary to precisely define their status as tax residents of France (I), to manage the differences between the two national tax systems (II), to then to apply the provisions of the treaty to determine in which country particular types of income will be taxed (III), and, finally, to apply the mechanisms to avoid possible double taxation of their income (IV).
I. Tax residence
Determination of the taxpayer’s tax residence status is imperative in order to be able to apply the provisions of the agreement. This concept is not a question of choice but of facts and is defined first by the national legislation of each country. If a taxpayer can be regarded as a tax resident under the laws of both countries, the dispute will be settled under the provisions of the Double Tax Treaty.
A. Tax residence under the United-Kingdom law
Originally based on a caselaw definition resulting from many court decisions, the notion of tax residence has been the subject of major reform by the United Kingdom’s tax authorities, HMRC (Her Majesty’s Revenue and Customs). Indeed, new legislation was introduced from 6 April 2013, applicable from the 2013/14 fiscal year.
This legislation, known as the “Statutory Residence Test” sets criteria for considering a person as a tax resident of the United Kingdom.
These criteria, under the “Automatic UK Resident” element of the SRT are as follows:
- stay of more than 183 days in the UK,
- a home located in the United Kingdom, and you spend sufficient time there
- full-time work in the United Kingdom.
If one of the three conditions above is fulfilled, the taxpayer is a tax resident in the United Kingdom under one of the automatic tests. On the other hand, if none of these criteria are fulfilled, the United Kingdom tax authorities also determine the degree of the taxpayer’s “personal ties” with the country, in the light of the following criteria of attachment:
- professional activity,
- more than 90 days presence in the UK in either of the previous two tax years
- more time spent in the UK than any other single country
These “personal ties” are studied in relation to the time spent in the UK during the fiscal year. Therefore, the more criteria applicable to a taxpayer, the less time he is allowed to spend in the territory before being considered resident. Moreover, this assessment differs whether if the taxpayer is “entering” or “leaving” the territory during a tax year.
B. Tax residence under French law
On the French side, the notion of tax residence in France is governed by the provisions of Article 4 B-1 of the French Tax Code, which lists a set of tax residence criteria:
- place of the home/household or most presence,
- place of the main professional activity,
- place of the centre of economic interests.
These criteria are called “alternative”, which means that it’s enough to fill only one of them to be considered as tax resident of France.
C. Determination of tax residence under the Double Tax Treaty
In case of conflict between the two countries in terms of tax residence, it is necessary to refer to the provisions of Article 4 of the DTA. This article lists a set of criteria that are:
- permanent home,
- centre of vital interests (the closest personal and economic links),
- habitual presence,
- and finally, nationality.
These criteria are referred to as “successive”. It is therefore necessary to study the situation of the taxpayer in regard to each criterion, taken one after the other until one of them results in the resolution of the question.
If these criteria still do not determine the tax residence of a taxpayer, the agreement provides that “the competent authorities of the States shall settle the question by mutual agreement” (Article 4-2-d).
D. The notion of “couple mixte”
Even if the French tax system is based on the concept of “household”, tax residence status is determined on an individual basis. Therefore, in the case of a couple, where one of the spouses is a tax resident of France, while the second is a resident of the United Kingdom (this situation is described as a “couple mixte”), then it is necessary to consider the non-resident spouse in determining the family quotient of the French resident and this is done by reference to the matrimonial regime of the couple.
When the couple is married or in a civil partnership under a “community regime”, both spouses are taken into account for the family quotient, but only the French income (not the global income) of the non-resident spouse is to be declared and taxed in France. On the other hand, when the spouses are married but under a separation scheme and do not live under the same roof, they are subject to separate taxation (Article 6-4-a of the French Tax Code). Therefore, the non-resident spouse is not considered, neither for reporting of his income nor for the family quotient. He will file a separate tax return declaring only his income from French sources, if, indeed, he has any.
In fact, this concept has little impact on British citizens, because their legal matrimonial regime is that of “separation”. Accordingly, the spouse (married under this UK regime) who is resident in France will file an individual tax return, declaring only his/her income; he/she will only benefit from one part. The non-resident spouse (married under this UK regime) will only be taxed on his/her own income from French sources.
II. Managing differences between the two national tax systems
There are major differences between the two national tax systems, which must be taken into account when filing a French tax return with UK income.
First of all, the British system taxes taxpayers individually whereas the French system taxes the “household”. But this does not pose a practical problem, since it is sufficient to group the income of spouses (and possibly their children) to make a joint declaration in France.
Many British taxpayers with no income other than pensions, salaries or investment income such as bank interest or dividends do not have to file an annual tax return in the United Kingdom. On the other hand, those who receive income that cannot be by nature subject to withholding tax (property income, income from self-employed activities, etc.) produce an annual tax return called a “Self-Assessment Tax Return”.
In addition, if the French fiscal year is simply based on the calendar year (January 1st – December 31st), when the British fiscal year begins on 6th April of a year and ends on 5th April of the year next. It is therefore necessary for the British tax residents of France to first pro-rate their income over the calendar year in order to declare their income in France, which can sometimes pose some practical problems.
Finally, it is necessary to convert into Euro the income which has been received in the British currency, the Pound sterling. It’s necessary to convert on the basis of the daily exchange rate adopted by the Banque de France on the day of receipt of the income. For the sake of simplicity, in the event of multiple receipts of the same income during a fiscal year, the administration permits the conversion into Euros from the average of the Pound Sterling exchange rates on 1st January (in practice at 31st December of the previous year) and 31st December of the year of payment.
III. Country of taxation of the different incomes
The Franco-British Double Tax Agreement determines the taxation of each type of income either by source country or by the country of residence. Only the income most commonly received by British residents of France will be discussed here.
A. Employment income
Article 15, paragraph 1 of the Convention, provides that employment income shall be taxed in the country where the employment activity is carried out. The OECD principles that govern the interpretation of this Article tell us that we must consider the physical presence in one or the other of the countries where the salaried activity is carried out, in order to know the place where the remuneration is taxed.
This principle of taxation in the country where the activity is carried out, however, includes some marginal exceptions provided for in paragraphs 2 and 3 of article 15 of the DTA.
In the United Kingdom, salary and other employment income (e.g. stock option gains) are taxed at source. However, they must be declared in France by the tax resident of this country, as determined under the provisions of Article 4 A of the French tax Code. In France, the part of the employment income that would be taxable only in the United Kingdom under paragraph 1, benefit from a tax credit equal to the amount of French tax, in order to eliminate double taxation.
B. Retirement pensions
There are three types of retirement pensions in the United Kingdom: the basic State Pension (“old age pension”), personal/private pensions and “Pensions paid in respect of government service”.
According to provisions of the tax treaty, the basic State Pension and personal pensions paid by private pensions schemes are taxable only in the country of residence. They are therefore declared and taxed as pensions received in France.
On the other hand, “Pensions paid in respect of government service” (Article 19-2), i.e. to former civil servants, military personnel, police, teachers are only taxable in the source country, except if the recipient pensioner has the nationality of the other country, his country of residence. For example, a UK public service retiree, tax resident of France, who receives a British Government pension is taxed in France if he has French nationality. If he does not have French nationality, his British “Pension paid in respect of government service” is taxed in the United Kingdom, then declared in France while benefiting from a tax credit equal to the amount of French tax, in order to eliminate double taxation.
The OECD model tax treaty provides that the taxation of dividends can be taxed in the country of residence of the company paying the dividends, but only up to a “treaty” tax rate of 15% but this income is also taxable in the country of residence.
UK Dividends are no longer paid to investors with any attributable UK tax credit or withholding tax i.e. they are paid “gross” and, in most cases, no UK income tax is imposed on non-residents of the UK.
They are taxed in France, either at a progressive rate (while benefiting from a 40% reduction) plus 17.2% social contributions, or at the flat-tax system (30% flat-tax = 12.8% income tax + 17.2% social contributions).
If, in the year of transfer from being UK resident to being French resident, UK dividends have suffered taxation in the United-Kingdom, then in order to eliminate this double taxation, the taxpayer can claim a tax credit equal to the amount of tax paid in the United Kingdom, up to the limit of 15% of the gross dividend.
As far as interests are concerned, the Double Tax Treaty provides that taxation is exclusively reserved to the country of residence.
This income is no longer taxed at source in the United-Kingdom, so is declared and taxed only in France by virtue of Article 12 of the DTA.
E. Rental income
Article 6 of the Double Tax Agreement provides that income from immovable property is taxable only in the country in which the property is located.
However, the rental income from a British source must still be declared in France, but a tax credit shall be granted to the French tax resident in order to eliminate double taxation.
In a lot of cases, this tax credit is given by the French tax administration for the income tax part, but often not for the social contributions (Contribution Sociale Généralisée – CSG, Contribution au Remboursement de la Dette Sociale – CRDS, Prélèvement de Solidarité – PS). This is a frequent error made by the French tax administration, mainly due to a software “bug”, and, therefore, the French tax resident in this situation must make a claim to get the benefit of the DTA tax credit for the social contributions part.
Quite often, rentals are furnished in the UK. The taxpayer resident in France must therefore declare them in the Bénéfices Industriels et commerciaux (BIC) category. It’s impossible to choose the “Micro-BIC” system for a foreign income, and this can be a problem, as the income could be increased by 25% because the UK furnished rental income is not verified by an accounting firm certified by the French authorities (Centre de Gestion Agréé – CGA).
IV. Elimination of double taxation
According to Article 4 A of the French Tax Code, « persons who have their fiscal domicile in France are liable to income tax on all of their income« , i.e. all worldwide income. British source income must therefore also be included in the global income declared by taxpayers who are tax resident in France. The Franco-British tax treaty therefore provides for mechanisms to eliminate double taxation.
The previous treaty opted for the “effective rate” method, which consists of not taxing foreign-source income, but to take it into account when calculating the average tax rate of the taxpayer applied to his French income. The 2008 Double Tax Agreement between France and the United Kingdom uses the “tax credit” method. Therefore, in order to avoid double taxation of income that, under the treaty is exclusively taxable in the United Kingdom, the taxpayer benefits in France from a tax credit equal to the French notional tax.
However, the tax credit is granted only “provided that the resident of France is subject to UK tax on the basis of such income” (Article 24-3-a-i of the Convention).
This notion of “subject to UK tax” has posed practical problems because of the difference between the two tax systems. This is particularly a problem in relation to the British system of “personal allowance”, which is an individual allowance (£ 12,500 or about €14,125) below which the British taxpayer pays no tax. So, for certain income taxable only in the UK under the DTA (e.g. UK rental income) this is sometimes completely covered by the personal allowance. In some cases, HMRC has recognised this and has removed the taxpayer from the Self-Assessment regime, so there is no longer any requirement to file an annual tax return.
Indeed, the French tax authorities initially considered this system of personal allowance as a tax exemption and not as a 0% tax bracket similar to the first tax bracket in our French tax system. Therefore, the administration considered that if the Franco-British tax treaty aims to eliminate double taxation, it was not intended to create a double exemption…
But this position was problematic in at least two hypotheses. First, that of persons with additional income in the United Kingdom exceeding the threshold of this personal allowance: £ 12,500 is not taxed, but the higher fraction is taxed at a rate of 20%. In such a case, would the tax credit of the agreement then apply to the entire income, or only to the higher taxed portion?
The second hypothesis is more complex for a taxpayer who has several types of UK sourced income, taxable in the UK under the treaty. If the total of these incomes exceeds the threshold of the personal allowance, but one of them taken in isolation but does not exceed it, how is one able to know which income exceeds this threshold and gives rise to taxation to benefit from the credit of tax?
After lengthily procrastinating, the French tax administration has come to accept that: “the fact that after the application of personal or age allowances reducing or cancelling all or part of the tax paid in the United Kingdom, must not lead to refuse to grant to the French tax resident, the tax credit provided for in the Double Tax Agreement. This position is consistent with the case law (Conseil d’Etat “Regazzacci”, July 27th, 2012)”.
This answer provided a clear position of the French administration, although it relies on a decision of the Council of State rendered about another device of the English fiscal law called “Remittance basis” and which has nothing to do with the personal allowance…
To summarize, as soon as British-source income has been declared in the United Kingdom, the benefit of the credit is granted regardless of whether or not a tax has been paid in the United Kingdom.
There remains only a practical problem for the British tax resident of France, in that if HMRC has removed them from the Self-Assessment regime because their UK taxable income is below the “personal allowance”, they have not strictly reported this income to HMRC. However, in case of a control by the French tax services, and the taxpayer is asked to justify the reporting of the income in the United Kingdom, this may be difficult to prove as it is not, then, possible to provide a copy of the return sent to HMRC as none exists. The British taxpayer resident in France is advised to keep the notification from HMRC that they are being removed from Self-Assessment. In all other cases, the taxpayer can provide a copy of their UK tax return and, if filed electronically, the acknowledgment receipt. But these documents do not always satisfy certain local tax offices… In addition, HMRC sometimes refuses to issue confirmation of paper filed tax returns! These situations sometimes involve lengthy negotiations with the French tax authorities.
Maître Cédric RIVIERE, with more than 10 years’ experience in dealing with these matters, can assist you if you face any problem with the French tax authorities.