British property owners in France are often concerned about French inheritance tax. It is frequently said that French inheritance tax is more punitive than inheritance tax in the UK. It is true that, in some circumstances, French inheritance tax can be levied at 60%, whilst inheritance tax in the UK is charged at a flat rate of 40%. However, because inheritance tax is not levied in the same manner in each country, this is a simplistic and distorted view. For estates given to broadly, unmarried partners, French inheritance tax is punitive compared to UK inheritance tax. However, when there are several children and a large estate, French inheritance tax may end up being considerably less than UK inheritance tax.
Fundamental difference UK v French inheritance tax
The primary difference is that whereas in the UK the estate as a whole is taxed, in France each beneficiary is taxed on the share which they receive. As such, the French system is a true inheritance tax (the heir is taxed) whereas the UK system is an estate tax (the estate pays).
So whereas in the UK there is a nil-rate band for the estate (of £325,000 for 2009/2010) and then everything over this is taxed at 40%, in France the nil-rate (or tax free allowances) and the rate of taxation vary depending on the relationship between the deceased and the beneficiary. The tax free allowances are revised annually in France for each calendar year. The nil-rate band is set in advance for future tax years in the UK.
Domicile/Residence
A further element of confusion is that the basis on which each country decides whether or not you are “connected” to them for tax purposes is different. France has a simple test based on where you are resident. The UK has a more flexible concept called domicile which is broadly where you intend to spend the rest of your days regardless of where you actually live. The UK concept of domicile is extended for tax purposes to include deemed domicile, which is broadly someone who has been resident in the UK for more than 17 tax years, even though they are not domiciled in the UK. France will tax you on your worldwide assets if you are a resident in France and the UK will tax you on your worldwide assets if you are UK domiciled. You can, of course, be both UK domiciled and French resident, in which case you will need to turn to the treaty as set out below to decide which country has the taxing rights.
All this needs to be borne in mind when looking at the examples given below.
Inheritance tax treaty UK - France
There is an inheritance double tax treaty between the UK and France, which provides that you will not have to pay inheritance tax twice on the same asset. So if French inheritance tax is payable on the French holiday home of a UK domiciled individual, a credit or refund can be claimed from the UK tax authorities when UK inheritance tax is paid on the estate. This involves calculating what portion of the UK estate is represented by the French property and consequently how much of the UK inheritance tax is attributed to that asset. A credit can be claimed up to the amount of tax payable on that asset in the UK. In effect the higher of the two taxes is paid. In addition, each country taxes assets situated in it, including moveables. The application of the treaty and the rules in France and the UK can be quite complex.
Married couples / civil partners / PACS – UK/France similar IHT exemptions
As most people are aware, in the UK when a spouse inherits they do not pay tax (there is one exception to this which relates to a non domiciled spouse). The same is true in France – a spouse inherits tax free from their husband or wife. This is a relatively recent innovation, dating only from August 2007. The same applies to people in a UK civil partnership or a French PACS. The tax exemption for UK civil partnerships has only been introduced in France very recently.
Unmarried couples / no civil partnership / no PACS
However, the situation in the UK and in France is different for a couple who do not have a formal partnership or marriage. In the scenarios below, Mr Smith and Ms Green are an unmarried couple who do not have a PACS.
Scenario 1: Mr Smith dies, leaving Ms Green all his assets, valued at £300,000 (or €353,000)
If he is UK domiciled, there will be no UK inheritance tax as the estate is within the nil-rate band. If he is French resident, French inheritance tax will be at 60% (the top rate) because they are unrelated. There is a very small tax free allowance of €1,564, so the remainder of €351,436 is taxed at 60%, giving a tax bill of €210,861. In this instance the situation is punitive in France compared with the UK.
Scenario 2: Mr Smith dies, leaving Ms Green all his assets, valued at £1,300,000 (or €1,529,000)
If he is UK domiciled, in the UK the first £325,000 will be tax-free, the remainder (£975,000) will be taxed at 40%, giving a tax bill of £390,000. If he is French resident, the inheritance tax will be at 60% (the top rate) because they are unrelated. There is a very small tax free allowance of €1,564, so the remainder of €1,527,436 is taxed at 60%, giving a tax bill of €916,461. The French tax bill will be roughly twice the UK tax bill (€916,461 is approximately £780,000).
Scenario 3: Mr Smith dies, leaving all his assets to his two children (in equal shares), his estate is valued at £300,000 (or €353,000)
If he is UK domiciled, there will be no UK inheritance tax as the estate is within the nil-rate band. If he is French resident, French inheritance tax will be levied on each child’s share (€176,500). The tax rates are incremental between parents and their children. Each child also has a tax free allowance of €156,359, so each child is only taxed on the remainder of their share, i.e. €20,141. This figure is taxed at incremental rates ranging from 5 – 40%. €20,141 puts the tax into the 20% band, giving a tax bill of €2,256 for each child and a total bill of €4,512 for the whole estate (approx £3,837). Whilst there is some tax payable in France and none in the UK, the amount is very low.
Scenario 4: Mr Smith dies, leaving all his assets to his three children (in equal shares), his estate is valued at £300,000 (or €353,000)
If he is UK domiciled, there will be no UK inheritance tax as the estate is within the nil-rate band. If he is French resident, French inheritance tax will be levied on each child’s share (€117,666). The tax rates are incremental between parents and their children. Each child also has a tax free allowance of €156,359, so the amount they each receive falls within each child’s tax free allowance, and there would be no tax payable in France. The position is the same in both the UK and France, no tax is payable.
Scenario 5: Mr Smith dies, leaving all his assets to his four children (in equal shares), his estate is valued at £1,300,000 (or €1,529,000)
If he is UK domiciled, in the UK the first £325,000 will be tax-free, the remainder (£975,000) will be taxed at 40%, giving a tax bill of £390,000. If he is French resident, French inheritance tax would be levied on each child’s share (€382,250). The tax rates are incremental between parents and their children. Each child also has a tax free allowance of €156,359, so each child is only taxed on the remainder of their share, i.e. €225,891. This figure is taxed at incremental rates ranging from 5 – 40%. €225,891 puts the tax into the 20% band, giving a tax bill of €43,406 for each child and a total bill of €173,624 for the whole estate (approx £147,656.). Here the UK tax bill is more than 2 ½ times the French tax bill.
Outcomes
It is clear that unmarried couples with no civil partnership or PACS who wish to benefit each other on death should consider the inheritance tax implications before becoming French resident.
Unmarried couples with no civil partnership or PACS who have unequal wealth, may wish to consider how they own their assets.
The favourable position of estates devolving to children, may lead spouses to consider whether they still wish to pass their estate to their surviving spouse, or whether leaving assets directly to children on the first death is preferable.
The above is a broad outline of the position, and does not take into account the detailed rules and possible exemptions which may be applicable in certain circumstances. In order to calculate probable exposure to inheritance tax in France or in the UK, advice tailored to your personal circumstances should be sought.
October 2009
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