US trust income: opinion of the French administrative Supreme Court clarifies French tax treatment

Fri 15 Sep 2023

The French administrative Supreme Court rendered an opinion on 18 April 2023 regarding the French tax treatment of trust income in the French-US context.  While this opinion clarifies an area of uncertainty, it certainly raises issues of double taxation which will not improve France’s tax attractiveness when dealing with the US trusts.

France does not have the concept of trust in its domestic civil law regulations. However, French law provides specific tax rules applicable to foreign trusts with a nexus to France. As a matter of principle, these rules consider trusts as opaque entities and tax the trust income only on its distribution to a French tax resident beneficiary.

In contrast, the US income tax treatment of trusts depends on the following types :

• The so called “grantor trusts”, where the settlor retains control over the trust assets, which are completely tax transparent and income deriving from these trust assets is taxed in the hands of the settlors as if they held the assets directly.
• Non-grantor trusts (simple or complex, where the settlor retains no rights, interests or powers over the trust assets) are considered as taxable entities and are taxed on the income which is not distributed to the beneficiaries. Simple trusts, contrary to complex trusts, must distribute the total income of the year to the beneficiaries who will then bear tax on that income.

This contrast in the approach taken by France and the United States has led to uncertainty regarding the tax treatment of trust income in France, particularly with the double tax treaty signed between the two nations on 31 August 1994.

The French government has referred questions to the French administrative Supreme Court to seek their opinion on this topic.

Trust incomes are excluded from the scope of the double tax treaty

The opinion of the Supreme Court rendered on 18 April 2023 states the following:

• The French domestic tax law does not recognise the transparency principle applicable to certain US trusts, thus taxes income only when effectively distributed from a US trust to a French tax resident. Such income will be taxed as a foreign dividend, regardless of the nature of the underlying assets held by the trust.
• The purpose of the double tax treaty between France and the US is to allocate the right of taxation between the two nations and not to modify the substantive domestic tax rules of the contracting states. In the absence of any explicit provision in the double tax treaty preventing the French domestic taxation of distributed trust income as dividends, the domestic rule thus continues to apply.   
• More specifically, Art. 7 §4 of the double tax treaty, which provides for a transparency principle regarding the income from “partnerships”, does not apply to trusts.  Trusts are not treated as partnerships. Certainly, the comments of the French tax administration on the double tax treaty set out an exhaustive list of the entities considered by the French tax administration as “partnerships”, without mentioning trusts.

On this point, the stance of the Supreme Court is questionable. Notably, the comments referenced in BOI-INT-CVB-USA-10-20, dated 12 September 2012, do not explicitly state that the entities listed as “partnerships” within the meaning of the double tax treaty are exhaustive. Moreover, the comments suggest that the following entities are excluded: “(…) “complex trusts”, which accumulate a portion of their income and are thus subject to US taxation for the portion of income accumulated in a given year”.

If the comments only explicitly excluded “complex trusts” from the definition of “partnerships”, one could understand that simple trusts and grantor trusts might be treated similarly to partnerships in the double tax treaty.

The earlier version of the tax administration comments (reference BOI 14B-3-99) already excludes “complex trusts”, in accordance to the same wording as the current version of the comments, but explicitly includes “estates” and “simple trusts” in the list of the “partnerships” under the treaty. When updating its comments on 12 September 2012, the tax authorities aimed to create a single database containing all previously published comments. Further, this reorganisation was meant not to impact the content of such comments. In this context, the deletion of the “simple trusts” from the list of partnerships might have been an oversight of the tax administration during this comment reorganisation.

Practical impacts

This opinion has the merit of establishing a simple and foreseeable rule: any income distributed by a US trust to a French tax resident, regardless of its nature or tax treatment in the United States, is subject to taxation in France as a dividend only when effectively distributed and is subject to a flat taxation rate at 30% (12,8% income tax and 17,2% social surcharges).

However, for all tax residents of France who are receiving income from trusts which were already taxed in the US, this opinion would lead to a double taxation of the trust income, which cannot, in our view, be resolved under the tax treaty from a French perspective.

This opinion of the administrative Supreme Court is not binding for the French tax administration or the taxpayers. However, it provides a good understanding of the court reasoning, as it is the highest jurisdiction for all tax disputes regarding of the income tax in France.

In light of this, we recommend settlors and beneficiaries of US trusts who intend to move to France to assess the tax consequences, and when feasible, restructure their assets before their move.