Article 1736 IV bis of the French Tax Code (FTC) imposes very high penalties for trustees who fail to comply with filing requirements imposed by French tax legislation applicable to trusts. Similar penalties exist for French tax residents who fail to disclose their foreign bank accounts, albeit at lower rates - the fine is 5% if the funds exceed €50,000. In a decision dated 22 July 2016, the Constitutional Court ("Conseil Constitutionnel") has cancelled the 5% penalty in relation to failure to disclose foreign bank accounts.
Penalties in respect of trusts
The penalties under Article 1736 IV bis of the FTC, for trustees who have failed to comply with the filing requirements for trusts, include a fine of either €20,000 or 12.5% of the total value of the assets held in trust, whichever is higher.
These fines apply in respect of declarations that should have been lodged on or after 8 December 2013. For declarations due before this date, the fine is 5% of the total value of the trust assets.
This penalty applies to all the assets held in trust and arises each time a failure occurs.
Generally, in respect of tax penalties, French tax legislation provides for varying levels of penalty depending on the behaviour of the taxpayers. In this case, however, the law makes no such distinction. Arguably it should, for instance, distinguish between penalties applicable for complete non-disclosure and penalties applicable for late or incorrect disclosure.
Currently, trusts that have never been disclosed to the French tax authorities are in quite a tricky situation. In a worst case scenario, the level of penalties that trustees are facing could, in theory, exceed 50% of the total trust assets, even in a situation where the trust would not otherwise be liable to French tax. Clearly, in some cases, this may give rise to a potential disincentive to disclosure. Accordingly, the Constitutional Court's decision is potentially good news for trustees in this situation.
The Constitutional Court's decision
The penalty for non-disclosure of foreign bank accounts is imposed in a similar manner to the penalty applicable for failure to disclose a trust. A percentage applies on the non-disclosed assets, but at a lower rate. As discussed above, the rate is 5% in respect of foreign bank accounts whose value exceeds €50,000 on 1 January of the tax year; otherwise the penalty amounts to €1,500 or €10,000.
In its decision dated 22 July 2016 the Constitutional Court ruled that this penalty is unconstitutional because it is not proportionate to the goal of the tax legislation which enacted it. These penalties were implemented in the context of fighting tax fraud. Here the penalty applies simply because there has been a failure in a disclosure obligation, even if no tax fraud can be identified in respect of the non-disclosed accounts. Tax fraud is a criminal offence under French law. Outside the context of tax fraud, a penalty of 5% applied to the non-disclosed funds is too high, and is against the constitutional principle of proportionality of penalties.
The same reasoning could easily be applied to the penalty for non-disclosure of trusts.
Unless the non-disclosure of the trust and the trust assets can be characterised as fraudulent, it would seem that the application of a 12.5% penalty on all assets of the trust) should also be regarded as too high and not proportionate. Even on assets which would otherwise not be subject to French tax.
We should expect a similar decision from the Constitutional Court in respect of trusts. Such a decision would definitely give some relief to trustees (who currently face very high penalties) and encourage further disclosure in the future. In any case, we would always recommend voluntary disclosure to avoid any allegations of fraud in particular cases and to keep penalties to a minimum where possible.