France’s 75% tax

Here we go again (it sounds worse than it actually is)

The controversial but popular 75% tax is now law, following the very recently confirmed constitutional court decision. It will be payable for the first time in April 2014 on the portion of gross employee and executive compensation over €1 million in calendar year 2013. As a temporary tax, it will apply for two years: payable in 2014 and 2015, unless, as often occurs, the tax is extended.

What exactly is the tax? Who pays? On what basis?

The tax is difficult to categorize since it is a “new” form of tax, a sort of hybrid between salary tax, social charges, and company taxes, but payable like VAT. What is clear is that the tax applies to companies with activities in France. This is a distinct difference from last year’s proposed version which applied to individuals as a personal tax. Last year’s law was eventually struck down by the Constitutional Court. Individuals have breathed a sigh of relief since the new tax is a company cost, not an individual cost.

The scope of compensation is determined annually on a per person basis and defined widely to include salary, bonus, benefits, retirement, and share equity plans. While top executives of multinationals were expected to be the target, other smaller companies, consulting based, for example, will also be affected. The biggest public debate has in fact concerned soccer players.

As always, the devil is in the detail : many positions remain unclear notably in cross border situations, or multi-company contexts.

Why 75%? Is that the actual additional cost of compensation ?

While the headlines refer to 75%, the rate is actually 50%. The new 50% rate is actually being added to the existing estimated 25% uncapped company social charges due on this level of compensation. Thus the total rate becomes 75%.

First, the tax will be capped at 5% of gross proceeds, thus limiting costs for smaller enterprises.

A closer insight shows a more mitigated cost factor. Admittedly, for a €1 million compensation package already over the €1 million threshold, the extra company taxes added will cost 50%, thus €500,000. Nevertheless, since the cost of compensation and ordinary social charges is corporate tax deductible, and the new 50% tax also partially deductible, the extra cost of €500,000 could be brought down to almost €300,000.

The real problem: retroactive laws, instability and significance of changes over tolerance level

The source of the very real tax anxiety in France is not the actual tax rate. Contrary to popular belief, the average tax rates are not comparatively that high for average households in particular when coupled with subsidized widespread health and education benefits. The real anxiety lies in retroactivity, the constant instability of the tax system. And most recently, this has been exacerbated by the significance of those changes.

Remember, France is one of the few countries without withholding at source for employees. Therefore, an individual who earns compensation in a given year does not pay income tax on such income until the following year. Accordingly, an individual needs to set aside income to pay taxes, a rather unnatural habit for most. Worse, the tax rates and rules can be changed during that year since the tax bill for income earned during the previous calendar year is only voted into law at the end of such year. The consequence is that an ordinary individual cannot follow a budget without knowing how much he or she will need to pay. The Constitutional Court does not consider provisions applicable to current year income as technically retroactive since the tax is not due until later. From an economic and budget point of view, legal acceptability of the “petite retroactivité” principle reaps havoc.

The anxiety is magnified when added to instability. New tax laws have been adopted every few months over the past several years. Last year, for example, capital gains taxes were significantly increased to be decreased this year, such that some of last year’s laws will never be applicable !

The anxiety becomes unbearable when the increases, often retroactive become magnified. French residents have accepted grudgingly the annual increase in social surtaxes on investment income which were more or less a percentage point on the average. But a 30% (last year for capital gains) or, as we see now, a 50% – this time for companies – increase is not a minor adjustment of one’s planned budget and breaches the threshold of tolerance, for individuals and companies alike.

Christina Melady

Christina Melady, Partner, has over 23 years’ experience practicing tax law in France and advises both companies and managers on personal tax matters. Christina created the specialized practice in France […]