The recent approval of the French Social Security Finance Law for 2010 provided clarity and relief for French fund managers, resolving a major question about the tax treatment of carried interest.
The government has already stated that carried interest from French private equity or venture capital fund structures will continue to be treated as capital gains, currently taxed at an overall rate of 30.1 percent. Employment income is currently subject to French progressive income rates up to approximately 40 percent, and requires 23 percent of social security contributions to come from the employee and 40 to 50 percent to come from the employer, according to Sylvie Vansteenkiste and Raphaël Béra of SJ Berwin.
“In France we have quite high social security contributions that are applicable to employment and salaries, and this is a huge cost for companies,” Béra said. “We had since last year provisions dealing with the tax regime of carried interest, but that only dealt with income tax and not with social contributions on employment income.”
The new law says that as long as managers have met their obligations under the capital gains regime – mainly, the GP must contribute at least 1 percent of the total commitments of the fund – then their carried interest payments will not be classified as employment income and thus will have no additional social contributions applicable. If the 1 percent obligation is not met then the carry is treated as a salary, taxed at a rate of 40 percent and subject to additional amounts paid to the French social security.
However, the penalty for non-compliance will be a flat 30 percent charge instead of the usual social security contributions, which is much less than under original proposals, and will only affect the individual manager.
While welcome news, he said the new provisions also require some fine tuning, as for instance it is still unclear whether the 30 percent social contribution charge is deductable for tax purposes. In addition, French authorities have also added new filing obligations for companies which employ carried interest holders.
“They will require more information, there will need to be specific tax returns provided by the management company and advisor which will set out the amount of carried interest per year, as well as the exact identity of employees and breakdown of individual capital gains distribution,” Béra said. “This means that tax authorities will pay more attention to this type of income and one cannot exclude that we will have new discussions next year.”
The government’s recent changes have ensured that France’s treatment of carried interest is more in sync with the rest of the world. In fact, as PEM reported last week, a bill working its way through the US Congress could mean that American GPs will be paying twice the tax rate of their French peers, which could make France a more ideal destination for domiciling a fund and investing capital.