French tax: To hell and back again

The [private equity] industry, already impacted by the downturn, will collapse in France should these measures take effect,” said Louis Godron president of the French Private Equity Association (AFIC) in a statement referring France’s 2013 Budget proposals back in October.

Only weeks before France’s left-wing President, François Hollande, had reiterated his desire to tax French top earners by exclaiming that there would be “no exceptions” to his (potentially election winning) 75 percent tax proposal for anyone earning more than €1 million per year. And that came just a day after France’s richest man, luxury magnate Bernard Arnault of LVMH, had filed for Belgian citizenship – though he claimed this was not to avoid French taxes.

Pierre Moscovici

It seemed as if the rich in France were being hung out to dry by the new government whose election pledges centred on major fiscal reform and a hard line approach to taxing the wealthy.

But what was specifically concerning for French private equity was Finance Minister Pierre Moscovici’s statement to tax carried interest not as capital gains but at the less favourable earnings tax rate.

The initial draft budget said carried interest could no longer benefit from the flat 19 percent tax rate, and instead be taxed up to 45 percent, with an additional 15.5 percent in social contributions – more in line with French income tax. 

This was seen as even more of a low blow for private equity as France’s Parliament decided years ago that carried interest qualified as capital gains, and recent clarifications to a 2008 law indicated that carry’s tax status would not be in danger. 

But luckily for French private equity a few weeks is a long time in politics. 

ANGRY BIRDS

It was not just the AFIC and French private equity professionals who were concerned about the proposed carried interest tax rate. A group of French entrepreneurs revealed a soft underbelly to the tough talking administration of Hollande. 

Calling themselves les pigeons, the entrepreneurs mounted an online assault gaining thousands of supporters via Twitter and Facebook. The pressure forced Moscovici in to an embarrassing reverse flip with a re-worked proposal now ensuring carried interest will continue be treated as capital gains. 

However, French firms shouldn’t crack open the champagne and don their party hats just yet: capital gains taxation will be increased, albeit not nearly as high as normal income, to the levels outlined in the initial Budget.

As it stands capital gains will be taxed according to progressive brackets from 2013, which has a top marginal rate of 45 percent plus an additional 4 percent tax on high income, whereby the final tax burden is reduced the longer you hold shares but is still subject to 15.5 percent social contributions, according to SJ Berwin French tax partner Raphaël Bera. 

“With regards to carried interest, if you continue to comply with certain conditions, such as investing one percent of the total fund size in order to obtain 20 percent carried interest, you can secure a capital gains regime,” explains Bera.

But Bera does heed caution as there are still unanswered questions regarding how to calculate the share holding period to benefit from the lower tax rate. 

There is also still movement in the French Senate with a faction of MPs intending to apply a specific 20 percent social charge to carried interest. However, these discussions would go against the position of the government, says Bera. “We can hope that once this is clarified there is a better understanding of the rules but at the moment it has created uncertainty.” 

MOOD IN THE CAMP

So now that the French private equity industry has received a tax victory, although a somewhat small one as the capital gains regime will become one of the most costly in Europe, how have French GPs taken the news?

“There was a sanity check and the government has moved back to a position that is much more comfortable, not ideal, but not terrible,” says one French GP speaking on the condition of anonymity. 

But were they really that concerned in the first place? The 75 percent tax proposal wouldn’t even reach French private equity professionals notes a second French GP. “It’s only going to affect about 1000 high earners in France, and I guess from private equity the impact will be close to zero as the government will structure the law in order to not affect a lot of people. This is pure French cosmetics, a lip service to the extreme left.”

If you look at the 75 percent rule it’s only applicable to salary on an individual basis, and therefore the government objective is to tax bank traders and very high earning chief executives more than anything. Because private equity isn’t structured like an investment bank, the impact would be minimal, according to the GP.

However, that’s not to say that all the changes and the strong promises of Hollande’s government were met with a Gallic shrug of the shoulders.

Although gone are the cries of disaster and ruin from French GPs and their trade body, to be replaced with a rather solemn acceptance that taxes will be increased and that they have to get on with it, the intense lobbying effort and the AFIC’s extreme message of a dying industry has served a significant purpose. 

“The original proposal was just completely out of whack with the rest of Europe,” says a separate French GP, adding that the effort of the AFIC and les pigeons has provided the French private equity industry with a much more tenable position.

The AFIC warned the Budget proposals could discourage international investors from entering France as they would portray a “devastating image of a country that doesn’t like success and hammers them with a confiscatory tax system”.

“There is no basis for comparison between an income received at the end of every month and the long-term risk taken by investment professionals,” said the AFIC’s statement back in October.

The French GP sums up the current scenario neatly by adding:  “If you think about where we started from with the budget, and where it looks like we are going to end up, I think the government has significantly adjusted its position reflecting on the importance of needing private equity as part of the ecosystem and would rather have onshore private equity than offshore private equity.”