Capitalisation bonds have long occupied a distinctive place in French wealth planning. A commonly used approach involves an individual subscribing for the capitalisation contract in full ownership before transferring the bare ownership of the contract to the next generation while retaining the usufruct.
Although this strategy has been used for many years, uncertainty remains over the tax treatment applied when the bare owner, having become full owner following the extinction of the usufruct, subsequently surrenders the bond.
This issue has recently come into sharper focus following a written question submitted to the French Senate, seeking clarification from the tax authorities. While the tax treatment remains subject to debate, advisers may wish to consider alternative structures that can help achieve similar succession planning objectives with greater certainty.
A Potential Solution to this Tax Uncertainty
This tax uncertainly can be addressed through careful planning involving the combination of a corporate structure and a capitalisation contract. For example, if the individual established a French legal entity, which in turn subscribed for the capitalisation contract, he could gift the bare ownership of the shares (rather than the capitalisation contract) and retain the usufruct in the shares.
Consider the following example.
- Mr Dupont, aged 52, establishes a new French legal entity (“France Co”) and subscribes for shares worth €8 million.
- France Co uses the €8m to subscribe for a capitalisation contract
- Mr Dupont gifts the bare ownership of the shares in France Co to his only child while retaining the usufruct.
- For French gift tax purposes, the bare ownership is valued at €4 million, with the remaining €4 million attributed to the usufruct.
- Mr Dupont pays gift tax of, say, €1.6 million on the transfer using his own resources.
- Over the following years, the capitalisation contract continues to be managed within the company, and the investment portfolio grows in value.
- By the time of Mr Dupont’s death, the shares in France Co are worth €15 million, reflecting the growth of the capitalisation contract held by the company.
- When the usufruct is extinguished, the child becomes the full owner of the shares.
- Importantly, no French inheritance tax applies to the €11 million increase in value accrued since the original gift.