Make the right choice before selling assets with divided ownership rights
Article up to date at 1 March 2022, drafted in accordance with French legislation in force, and applicable to individuals whose tax residence is in France.
The division of ownership is a tool used in wealth transfers. In the case of securities (such as a securities portfolio) or other assets with divided ownership rights, it is a good idea to plan what you will do with the proceeds of any sale before the sale occurs so that you can control how the transaction will impact your assets and tax liabilities, as shown by two recent rulings by the French Council of State.
The benefits of holding assets with divided ownership rights
Full ownership of an asset may be divided into usufruct, which is the right to enjoy the use of an asset or receive its income, and bare ownership, which is the right to become the full owner once the usufruct expires. Such assets are said to have “divided ownership rights”. As an example, ownership rights may be divided for an inheritance if the surviving spouse chooses to receive 100% of the estate's assets in usufruct, with the children receiving bare ownership rights. Divided ownership may also be used in a preparation strategy for transferring your wealth. Gifting bare ownership while retaining usufruct offers many advantages:
The usufructuary continues to use the asset or receive its income (rent, dividends, etc.)
Gift tax is calculated based on the value of the bare ownership rights, defined according to a scale that depends on the age of the usufructuary on the date of the gift(1): the younger the usufructuary at the time of the gift, the lower the taxable amount for the bare owner(2).
Upon the death of the usufructuary, the bare owner becomes the full owner of the asset without having to pay additional tax.
What happens when assets with divided ownership rights are sold?
First, keep in mind that assets with divided ownership rights cannot be sold unless both the usufructuary and the bare owner agree to the sale.
Article 621 of the French Civil Code stipulates that if the usufruct and the bare ownership of an asset are sold at the same time, the sale price is divided between the usufructuary and the bare owner based on the respective value of each of these rights, unless the parties agree to redirect usufruct on the price. The biggest disadvantage of dividing the sale price in this way is that ownership is no longer divided: the share of the proceeds that goes to the usufructuary will be deemed fully owned and therefore subject to inheritance tax at the time of death.
The rule for dividing the proceeds is optional so the parties can deviate from it. If the parties have previously agreed to reinvest the sale price, the bare owner then becomes, in principle, the sole party liable for paying the related tax(2). The division of ownership strategy is retained, but the bare owner pays income tax on income they do not receive. Consequently, it may be a good idea to also compensate them with full ownership of assets. If the parties involved planned before the sale to allocate the price to the usufructuary under a quasi-usufruct agreement, the capital gain is taxable to the usufructuary. The bare owner therefore has a receivable amount corresponding to the proceeds of the sale that they can claim as a liability of the quasi-usufructuary's estate.
What are the important points?
Two recent rulings by the French Council of State (CE, 2 April 2021, No. 429187 and CE, 17 November 2021, No. 437329) reinforced the need to plan what to do with the proceeds ahead of time and to carefully draft contractual clauses:
First, it is important to note that the person liable for income tax is determined on the date of the taxable event, i.e., when analysing the “contractual clauses in force at the time of sale”.(3) In other words, although it is not necessary to deal with the sale price of securities with divided ownership at the time they are gifted, the terms absolutely must be determined before the sale;
Second, the Council of State distinguishes between the optional and obligatory aspects of reinvesting the sale price set out in the deed of gift. When the usufructuary retains the option, but not the obligation, to reinvest the proceeds of the sale of the securities in question, “the right of usufruct must be considered, for the purposes of the capital gains tax resulting from the sale, as redirected on the proceeds of the sale, making the usufructuary fully liable for the resulting tax”.(4) In such cases, it doesn’t matter whether the proceeds were actually reinvested.
In closing, given the major challenges related to the payment of income tax and the maintenance of the wealth transfer strategy, the parties must decide in advance what to do with the proceeds of the sale of assets with divided ownership. If applicable, the clauses of the deed of gift could guide the parties by reminding them of the importance of signing a carefully drafted agreement before or at the same time as the securities are sold.
Our experts at Societe Generale Private Banking work alongside your wealth advisors to help you make these decisions.
(1) Article 669 of the French General Tax Code.
(2) As an exception, in the event that securities are sold from a portfolio with inherited divided ownership rights, the usufructuary and the bare owner may decide that the capital gains tax will only be paid by the usufructuary (this decision is express and irrevocable, and the bank must be informed of it)
(3) CE, 17 November 2021, No. 437329.
(4) CE, 17 November 2021, No. 429187.
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