French tax credit relating to foreign source income

Two recent decisions of the State Council shall specify the method of calculating the tax credit equal to the French tax attributable to income of German and American. 

Since the late 1980s, the tax treaties signed by France based, for the elimination of double taxation of income previously subject to the rule of exemption with the effective rate on an original method, the tax credit equal to the French tax.

The method of the  effective rate  that leads to foreign income, by definition non-taxable in France because of the tax treaty, or while being exempt in our country, taken into account when calculating the tax rate applicable to other income of the taxpayer, taxable in France. The method of  tax credit equal to the French tax  is that the foreign income is included in the taxpayer’s taxable income but that it has a tax credit represents the share of French tax attributable foreign income.

The administration has not explained the reasons which led, after so many tax treaties based on the effective interest method, to select a method of credit equal to the French tax, unknown in other countries, we simply found that this method had replaced the first as the extended network of tax treaties and modernize.

In fact, this choice was made ​​to try to answer  taxpayers’ misunderstanding  which did not admit easily that foreign income which was described as exempt on the basis of the tax treaty is really when they had to include them in their tax returns. To avoid unnecessary debates and endless explanations, it seemed to respond better to the foreign income was effectively taxed but the taxpayers did not suffer double taxation because they were entitled to a tax credit clearly visible and identified as such in their tax returns.

But criticism was quickly drawn to the  calculation method  itself because details of the mechanism remained uncertain if not precisely explained by tax treaties. Some agreements provide no indication, even in principle, and others define some concepts but so far insufficient for the solutions are fully insured.

In this context, the Council of State has to specify how the  costs of the total income  must be taken into account when calculating the tax credit corresponding to the French tax on foreign income:

  • about a taxpayer’s tax resident in France who had seen in 1999 and 2000, in addition to income from French sources, wages of German origin and removed from the business profits of a German company (EC July 26, 2011 No. 308679 , Turckheim);
  • and about a taxpayer resident in France who had seen in 2001 and 2002 the wages of U.S. source taxable in the United States (July 26, 2011 EC No. 308968, sauces).

In one case as in the other, the debate was of pure principle, which gives the solution adopted by the Council of State a scope that goes beyond the scope of tax treaties between France and Germany and Franco-American.


Unification of concepts

Both cases were initially allowed the State Council to unify the concepts by retaining the same solution when the tax treaty does not contain a definition (as in the Franco-German Convention of 21 July 1959 in the form adopted for an amendment of June 9, 1989) and when one has in (the case of the Franco-American August 31, 1994 as amended).

As for individuals, the  tax treaty between France and Germany  is based on an alternative method of elimination of double taxation

  • for dividends, fees and income of temporary workers, it provides that the German tax is a tax credit against in France, in which case, the German income is subject to French tax but the tax is German then deducted from French tax so that the income is not taxed twice;
  • for other income, she said that German income is subject to French tax, but the beneficiary is entitled to a tax credit equal to the French tax (not to German tax as before) and this particularly applies to wages earned by a resident of France in respect of an activity carried out in Germany and the business profits that it earns from the operation of a German company.

It’s about this second category of revenue has grown contentious debate that has been decided by the Council of State: what if the tax treaty merely lay down a principle  without defining the terms that it uses and how to say French tax attributable to foreign income should be calculated?

The administration had estimated, in a statement of March 19, 1993 commenting on the Franco-German Convention, when the French tax is computed by applying a progressive scale, the  amount of French tax attributable  to income of German origin means the product of the amount of such net income (net income German) by the rate resulting from the relationship between the tax actually payable on the total net income taxable under French law (sum of net income French and German) and the amount of total net income. This rule is presented as enabling France to preserve fully the progressivity of the income tax paid in France, a similar rule as the effective rate.

The Council of State  validates  this view in terms of principles, he considers, in fact, that the amount of French tax attributable to income from German sources, that is to say the amount of credit tax due on the French tax, the product must be understood in the amount of tax on all income sources of the French and German, as provided in Tax Code, by the ratio of net income of these source categories and all the German net taxable income of the same categories (the “income groups” in question are those that fall within the scope of the mechanism of the tax credit equal to the French tax) .

This method of determining the tax credit is consistent with the clarification provided by the  US-France income tax treaty of 31 August 1994, which, by difference with the Franco-German, provides a definition and indicates, in fact, that “the expression amount of French tax attributable to such income is used to designate: (…) bb) If the tax on such income is computed by applying a progressive scale, the product of the amount of such net income by the rate resulting from the relationship between the tax actually payable on the total net income taxable under French law and the amount of that total net income. “

But adding this precision in the French-US tax treaty did not mean that the solution had to be different in the Franco-German tax treaty negotiators had simply wanted to correct an imperfection of the first model, which actually lacked precision but without changing the solution.

Therefore, subject, possibly, tax treaties contain substantially different definitions,  the principle is confirmed.  The tax credit equal to the French tax attributable to foreign income is determined by the rule of three following French tax on net income x French and foreign aggregate foreign net income / net income aggregate French and foreign.


Consideration of charges of aggregate income for the calculation of net income abroad

The decisions provide a commentary second lesson is that the calculation of net income in calculating the foreign tax credit.

On this point,  the administrative doctrine has wandered a bit  , the instruction of 1993, supra, set out certain principles, but these were later clarified by a statement of 16 April 1999 which eventually give itself a “practical solution “that contradicts the principles it lays down and which validates the example set by the instruction of 1993 …

About the  Franco-German Convention,  the 1999 statement, which referred to difficulties of interpretation for the consideration of the deductible expenses from total income, begins by stating that the German net income categorical contribute towards the expenses deductible from income comprehensive as any other household income as a percentage of net revenues considered in relation to the overall aggregate gross income of the household, she added that it should therefore in principle to allocate the net income from German sources selected categorical the numerator a share of these charges determined by the following formula: net income from German sources categorical – (expense of overall income x net income from German sources categorical / aggregate gross income).

But the statement goes on to say that, given the complexity of this calculation, it is ”  as a rule of thumb  “to ignore the charges of the total income of both the numerator and denominator of the ratio used to determine tax credit equal to the French tax and, therefore, to retain the overall gross income in the denominator, and it validates the solution given by the example provided by the instruction of 1993, which takes into account the loads aggregate income or the numerator or the denominator (but nevertheless wishes the charges categorical).

This solution is censored by the State Council, but without resulting in favorable consequences for the taxpayer because, finally, the approach taken by the administration in these cases was slightly better than the solution should be chosen according to the State Council.

In terms of principles, it is indeed found that, in calculating the amount of net income from foreign sources,  a share of the expenses deductible from total income  must be deducted from such income, in proportion to their share in total income gross of expenses. In both cases, it is failing to mention that the amount of foreign source income would be reduced by a share of the expenses deductible from total income computed in proportion to the share of these revenues in the aggregate gross income, as the cases of appeal have been canceled for error of law.

The State Council did not rule on the issue of  categorical charges,  such as the deduction of 10% on salaries and wages, which was not asked. It is true that, in most cases, the assignment may be made ​​without difficulty, the deduction can be applied equally to wages and salaries French foreign, but the impact of the  cap  poses a problem, whenever the ceiling is reached in globalizing French and foreign wages while he would not be if the 10% deduction applies separately to French and foreign wages. In our opinion, it is necessary, as suggested by the rapporteur public Olléon Laurent in his excellent results in these cases to calculate the overall cap and then assign the deduction to wages French and foreign share of gross wages and French foreigners.

However, the Council of State decides the question of the allocation of  costs of total income,  including alimony, the Administrative Court of Appeal held that, in the absence of definition in the tax treaty between France and Germany , the provisions of national law should be taken into account and, therefore, where the tax in France in respect of income from Germany is calculated by applying a progressive scale, the tax credit allowed against the French tax should be set at an amount equal to the product of net foreign source income by the ratio between, on one hand, the tax would be payable on the total net income taxable under French law and secondly, the amount of the total net income, such a method preserving the progressivity of tax rates as organized by the legislation applicable law.

But this view, right in his statement was incorrect in its findings because the court did not take into account the costs of overall income. The State Council has taken good care by deciding not only that these charges should be taken into account but should be divided between French and foreign income  as a proportion of gross income taxable.  rapporteur public justified this solution as “the most realistic,” noting that “on this basis that the coverage of common charges is most often within a couple” that “is also on the proportion of gross income that agreements regulate divorce, usually the allocation of the burden of joint taxation between the former spouses “and that” it’s even on this basis that the administration itself admits in its pleadings, that there place to break a deduction or a deduction when the addition of income from French sources and German source that leads to cap the deduction or allowance. “

However, in both decisions with commentary, the Council of State is, without giving details, it is clear from the statement that the calculation of the tax credit method practiced by the administration, which is to multiply tax by the ratio between the income of German or American, no less a share of the expenses deductible from gross income overall, and the aggregate gross income, not the total net income, results in an amount of  credit tax slightly higher  to that adopted by the Council of State (10). Judge it because it’s a misconception that the administrative courts had concluded that the discharge in both cases, finally giving in favor of the minister.

The Bottom Line

The essential contribution of the decisions and Turckheim sauce is, in our opinion, to confirm that the  charges of the total income  must, in calculating the tax credit equal to the French tax be apportioned in proportion to foreign income French and income, the State Council shall deduct this as a logical solution, with respect to charges of income “global”, there would be no reason to consider that they should be charged only to only income from French sources. As for how they should be ventilated, the sauce is more explicit decision that the decision Turckheim because it clearly states that this breakdown must be made  ​​in proportion to the share of gross income  from U.S. sources in the aggregate gross income.

However, the consequences drawn by the State Council do not upset the current practice, since if the doctrine is inconsistent with the administrative principles laid down by the State Council, it achieves a “slightly” more favorable to the taxpayer.

The comparison gives, in effect, the following results if we take the example  of a taxpayer fiscally domiciled in France, which has gross wages of German source 100 and gross wages from French sources of 900 (after deduction of social but before the deduction for business expenses by 10%) and assuming that the taxpayer has deductible expenses of overall income in the amount of 50, admitting that the French tax on net taxable income of 850 is 250:

  • according to the  Council of State,  the tax credit is equal to 25, ie 250 x 85/850, as the German net income to be considered must be equal to 100 minus the deduction of 10% and a share of the expenses of the total income of 50 in the ratio of 100 / 1 000, 5;
  • method apparently followed by  the administration  in the affairs Sauce and Turckheim, the tax credit would be equal to 25.14, ie 85.5 x 250 / 850 net income since German seems to have been dropped off the deduction of 10%, a share of the expenses of the total income of 50 in the ratio of 90 / 1 000, or 4.5 (13).

Can be seen, the results are not very different and the taxpayer is  slightly favored  by the calculation apparently carried out by the administration. However, if we use with this example, the simplified method proposed by the administration, the result becomes the same as if one ignores loads of aggregate income in the calculation of the report, the credit Tax is 25, ie 250 x 90 / 900 (14), the same result as that which results from the formula adopted by the Council of State.

Subject to a more complete analysis of the different possible cases, it therefore seems that the practical solution adopted by the administrative doctrine must always be challenged to consider the principles which have been raised by the Board of State.