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France's Complicated Tax System May Be Main Problem

Monday, 19 Nov 2012 | 2:59 AM ET

High tax levels in France have recently made the headlines, whether it be regarding the new 75 percent income tax, or over celebrities leaving the country on a quest for tax havens. But France's main tax issue may lie elsewhere, Fanny Combourieu, lawyer at SJ Berwin, a law firm specializing in tax law, told CNBC.

Phillipe Huguen | AFP | Getty Images

"We could benefit from a simplification of the law," Combourieu told CNBC, "our tax code is full of texts that come one after the other as layers piling up. Some homogenization would be a good thing."

Combourieu is not the first one to question the tax system. When the former CEO of EADS, Louis Gallois, was asked by the newly elected government to report on ways to improve France's competitiveness, he issued 22 recommendations to turn around the country, and the very first item referred to the need for stability and certainty around taxes.

Indeed, in the "national pact for growth, competitiveness and employment" that the French government issued following Gallois' report, the government highlighted that "French fiscal law is characterized by an excessive instability. 20 percent of the tax code is amended every year."

The government goes on to explain how the uncertainty that results from such a complicated tax code can be an obstacle to investment.

  • Read More: France Furious at Economist's 'Time-Bomb' Cover

The constant changes also keep Combourieu and the other tax partners in Paris, very busy.

"Indeed, our clients have many questions," she said, "but even for us, as tax experts, it is difficult to keep track of the changes going in all directions."

The lack of consultation with tax law professionals and the business community in setting tax policy is also something Combourieu says is regrettable.

Combourieu points to the "Pigeons"—French for "the fall guys"—a group of internet entrepreneurs who took a stand on social media against the government's plan to tax capital gains at the same rate as earned income.

Heavy Tax Environment

The complicated and uncertain tax code on top of the heavy burden of taxes makes it especially unpalatable to businesses.

"No taxpayers would complain about legal instability if it meant lower taxes," Combourieu said.

The 2013 budget that Francois Hollande unveiled in September includes a 75 percent tax on incomes over 1 million euros ($1.27 million).

The French income tax system has five tranches each with its own marginal tax rate from zero percent for the first 6,088 euros to 41 percent for income over 72,317 euros.

Hollande's measure actually means a temporary 18 percentage point increase in the marginal tax rate on income over 1 million euros, which, when added to a permanent 4 percent increase for the last tranche, another 4 percent "exceptional contribution for high revenues" voted under his predecessor Nicolas Sarkozy, and social charges that are as high as 8 percent, results in income over 1 million euros being taxed at a 75 percent rate.

The 18 percent tax—which will only be applied on income generated by work—only applies to income earned for 2012 and 2013 as the government tries to deal with its fiscal gap.

"You have to keep in mind that the measure is a temporary one," Combourieu explained.

But it's not only the very rich in France who have to cough up more in taxes. The budget also targets more humble households.

By applying the progressive tax system on value-added taxes and dividends—the same way it is applied on income—the new budget will impact middle-class investors.

French President Francois Hollande.
Jacques Brinon | AFP | Getty Images
French President Francois Hollande.

For example, where the rate used to be 19 percent, it will now be applied at the corresponding marginal tax rate, "including for the rather wealthy, but not, under certain conditions, managers who realize a capital gain on the sale of their company," Combourieu explained.

They remain taxed at the 19 percent rate following action by the "pigeons".

Scaring Taxpayers Away

The increase in taxes may encourage more wealthy French citizens to seek a more tax-friendly destination, but those wanting to avoid taxes should be warned, says Combourieu, it might not be as convenient as you think.

"Of course, one is free to leave," she says.

"With the open borders, it is easy to go and settle abroad, even more so given the more fiscally friendly countries that surround France... but it is difficult, because there are indeed some tax restraints."

Indeed, in order to fight tax evasion, former president Sarkozy's administration had reinstated the so-called "Exit Tax," which results in the immediate taxation of underlying added-value income in the case of an investor leaving France.

Moreover, physically leaving France does not necessarily imply leaving the jurisdiction of French taxes.

"It's not that easy to organize when one has a family, children, and assets in France, a fiscal expatriation is extremely constraining," Combourieu said. "The risk is that of a tax audit."

The French government can also look at a number of factors to test whether a suspected tax evader is really no longer a French resident.

Besides the obvious question of whether the individual has a place to live in both countries, the core legal test lies in where the person's center of economic interest lies, Combourieu said. "It is essential that the center of economic interests is set abroad."

The "center of economic interests" is where a person's main income comes from, where one's family is located, how one lives, the time spent in the country—and where the person's economic assets lie.

"It truly implies a major change of lifestyle," Combourieu said. "It is not just about moving and regularly coming back home… it is a true modification, a complete life changer."

—By Guillaume Desjardins, Assistant Editor, CNBC.com

@GuillaumeCNBC