Planning for the US person moving to Europe

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Arthur J Dichter
Berkowitz Pollack Brant, Miami
adichter@bpbcpa.com

Report on a session of the IBA Private Client Tax Committee at the IBA Virtually Together Conference

Friday 20 November 2020

Session Chair

Jérôme Assouline  Sekri Valentin Zerrouk, Paris

Speakers

Rachel Harris  Loeb & Loeb, Los Angeles

Florentino Carreño  Cuatrecasas, Madrid

Nicola Saccardo  Maisto e Associati, London

Mark Summers  Charles Russell Speechlys, Zurich

This panel discussed various income tax and estate/gift tax planning issues that arise when a person from the United States relocates to Europe.

Rachel Harris, as the moderator of the session, presented a case study for which each of the panellists provided commentary regarding the tax treatment in their various jurisdictions:

• Jérôme Assouline representing France;
• Florentino Carreño representing Spain;
• Nicola Saccardo representing Italy; and
• Mark Summers representing Switzerland and the United Kingdom.

Case study: part one

Mr and Mrs A, both US citizens, are planning to move to Europe from California – they have community property. They are founders of California-based company WineCoke, which sells a delicious drink that is a mix of wine and Coca-Cola. This is a very successful business as there is obviously a large market for such a product.

They have funded a revocable trust as a will substitute that was put into place as part of their recommended California estate plan – to avoid court probate at death. Mrs A is also the settler and trustee of an irrevocable trust created years ago for their children. That trust is a ‘grantor trust’ for US tax purposes – meaning that for US income tax purposes, Mrs A picks up the income of the trust on her personal tax return.

France

The clients should consider seriously whether they need to keep the trusts or whether they can get rid of them. There will be very burdensome reporting obligations in France. Any trustee of a trust that has a French settler or a French-resident beneficiary must report to the authorities, and it is not an annual return; rather, a return is required each time something happens with the trust.

The timing of the trust formation is not relevant, and as soon as the clients become resident in France, they will fall within the scope of the reporting obligations.

If the clients cannot get rid of the trusts, they may be able to treat them as transparent, in which case they would pick up the income from the trusts on a yearly basis with a tax credit if all the income is from US passive sources.

Upon death, the standard inheritance tax regime will apply as if the clients were inheriting directly. Under the US/France estate tax treaty, if you can show that you did not plan to remain in France forever and you die within the first five years of moving to France, inheritance tax will not apply. After five years, more planning should be done to avoid French inheritance tax, as the rate may be as high as 45 per cent.

Italy

Italy levies all taxes (ie, income tax, wealth tax, and inheritance and gift tax) based on residence (the ordinary regime). A resident is generally subject to these taxes on a worldwide basis. A resident individual is also generally subject to reporting obligations on foreign-held assets – similar to an US Foreign Bank Account Report (FBAR), but applicable to all types of assets.

A non-resident individual transferring its residence to Italy may, however, opt for one of three special regimes, which are meant to attract high-net-worth individuals (HNWIs), employees and pensioners.

The lump sum tax regime is meant to attract HNWIs and is based on: (1) an annual flat tax of €100k (€25k for family members willing to join the main applicant in the regime) on foreign source income and gains; (2) full exemption of non-Italian situs assets from wealth tax, and inheritance and gift tax; and (3) no reporting obligations on foreign-held assets. No foreign tax credit is allowed.

For income tax purposes, trusts may be treated as a separate taxable person or as a look-through (income and assets being imputed to the settler or the beneficiary depending on the circumstances).

These two trusts would be treated as look-through, and the settler will be liable to income tax on the underlying income. If the settler is under the ordinary regime, it will be subject to income tax on the underlying income and gains, subject to wealth tax on the underlying assets and subject to reporting obligations on the underlying assets. If the settler is under the lump sum tax regime, then the underlying income, gains and assets are covered by the €100k/25k flat tax (with no foreign tax credit (FTC)) and no reporting obligations on the underlying assets.

For inheritance and gift tax, trusts are never looked-through. Creating the trusts prior to moving to Italy may be a very effective tool. The assets will not be part of the estate of any of the individuals and will not be subject to inheritance tax. Further, no gift tax would be imposed on distributions because they are outside the territorial scope (created by a non-resident upon settlement and no Italian situs assets). In summary, even under the ordinary regime, creating the trust prior to moving to Italy is an efficient pre-immigration planning tool as it will eliminate the exposure to inheritance and gift tax.

On the other hand, if a trust is created while the individual is resident in Italy, then gift tax is due unless the individual is under the lump sum tax regime and the assets are located outside Italy.

Under European Union regulations, individuals may elect to apply US succession law to prevent the application of forced heirship rules. Trusts are recognised, but they cannot affect the application of forced heirship rules (even if a trust was created before the individual moved to Italy).

Spain

Spain is a very decentralised country, and the regions have sovereignty to administer some of the taxes relevant to clients. Wealth tax, inheritance tax and gift tax are administered by region, so it matters which region the clients settle in as the tax consequences in Valencia or Barcelona will be very different from those in Madrid.

Spain does not recognise the legal status of trusts and has not signed the Hague Convention. As a result, there are very limited administrative court decisions involving trusts. The basic approach is that a trust is disregarded for Spanish tax purposes. All the assets remain under the settler until control of the trust is passed to the beneficiaries.

If assets are distributed to the beneficiaries, this normally qualifies as a gift. Once the settler passes away, there will be an inheritance.

Under EU regulations, the individuals should choose to apply US succession law.

Spain taxes on a worldwide basis. The trust will be treated as transparent, and income earned by the trust will be taxable to the settler during the individual’s life. There is also a risk that, if the trustee of the trust is a Spanish resident, the trust may be treated as resident in Spain.

There is a special tax regime available in Spain, but it does not appear to be applicable in this case. The special regime is for individuals coming to work for a Spanish company, but it does not apply if the company is more than 20 per cent owned by the individuals.

Switzerland

Like Spain, tax consequences in Switzerland depend on the region (‘canton’) within the country in which the clients reside. The tax rate depends on the canton, and the cantons collect and assess tax. Taxes in Switzerland can often be negotiated, and advance rulings are available.

Individuals coming to Switzerland may be subject to normal tax, which is what is ordinarily recommended for Americans because they will be able to get tax credits against their US tax bills. If they are not coming to work in Switzerland, individuals can come on a special lump sum deal (farfalle). This is more common in the French-speaking part of Switzerland. However, there will be no credit against the individuals’ US tax, so this is typically not recommended.

Under normal tax, individual marginal tax rates are from 13.15 per cent to 48 per cent. Switzerland signed the Hague Convention and recognises trusts. However, prior to moving to Switzerland, it is recommended that individuals get a ruling. The revocable trust is likely to be viewed as being disregarded for income tax purposes. Generally, there is no tax on capital gains in Switzerland.

Wealth tax and inheritance tax must also be considered, and will depend on the canton. Inheritance tax is imposed at both the federal level and cantonal level.

The irrevocable trust may be ruled as being not transparent and would remain outside Swiss taxes unless the children (beneficiaries) move to Switzerland. They could then be subject to Swiss tax on distributions. This can create a mismatch between the settler, who may be paying income tax with respect to the trust, and the beneficiaries, who are also paying tax on the distributions. This should be resolved through a ruling.

UK

The UK does not have community property. It is a separate property state only. It is also the divorce capital of the world. There is a sharing principle that is similar, but different because it is judicially driven. The clients should consult a family lawyer and talk about that as well to understand what happens to their matrimonial regime when they move.

Normally, when people who are foreign move to the UK they are taxed on the remittance basis of taxation. Under that regime, the UK is the tax residence, but not the domicile or permanent home. Under the remittance basis, individuals are taxed only on what they generate in the way of income and capital gains in the UK.

With individuals emigrating from the US, this is a bit trickier. Those individuals will continue to be subject to US tax (unless they have renounced their citizenship or surrendered their green card). There is an income tax treaty between the US and UK, but not all things are resolved neatly under the treaty.

The first thing to do is to look at the assets. The UK has offshore company rules similar to the US passive foreign investment company (PFIC) rules, so it is recommended that individuals identify problem assets and consider moving them to other types of investments. Turning over the assets prior to becoming a UK tax resident also refreshes the basis in those assets. The current capital gains tax is 20 per cent.

Grantor trusts and limited liability companies (LLCs) are not disregarded under UK rules. That creates an opportunity for a UK step-up without creating US tax.

The treaty will be helpful for federal taxes, but state tax is not creditable in the UK, so to the extent that the clients are taxed in California, there will be no tax credit available in the UK.

The UK may treat a revocable trust as a real trust. The trust must be reviewed, particularly for capacity issues. If the trustee of the trust becomes a UK resident, the trust will become a UK resident trust. Then mark-to-market tax applies if the clients later leave the UK.

If the trust has only non-UK assets in it, the clients will avoid UK inheritance tax, which is otherwise a 40 per cent tax on death. The inheritance tax exemption is £325,000.

Case study: part two

Mr A is the beneficiary of a trust created under his mother’s California will that has many millions of dollars in it. The terms of that trust require Mr A to receive all trust income each year, and the trustees can make discretionary distributions of principal to him.

France

The income will be taxable to Mr A in France. The question will be whether a tax credit is allowed or not. If the income is from a US source, the credit may eliminate the French tax entirely.

Distributions of principal would be considered a gift or inheritance and should not be subject to tax in France under the US/France inheritance tax treaty.

Italy

Assuming Mr A has no significant powers, the trust is a separate taxable person and will be respected as separate from the beneficiary. Provided that the trustee remains outside Italy, the trust would be treated as a non-resident trust.

However, because the beneficiary has the right to income, a specific transparency regime will apply. The income will be computed at the trust level and imputed by way of transparency to the beneficiary. Under the ordinary regime, that income would be subject to progressive tax rates of up to 45 per cent with a foreign tax credit. Reporting would be required, whether or not the trust is discretionary. This is based on a recent unpublished ruling in which the revenue agency took the view that the resident beneficiaries of a non-resident trust are taxable, regardless of whether the trust is discretionary or not discretionary.

Under the lump sum tax regime, the income will be treated as a foreign source and will be covered by the €100k/25k flat tax (with no FTC) and there will be no reporting obligations.

The trust should eliminate exposure of the assets to inheritance and gift tax.

Spain

The trust will be disregarded. Unless there is something special in the trust deed, the assets will be deemed to be inherited at the moment the settler passes away, and from that moment, they will be part of the estate of the beneficiary. The beneficiary will have an obligation to disclose. The assets will be included in the beneficiary’s estate for inheritance tax purposes. The beneficiary will be subject to regular income tax on the income generated by the trust assets.

Switzerland

Again, this will depend on the canton and how familiar they are and how they understand the trust. It is likely that this would be treated as a life interest being assessed on Mr A. Discretionary distributions are likely to be all treated as income. Therefore, Mr A is likely to be taxed in Switzerland on these trust distributions.

UK

With this trust, it is likely to be beneficial for the clients to have the income taxed on a remittance basis with a foreign tax credit.

Discretionary distributions of principal are potentially a problem because individuals can strip out realised gain in the year that it arises; generally they can claim a credit on the tax paid in the UK on the distribution. However, if individuals build up undistributed income on a capital gain in a trust, that is poisonous from a tax point of view, very much like the throwback tax in the US.

If the funds are remitted to the UK, in order to get a foreign tax credit in the US, individuals really need to manage the distributions, strip them out and get them into the UK.

Case study: part three

Mrs A anticipates that when her father dies, she will receive a significant inheritance, and has asked whether her father should change his will to leave it to her in trust instead of outright.

France

Under French domestic law, before year six, Mrs A would not be subject to inheritance tax if she was to receive an inheritance from the US. If she stays more than six years in France, even in that situation, the inheritance would not be subject to tax in France under the US/France inheritance tax treaty.

Italy

If the assets are transferred to Mrs A, then she will be liable to inheritance or gift tax in the future.

On the other hand, irrespective of whether Mrs A is under the lump sum tax regime, the trust should provide protection from inheritance and gift tax. Assuming Mrs A has no significant powers, the trust would be a non-resident trust as a separate taxable person not subject to income tax if there is no Italian source income. If Mrs A has no right to the income, then there is no transparency.

Distributions of capital are not subject to income tax. If the trust is subject to a foreign tax regime that does not qualify as a low tax regime (more than 50 per cent for the Italian one), then the distribution of income to a resident beneficiary is not subject to income tax in Italy (even if there is no lump sum). Trusts subject to tax in the US would not qualify as low tax.

Spain

There is no difference based on whether Mrs A received the inheritance directly or through a trust.

Case study: part four

Mr and Mrs A want to come and work in your jurisdiction in a subsidiary of WineCoke US, the group parent company. In the future, they may sell a portion of their WineCoke shares.

France

There is a good chance they could come to France and they could sell their shares in the company and completely avoid French income tax. Because they are US citizens and because it is a US company, by coming to France, they may have no tax and avoid California tax also, with good planning.

Italy

Apart from the lump sum tax regime, there is a separate regime for inpatriate individuals coming to work in Italy. It is an alternative to the lump sum tax regime. It provides a 70 per cent exemption from Italian source employment income for five years and a 50 per cent exemption for another five years if accompanied by a purchase of residential property or the taxpayer has at least one minor child or economic dependant. In limited cases, the exemption percentage is 90 per cent.

There is a special rule applicable to the sale of a substantial shareholding (more than 20 per cent of the company) that provides that a sale within the first five years does not benefit from the lump sum tax regime and is subject to 26 per cent capital gains tax. It is possible to obtain a ruling that, if the individual commits to remaining in Italy for five years, the capital gain will be eligible for inclusion in the lump sum tax regime. The ruling may be obtained prior to the individual moving to Italy.

Spain

Spain offers special tax treatment to a family-owned business, provided certain requirements are met with regard to some of the members of the family working. Inheritance and gift tax will be avoided.

Gains from the sale of participation in WineCoke will be taxed at 23 per cent.

A fast track to a Spanish passport is available for individuals coming from Latin American countries (not the US) , whereby they can start the process after two years of residency to obtain a Spanish passport – ordinarily, it would take ten years.

Switzerland

Salary income is subject to income and social security tax. Individuals must be careful as to how the sale of shares would be viewed in Switzerland and what canton the individuals are in. A ruling may be obtained – and it may be obtained in advance of the move to Switzerland.

UK

If employed in the UK, for the first three years, individuals can opt to effectively only pay tax on social security on their UK work, but then they cannot claim a remittance after that. The individuals will be taxable worldwide.

Taxation on the sale of the shares depends on how the shares were acquired. If acquired through warrants or options, is it really capital gains or ordinary income from employment? Employment-related securities are a complicated area and there are new rules internationally as to how individuals apportion these things. If the securities are unrestricted, that could be a taxable event in the UK, and there would be no liquidity to pay the tax.

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