Trust and inheritance tax: the taxable event postponed to distribution

Imagine: you live in Millau, you have placed assets in an Anglo-Saxon trust to prepare your succession. You die. Your heirs believe that inheritance tax is due immediately. But no. The Court of Cassation has ruled: the taxable event for the tax is the distribution of the assets to the beneficiary, not the death. A subtlety that can be costly… or, on the contrary, offer a tax respite. So, what is the use of this case law?

This question is asked by many property owners, especially those with links abroad. A trust is a legal structure that allows assets to be managed on behalf of another person. But under French tax law, the moment when tax becomes payable is crucial. And the tax authorities have long considered that the death of the settlor (the person who creates the trust) triggered the tax. The Court of Cassation says no.

In a judgment of 18 November 2020 (No. 18-14.242), the high court recalled that the taxable event for gratuitous transfer taxes (inheritance or gift tax) is the transfer of ownership. For a trust, this transfer only occurs upon the distribution of the asset to the final beneficiary, at the time of the trust's closure. A decision that protects taxpayers against early taxation.

The facts: a story that happens every day

Mr W G..., a Frenchman living in Espalion, had set up a trust during his lifetime to manage his financial assets. He had retained the usufruct (the right to use the assets and receive their income), while the bare ownership (the right to dispose of the asset, without use) was granted to his heirs upon his death. On his death, the trust provided that the usufruct would end and the heirs would recover full ownership.

The tax authorities wanted to tax this extinction of usufruct as a taxable transfer of ownership. They considered that the settlor's death was the taxable event for transfer taxes. The heirs contested this: according to them, the death merely extinguished the usufruct, without any new transfer of ownership. The bare ownership already belonged to them since the death of Mr W G..., and the usufruct had ended without giving rise to taxation.

The case was brought before the courts. At first instance, the court ruled in favour of the tax authorities. But on appeal, the Court of Appeal reversed the decision, holding that the transfer of ownership to the heirs had only occurred upon the closure of the trust, at the time of the actual distribution of the assets. The tax authorities appealed to the Court of Cassation, but the Court of Cassation upheld the appeal decision, dismissing the appeal.

The reasoning of the court — dissected

The Court of Cassation relies on Article 750 ter of the General Tax Code (CGI), in its wording resulting from the law of 30 December 1998. This text provides that the taxable event for gratuitous transfer taxes is the transfer of ownership. For the Court, in the context of a trust, this transfer does not occur upon the settlor's death, but at the moment when the trust assets are distributed to the final beneficiary, i.e., at the trust's closure.

Why? Because the trust is a separate legal entity that holds the assets. The settlor, by creating the trust, disposes of his assets. It is only upon distribution that the beneficiary receives ownership. The settlor's death is merely an event that may trigger the distribution, but it is not the transfer itself.

The Court thus rejects the tax authorities' argument that the extinction of usufruct upon death constitutes a taxable transfer. It recalls that usufruct and bare ownership are separate rights. The bare ownership already belonged to the heirs since Mr W G...'s death (by virtue of the trust provisions). The extinction of usufruct merely reunited the two rights without creating a new taxable transfer.

This judgment confirms a jurisprudential trend protective of taxpayers against the tax authorities. It is not a reversal, but an important clarification on the timing of taxation of trusts.

What this changes for you — concretely

If you are a settlor of a trust (the person who creates the trust) or a beneficiary (the person who receives the assets), this decision directly concerns you. Concretely, inheritance tax is not payable on the day of your death, but only when the trust distributes its assets, sometimes years later. This may allow you to defer the payment of tax, or even optimise your tax situation if the distribution occurs in a more favourable context.

Let's take a concrete example. Imagine a trust in Espalion containing €500,000 of assets. Upon the settlor's death in 2020, the heirs are taxable at 20% (i.e., €100,000) if following the tax authorities. But with this case law, if the trust does not distribute the assets until 2025, the tax is only due in 2025. In the meantime, the heirs can invest the funds and earn interest.

Be careful however: if you are a beneficiary, you must declare the distribution and pay the tax at that time. Do not neglect this obligation, as the tax authorities can reassess you with penalties. If you are an heir of a trust, check the trust's closing date and anticipate the payment.

Four tips to avoid this type of dispute

• Keep all trust documents: trust deed, amendments, account statements. They prove the date of creation and the distribution terms.
• Declare the trust to the tax authorities since 2011 (amending finance law). Failure to declare can result in heavy penalties.
• Anticipate the trust's closing date: if you are a settlor, include a clause for distribution on a specific date to control the taxable event.
• Consult a lawyer specialising in international tax law before creating or receiving assets from a trust. The rules are complex and vary by country.

Further reading: related case law and developments

This decision is part of a line of judgments protective of taxpayers. For example, the Court of Cassation had already ruled (Civ. 1st, 15 May 2019, No. 17-27.845) that a trust is not a taxable legal entity in France, but a simple 'arrangement'. The tax authorities had tried to tax the trust itself, without success. Here, the Court specifies that the taxable event is the distribution, which prevents the tax authorities from imposing tax before the actual transfer.

On the other hand, a judgment of the Conseil d'État (CE, 9 July 2019, No. 417050) had considered that the settlor's death could be the taxable event if the trust provided for automatic distribution upon death. The nuance therefore lies in the terms of the trust. The current trend is to adhere to the letter of the deeds: if the trust provides for distribution upon death, the tax is due upon death; if it is deferred, the tax is deferred.

For the future, expect the tax authorities to increasingly challenge such arrangements, invoking abuse of law if the trust is used solely to defer tax without any real economic purpose. Caution is therefore advised.

Frequently asked questions

1. What is a trust? An Anglo-Saxon legal structure where a settlor transfers assets to a trustee (manager) who manages them for a beneficiary. The settlor may retain the usufruct.
2. Is a trust taxable in France? Yes, since 2011, trusts must be declared. Distributions are subject to gratuitous transfer taxes (inheritance or gift tax).
3. When must I pay inheritance tax on a trust? At the time of the actual distribution of the assets to the beneficiary, not upon the settlor's death, unless the trust provides for immediate distribution upon death.
4. What should I do if the tax authorities demand tax before distribution? Challenge it by referring to this case law. Consult a lawyer to prepare a contentious claim.
5. Can I avoid tax by creating a trust? No, the tax will be due one day or another. The trust allows deferral, not the elimination of the tax debt.

Are you in a similar situation? A first 30-minute consultation with Maître Zakine (€45) can save you months of proceedings — and often much more. Book an appointment →