France – U.S. Tax Treaty pertaining to U.S. Citizens and their investment strategy
Among all of the tax treaties that the U.S. has signed around the world, one of the most favorable for U.S. citizens living abroad is the tax treaty with France. The present treaty dates to 1994 (updated with protocols in 2004 and 2009), provides special French tax benefits. These become the key to investing while living in France, because a US person can choose a variety of different ways to take advantage of either the French or the U.S. tax rules, whichever is more favorable.
The tax treaty is not easy to read (https://www.irs.gov/pub/irs-trty/france.pdf). Some of the provisions or articles appear to be very clear, but then they are reversed in later provisions. The most important articles to understand are articles 18 and 24.
Let’s start with article 18. This is the section that deal with retirement income. To summarize, if you have pension income from past employment in the U.S., or social security benefits, then the taxes will be paid in the United States, not in France. This is the case whether it is received in a lump sum or over time. This seems to make sense from the point of view that the pension or benefits were earned while one was in the U.S. but the taxes were deferred. Hence, when they are finally taxed, they would be taxed in the U.S. where they were earned. This is a guaranty that there will never be double taxation on these proceeds.
The far more interesting article is number 24, while is also designed to prevent double taxation and applies to investment income that has originated in the U.S. If a U.S. person is considered a resident of France, then they are effectively exempt from most French taxation on U.S. investment income, meaning interest, dividends, royalties and capital gains. The reason we say U.S. persons is because some people are U.S. persons even though they are not U.S. citizens. But clearly this applies to all U.S. citizens who are tax residents in France.
There are some very important clarifications, however, to understand. First, this is referring to U.S. stocks of U.S. corporation for example, not stocks held in an account in the United States. So, if you have a brokerage account with your French address, and you own stock in, let’s say for an example, McDonalds, then the dividends and capital gains on that stock will be taxed in the United States. Same with interest on U.S. T-Bills. This rule applies only to U.S. corporations, not foreign ones. So, if you own Japanese stocks, even though a U.S. traded ETF even if in a U.S. brokerage account, then the Japanese stocks would not be taxed in the U.S., they would be taxed in the country of residence, meaning France.
Why is this important? French taxes in most cases tend to be higher than taxes in the U.S., and although recent changes in both U.S. tax law have increased the U.S. tax liability and changes in the French capital gains rate has reduced the French tax liability, there is still an important difference.
A second important aspect is that France does have a “quasi-tax” which applies to the income and capital gains of even U.S. securities, which is part of the PUMA system of health insurance. This will be charged even on U.S. securities. It is seen as a quid prop quo for health insurance in France. Most French citizens or those who have worked in France receive the universal health coverage because they pay for it from their salaries. But a retiree that has moved to France from the United States, while receiving the insurance, has not yet paid for it. Hence the “tax” on investment income. And you must opt in for universal health whether you want to or not. (Although not everyone has applied for the coverage, everyone should).
For portfolio construction, one should consider what securities to own and how. For example, if you own individual stocks in Europe, you can take advantage of certain French tax constructs, such as the PEA, which make European stock investing tax favorable in France. So, a portfolio of a European resident, to be properly diversified and to produce the most favorable after-tax returns, should consider what securities will be taxed where and build the portfolio in such a way as to always maximize after-tax, after-fee returns for a given level of risk.
If you are a US person living in France, you should also seriously reconsider any thoughts of renunciation. The odds are in your favor, and as long as you design the portfolio properly, you should be able to win the tax game.
6 February 2023