Life for UK resident owners of French holiday property has not been dull in the past few years, although they may now feel rather like victims of the ancient Chinese curse “May you live in interesting times”.

Greatly improved travel links to the Continent (no more cause for one of my favourite all time pre-war newspaper headlines: “Fog in Channel – Continent cut off”) and reasonably priced property in rural regions of France have encouraged many British people to invest in a French holiday home. Nor is this purely, for geographical and economic reasons, a London and Home Counties trait; two of my best friends own a couple of holiday homes in Normandy, and they live in the teeming cosmopolitan metropolis that is Wigan. Actually, when I lived there it probably was a teeming cosmopolitan metropolis; certainly it had the largest concentration of night clubs per head of adult population in the UK.

Being resident in one country and owning property in another has always been fairly exciting for tax purposes, as all countries are keen to levy tax on rental income from properties in their own country. Given that most UK-resident French property owners can only afford the luxury by letting it out when they are not living there, this applied to the majority. Under the UK:France Tax Convention the UK gives credit for French tax paid on property income, so double taxation was traditionally avoidable.

If one required evidence that this country has never quite abandoned its instinctive, island nation, enthusiasm for splendid isolation, or grasped the full concept of the European Union, you might care to examine the recent history of our tax system. It is one of the central principles of the EU that the tax system must not place obstacles in the way of cross-border trade, and must not discriminate in favour of resident taxpayers at the expense of those from other EU countries. The UK Treasury has never, ever, truly got this concept.

The history of the European Court of Justice is littered with cases brought against the UK for discriminating in precisely this manner, or for allowing excessive State Aid to UK businesses: corporation tax group relief, Enterprise Investment Scheme, Venture Capital Trusts, etc. etc. One of the more flagrant examples of this, which survived on the statute book for a remarkably long time, was the furnished holiday lettings tax regime.

Traditionally in this country letting income has been taxed as investment income, with consequent restrictions on offset of expenses, availability of capital allowances and use of losses, and lack of availability of capital gains tax and inheritance tax reliefs. Realising that tourism was important to the UK, and that our climate meant that providers of holiday accommodation might need a little extra help attracting visitors, a special tax regime was introduced for providers of furnished holiday lettings (“FHL”), basically those who made property available for let for 5 months of the year, and actually let it for 2.5 of those months for no more than 1 month at a time to any tenant.

That regime was extremely generous, effectively treating the lettings as a trade for expenses, capital allowances, loss relief and capital gains tax purposes (the inheritance tax position was always controversial). The problem was that the relief extended only to property in the UK. It took the ECJ an extraordinarily long time to come to grips with this, but in the end the Labour government acted just prior to the 2010 election, although whether the EU issue was a pretext or a genuine motivation remains an interesting question.

They announced a one year extension of FHL  treatment to all property within the European Economic Area (the EU plus a few other countries such as Norway, Switzerland and Iceland), followed by a complete abolition of the regime. Cue uproar, and a promise from the Conservatives to review this decision if they won the election. Subsequently, the coalition partly reversed the decision by keeping some of the tax reliefs and jettisoning others, and also making the letting tests harder to meet by extending the ‘available for letting’ period to 7 months and the ‘actually let’ period to 4.5 months. However, the new regime applies across the EEA.

Thus French holiday let property owners were given a competitive advantage compared to the previous position, or perhaps more accurately had a competitive disadvantage removed. However, in case they were tempted to celebrate this change, the new French government had a very nasty surprise in store for them.

The one downside of the ‘old’ UK FHL regime was that, because the activity was treated as a trade, it was necessary to pay Class 4 national insurance contributions on the profits. Leaving aside the technical point that Class 4 contributions confer no social security benefits, and therefore appear  to have no connection whatever with national insurance, this did add a further 7 or 8% to the tax costs of FHL activity. However, that is a mere bagatelle compared to the new French system.

With effect from 1 January 2012, there is a ‘social contribution’ of 15.5% of rental income, levied by the French government on all foreign owners of French property. This is similar to a UK national insurance contribution, which creates two problems for UK resident French property owners.

Firstly, rather like Class 4 national insurance contributions, non French residents will derive no benefit from the social contribution, as they will be unable to claim under the French social security system, above and beyond the extent to which they could do so anyway as EU residents. Secondly, because it is a social security contribution and not a tax, it is ineligible for relief against UK tax under the terms of the UK:France Tax Convention. Thus it stands to be an absolute cost to UK-resident owners of French FHL property.

But it gets worse. The 15.5% social contribution will apply not only to rental profits from French property, but also to capital gains on its sale. Thus the effective full rate of French capital gains tax on a property sale will increase  from 19% to 34.5%. although the system is more complicated than this suggests, as there is a taper relief applicable to property owned for more than 5 years. Once again, however, there will be no relief under the Tax Convention for the social contribution, as the concept of paying national insurance contributions on capital gains is not one that has caught on in the UK (yet?).

UK owners of French FHL property therefore stand to be ‘damned if they do and damned if they don’t’, as they will suffer the social contribution whether they decide to continue letting the property or to sell it. Only those sufficiently rich not to be required to let their property will escape the charge, which seems a little odd for legislation introduced by a socialist government, but then we are used to that sort of eccentricity in the UK tax system also.

Given that the same level of social contribution will apply to the rental income and capital gains of French residents, there is no question of the ECJ stepping in and saving the day for foreign owners of French property, who will therefore have to decide whether it is still worthwhile to carry on owning and letting French property, or whether to sell. This seems likely to have a depressing effect on French property values, but on the bright side perhaps it will encourage owners to invest in UK holiday property. Now about that weather ……..