The present exemption of the principal residence from capital gains tax could well be a casualty in the planned abolition of wealth tax.

President Sarkozy has announced that he proposes a major reform of the taxation of personal wealth (patrimoine) next year.

The centrepiece of the plan is the abolition of the wealth tax (l'impôt de solidarité sur la fortune - ISF).

Also to go is a tax principle emblematic of the Sarkozy presidency, the 50% tax shield (bouclier fiscal).

This rule guarantees that the total tax bill of individual taxpayers from the different taxes they pay should not be greater than 50% of their income in the year.

The cost of abolishing the wealth tax will be around €4 billion, offset by around €700 million savings from abolition of the bouclier fiscal.

However, given the parlous state of public finances in France, the question remains just what is to replace the loss of €3.3 billion into the exchequer?

On this point the President has only hinted at what is to come.

‘The error made in the past has been to tax capital, rather than the income of capital’, the President stated in a recent interview on French television.

Accordingly, the President is proposing a new tax on the income from personal wealth, rather than on capital per se.

This deals with the main problem he says he is seeking to resolve, which is the liability to wealth tax of those with dormant capital who are 'capital rich but income poor'.

Whether a new tax, or merely an increase in existing taxes, what seems clear is that there will be an increase in the taxation of income from dividends, interest and rents.

The present exemption of the principal residence from capital gains tax could well be removed, and there could also be higher rates of taxation on capital gains from shares.

Political Risks

Such a sweeping reform seems to be high risk political strategy for the President as he is going to be open to the accusation of making a free gift to the very rich at expense of the taxation of those with more modest levels of wealth.

The number of taxpayers who obtain income from their personal wealth is far higher than those who pay the wealth tax.

According to representative body for tax officials, the Syndicat Unifié des Impôts(SNUI), around 550,000 taxpayers pay the wealth tax, while around 3 million receive rental income, and 10 million income from shares and other investments.

‘The major risk of this proposed reform is to impose on a larger number of taxpayers a tax which at the moment is only paid by well off households’, considers the SNUI.

Jacques Chirac has publicly stated in the past that the abolition of the wealth tax in 1987, when he was Prime Minister, cost him the presidential election in 1988. The tax was later re-introduced by President François Mitterand.

Do the Maths Add Up?

President Sarkozy also needs to be able to square the circle in budgetary terms, and on this point he does not seem to be getting overwhelming support from his colleagues.

As if to remind the President of the financial situation in the country, the day after he made his announcement the Prime Minister François Fillon stated to the French Parliament that the budget deficit was ‘the absolute priority’.

There seems to be similar caution about the reform proposals from Christine Lagarde, the Minister of Finance, who has stated that the idea was an ‘ambitious’ one, which would be undertaken jointly with a ‘reduction in the deficit’.

As if to try and make things easier, the Minister of Budget, François Baroin, stated that by merely increasing the threshold at which wealth tax is payable, from €790,000 to around €1.2 million, it would be possible to lift up to 300,000 taxpayers out the tax.

Alternatively, to exempt the main home from the calculation of liability to wealth tax, or to increase the abatement against the main home from the present 30% level to, say, 50%.

Another influential senior political figure, Phillip Marini, spokesman for the Senate Finance Committee, also considers that an increase in taxation on income from personal wealth would not be sufficient to compensate for the loss of revenues from the abolition of the wealth tax.

‘We do not have a tax base large enough’, he warned, as a result of which he considers that the President should introduce a new rate of income tax for top earners, an idea that has already been rejected by the President.

It's Already Happening!

Other commentators have also pointed out how the process of increasing the taxation of income from capital has already begun, with an increase in taxes introduced by this year’s finance act.

These measures include the abolition of the tax credit on dividends, an increase in the rate of the withholding tax on investment income, an increase in the rate of capital gains tax, and a toughening of the taxation of assurance-vie contracts.

During the progress of the finance bill there was also strong pressure from some senior parliamentary figures to impose social charges of 12.3% on the proceeds of the sale of property, including the principal residence.

At the present time the principal residence is exempt, and other property receives an abatement based on duration of ownership, with complete exemption after 15 years of ownership.

Their amendment was only finally quashed pending the wider review of the taxation of personal wealth announced by the President.

Accordingly, despite newspaper reports last week that social charges will be imposed on all property sales from January 2011, this will in fact not be the case. The existing rules will continue to apply.

Wider Reforms

As the announcements continue to trickle out from the government, it seems that the review may also encompass a wider review the system of local government taxation, inheritance tax, income tax and business taxes.

If this is the case, then it is quite likely that implementation of many of the reforms would have to wait until the outcome of the presidential election in 2012. No need to panic quite yet!