French capital gains tax reform spells trouble for PE

Greg Gille
14 September 2012

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The French government is pushing forward with an in-depth tax reform, as announced by new President François Hollande during the Spring election, which will see capital gains taxed at the same rate as income tax – a move likely to worry local fund managers. Greg Gille reports

The reform of capital gains tax has gained traction across Europe in recent months as governments turn to fiscal austerity in order to mend ailing public finances. The debate was particularly heated in the first half of the year in Sweden, where the finance ministry proposed taxing carried interest as income up to a ceiling, at which point it would revert to the 30% capital gains taxation rate.

But many eyes were also set on France, where capital gains taxation is already high with rates of up to 39.5%. François Hollande, at the time the Socialist candidate in the country's presidential election, had warned that if he were to get elected, the new government would look into aligning capital gains tax with income tax in an effort to plug France's sizable public deficit.

Now in power, the Socialist majority is pushing forward with the reform, which should be implemented this year. Capital gains would now be taxed at up to 45%, with an additional 15.5% in social contributions. The taxation would be done in two steps, with taxpayers charged at the old rate on the first year before paying the remainder the following year as part of their income tax.

The change is likely to get a chilly welcome from French private equity practitioners, and not only given its obvious impact on the taxation of carried interest. The reform could also have a negative influence on primary dealflow: while entrepreneurs selling their business when they retire will still be exempt from paying tax on the exit proceeds, other private vendors would see taxation on their proceeds go from the current 34.5% to rates in excess of 50%.

"This is really bad news for French M&A activity," says Argos Soditic president Gilles Mougenot. "There will be a 'wait-and-see' period as vendors weigh their options, given that very few entrepreneurs would gladly be taxed at 50% or more on the proceeds of a sale. This is likely to have a significant impact on small- and mid-cap dealflow, but also on the economy as a whole."

Mougenot adds that the proposed change will add a layer of complexity in all transactions, regardless of the issues faced by vendors: "The reform will also have an impact on management packages in LBOs. There is a real appetite for a move abroad coming from managers in mid-sized businesses with a European reach."

The French government's activism will no doubt infuriate buyout players, but keep local tax advisers busy. Growth capital providers can meanwhile take solace in the fact that tax rebates for retail investors in FCPI and FIP funds will stay in place next year. President Hollande was planning to cut the 50% rebate on wealth tax offered to retail investors to 25%, but finance minister Pierre Moscovici announced earlier in the week that the existing scheme wouldn't be amended.