What Do Legal Texts Say?
Article 2 of the Civil Code stipulates that the law only provides for the future and has no retroactive effect.
However, the legislative value of this rule does not constrain the legislator, who can therefore deviate from it without risk of constitutional censure, provided that more severe penal provisions are not made retroactive, in accordance with Article VIII of the Declaration of the Rights of Man and of the Citizen of 1789 and Article 7 of the ECHR.
The Constitutional Council considers that this principle of non-retroactivity of more severe criminal law does not apply to tax provisions, except for those relating to sanctions that may be imposed on taxpayers.
>Tax law can therefore be retroactive
What Are the Possible Retroactivities of Tax Law?
Tax matters are those in which retroactivity applies in its most ultimate difficulty, as we count three retroactivities: legal retroactivity, economic retroactivity, and small retroactivity.
These three retroactivities are distinguished from one another according to the temporal framework in which they fall:
- “Small retroactivity” or “retrospectivity”
This corresponds to the principle whereby the tax provisions provided for by the finance law for year N+1 (for example, 2025) apply to all operations carried out during year N (in our example, 2024). Concretely, modifications to the rate or base of income tax (IR) and/or corporate tax (IS) provided for by the finance law promulgated at the end of December of year N (=2024) apply to income and profits occurring during year N (=2024), i.e., prior to the entry into force of these modifications.
More concretely, in the case of application of this retroactivity, the introduction of a surtax or an increase in CEHR for individuals, and/or an IS surtax for certain companies, by the Finance Law for 2025, could thus apply to income received in 2024.
This is not formally retroactivity insofar as the adoption of the finance law for N+1 (=2025 in our example) occurs in practice around December 29 of year N (=2024), that is to say a few days before the date on which the taxable event occurs:
- for IR, on December 31 of year N (=2024), and,
- for IS, at the close of the annual financial year.
Within the framework of the withholding tax for IR, in effect since January 1st, 2019, the possible evolution of taxation rules now leads to a posteriori adjustments occurring only after income declarations made by taxpayers the year following that of income receipt. In other words: certainly, the taxpayer has already paid, but it was only an advance payment, so they will have to pay the rest.
It will be usefully recalled here an example concerning the ISF: in 2011, it was not possible to make the ISF reform retroactive, since this tax is determined, not on December 31 for the entire year N, but on January 1st of year N. The adoption of the Finance Law at the end of the year therefore prevented application before the following year. An exceptional wealth contribution was then created, applicable to all income received in 2011, otherwise known as… CEHR.
While small retroactivity
promotes the reactivity of fiscal policy by quickly and effectively adjusting taxation rules to the evolution of the economic situation in accordance with the objectives pursued by the Government, it represents a major uncertainty for individuals and businesses. In this context indeed, they cannot determine in a sure and definitive way the fiscal rules to which their income and profits already realized during year N will in fine be subject.
Legal retroactivity is therefore in the crosshairs of the courts, which study and seek to frame its effects, so that the taxpayer who has paid the tax can no longer be called upon to pay on a gain already realized. However, as was the case with ISF in 2011, the legislator manages to be creative enough to successfully circumvent judicial barriers.
France is not the only country to apply this form of retroactivity, as it is applicable in many European Union states as well as in the United States.
- The “full retroactivity” or “legal retroactivity”
It is characterized when tax provisions apply to taxable events that have already occurred at the time they come into force.
The legal retroactivity of tax law can take several forms, depending on its intended purpose:
– validation law -> aims to legally secure tax rules in order to overcome a court decision that could challenge them and consequently lead to a tax discharge in favor of the requesting taxpayers;
– interpretative law -> aims to clarify the application modalities of tax provisions suffering from ambiguities or technical defects that create uncertainty about the initial intention of the legislator;
– law applying the fair announce
rule -> aims to neutralize the time between the date when a tax measure is announced and the date when it is adopted, in order to avoid windfall effects or optimization behaviors, or to immediately benefit taxpayers from a favorable tax measure.
This rule is essential, particularly in terms of wealth taxation: as such, from the announcement of the reform, the old rules cease to apply. It is then useless to rush: it is already too late. This often explains why tax specialists and wealth managers constantly remind us that we must… ANTICIPATE.
- The “economic retroactivity”
This retroactivity refers to the future modification of tax rules under which taxpayers have based their economic decisions.
Although they do not have a retroactive effect in the strictly legal sense, these modifying tax measures disrupt the microeconomic calculation bases on which individuals and businesses have relied to determine their savings, investment or production choices, by abruptly changing the rules applicable to ongoing situations.
For example: the 1984 finance law reduced the duration of exemption from property tax on built properties applicable to social housing completed before 1973 from 25 to 15 years.
Another example: the 2000 finance law abolished an incentive tax regime established by the 1998 finance law, which had created a tax credit for a period of 3 years in favor of job-creating companies.
As a source of instability, this “economic retroactivity” has even stronger consequences on taxpayers’ interests as it is not necessarily accompanied by transitional or support measures that could defer its application.
What are the framework and limits to this retroactivity?
The organic law n° 2001-692 of August 1st, 2001 relating to finance laws (LOLF) has implemented several provisions to guarantee Parliament’s information regarding tax measures proposed by the Government.
Regarding the implementation of transitional, compensation or support measures that might be required in case of adoption of retroactive tax provisions, constitutional jurisprudence does not provide for any obligation in this matter.
Only administrative jurisprudence requires the regulatory power to accompany new regulations with transitional provisions when their immediate application would excessively harm public or private interests, in virtue of legal security (e.g., Council of State, KPMG ruling).
While the legal retroactivity of tax provisions is subject to tighter judicial control, their economic retroactivity, i.e., the future modification of tax rules under which taxpayers have entered into contracts, is controlled more flexibly.
Indeed, despite a favorable jurisprudential evolution towards the protection of legitimately expected effects
of situations legally acquired by taxpayers, no supra-legislative principle currently guarantees the intangibility of special tax regimes to which contracts extending over more than one year are subject.
As “Maurice Cozian wrote: this is equivalent to the” State telling taxpayers “Play first, we’ll give you the rules of the game at the end of the match!”.
While it does not appear easy or essential to challenge the “retrospective” nature of the finance law, controlling “legal retroactivity” and “economic retroactivity” allows for strengthening the predictability of tax rules.
The report submitted in 2008 by Mr. Olivier Fouquet, revisited in 2021 by Mr. Charles de Courson in his own report aimed at limiting the use of retroactivity in tax laws, recommended inscribing the principle of legal certainty in the preamble of the Constitution or, failing that, inscribing the principle of non-retroactivity applicable to provisions unfavorable to taxpayers.
Let’s hope that a report in line with the two previously mentioned ones may one day come to fruition.
What are the risks?
The first risk, related to both tax insecurity and the pressure experienced by taxpayers, lies in the application of the LAFFER curve.
This curve, or theory, was developed within the framework of economic modeling and elaborated by supply-side economists, particularly Arthur Laffer. It formalizes the idea that the favorable effects of a high tax rate on the growth of state revenues would disappear when the tax rate becomes too high
(without this threshold having been defined).
According to this rule, when mandatory contributions are already high, an increase in tax pressure would lead to a decrease in state revenues, not an increase. Why is that? Because over-taxed economic agents would then be incentivized to work less, to limit their income, so that the increase in the tax rate would be more than offset by the reduction of its base.
Thus, very small businesses and SMEs, with managers who can control their remuneration, would be incentivized to reduce their tax bases.
Additionally, consumption would then slow down if the tax pressure attached to transactions is too high.
Alas, taking into account open borders does not change Laffer’s result, since it gives over-taxed individuals opportunities for “tax evasion” that can only accentuate the decrease in state revenues in case of excessive taxation.
