Non-residents often wish to acquire real estate in France - perhaps a Parisian pied-à-terre or a holiday home on the Côte d'Azur or near the Alpine ski resorts. These acquisitions, which may involve considerable sums of money, are often made on a whim, without considering the tax consequences that may arise in France. These consequences can be significant, both in the short and long-term, even if the asset does not generate any rental income.
So, what are the essential tax rules? How can purchasers avoid what might prove to be expensive errors?
To set the scene, the tax environment facing those looking to acquire property in France consists mainly of the following:
- income tax - whether the building is rented (even if only seasonally), or even if there is no rent should the purchaser be a business firm or a resident of a state with a "bad" reputation in tax matters (taxation of a fixed-rate income);
- wealth tax - with non-residents of France normally liable to this tax in France on the value of their real estate assets located there (0.55% to 1.8% of the market value exceeding €790,000, payable every year);
- inheritance and gift taxes - in the event of the transfer of French real estate for no consideration, with the rate of such taxes set at 40% in the event of transfers to children, or 60% if there are no family ties, with the tax due on the value of the assets transferred;
- the 3% tax - an annual tax based on the value of the real estate assets. It is payable by any company holding real estate assets in France, whether directly or indirectly, if such assets constitute its main French assets. This is unless such company is resident in a state that has concluded a tax convention with France and the identity of its ultimate shareholders (in particular, individuals) is known[1] . This tax is mainly intended to ensure the effective application of the above-mentioned taxes, with any "concealed" operation being heavily penalised.
Finally, there is the issue of the residence for tax purposes of the owner of the asset. Certain aspects of French law, when combined with the applicable tax conventions, permit the French tax authorities to consider the owner to be a French resident for tax purposes. As the owner will then become liable to French tax on his or her worldwide (and not just French) income and assets, this may be a matter of serious concern!
If, following this short presentation, you still wish to acquire a property in France, here are a few of the precautions we consider necessary to avoid your dream turning into a tax nightmare.
We will first briefly present the main tax rules applicable, then outline the structuring of the acquisition of real estate.
Note the possible application of VAT to acquisitions of real estate:
The cost of acquisition of real estate can be significantly increased where VAT (19.6%) is applicable, as this VAT cannot be deducted on account of the intended purpose of the asset (dwelling). VAT is particularly applicable (on the total price or on the vendor's margin, as appropriate) to acquisitions from VAT-liable persons of land for building or of dwellings completed within the last five years.
1. Short presentation of the relevant taxation
(a) Rental income:
Provided it is used only by its owners or is made available for no consideration, if the real estate is directly held, there will be no taxable rental income[2]. If it is rented, on the other hand, the rental will be subject to French income tax (on a progressive scale with a minimum rate of 20% and a marginal rate of 40%).
If the asset is held through a company, any taxation will depend on the type of company and its partners. If the company used is fiscally transparent (SCI-type companies, i.e. non-trading real estate investment companies) and the partners are individuals who are the users of the property, the tax authorities consider that the company is not generating any income and the partners will therefore not be subject to tax on this account. If, however, some or all of the partners are legal entities, their portion of the company's results will be subject to corporation tax at a rate of 33#%, it being specified that, in the absence of any actual rent, the income for tax purposes is calculated on the basis of a notional rent.
(b) Resale:
Depending on the situation, this may relate to the building or, according to circumstances, to the company (French or foreign) that owns it.
Resale of a real estate asset:
If the asset is subsequently sold, the capital gain realised by the vendor will be taxable in France, i.e. where the asset being sold is located:
- If the vendor is an individual or a fiscally transparent company held by individuals, the capital gain will be subject to tax at a rate of 33#% or 16% if the person liable to pay the tax is a resident of a European Union Member State (or Iceland or Norway), with an allowance of 10% for each year that the asset is held from the fifth year, meaning complete exemption after 15 years. This levy is in discharge of income tax. Note that this regime will not apply if the vendor is deemed to be holding the building for business purposes.
- If the vendor (directly or via a fiscally transparent company) is a company liable to tax, the capital gain will be subject to tax at 33#% irrespective of the holding period. The cost price of the building used to calculate this gain will also be reduced either by depreciation for accounting purposes for companies that are resident in a European Union Member State (or in Iceland or Norway) or, for other companies, by 2% for each year that the building is held (the capital gain is therefore increased to the same extent). No allowance is made on account of the length of the holding period. This tax is charged against the corporation tax due and, in the event of any excess, the levy is refundable, except in the case of a company resident in a "non-cooperative state".
In both cases, the tax is increased to 50% if the vendor is domiciled, established or constituted in a "non-cooperative state" (in brief, these are states with which there is no effective agreement on the exchange of information; an official list of these is published each year).
Resale of a company:
If the real estate asset is held by a company, it may be tempting to sell the company itself, as the taxation would then be the same. The notable exception is that – provided the vendor is resident in a state that has concluded a tax convention with France that expressly contains such a provision – any capital gain on disposal of the shares in the company will not be taxable in France, but rather in the state of residence. Conventions that include this type of clause are rare (mainly the oldest ones, e.g. with Luxembourg, Germany, etc.). This option is therefore of interest only where the tax convention is advantageous in this respect and if the capital gain would not be heavily taxed in the state of residence that has the right to tax it. At present, these conditions are met mainly by Luxembourg or, in some cases, Belgium.
Two further aspects should be added to this:
- first, when claiming application of the convention, the vendor must in fact be a resident of the relevant country, as the tax authorities may consider that if, in the light of the facts, this is not the case, the convention will therefore not apply;
- second, if the acquisition relates to a fiscally non-transparent real estate company (for example a société anonyme or joint stock company), the purchaser will be the owner of a company whose assets include a real estate asset, the value of which is generally considerably lower than the value used in acquiring the shares in the company. If the purchaser subsequently resells the building (it is in fact the company that makes the disposal), the deferred capital gain existing on the company's books at the date of acquisition will then become taxable. It is therefore usual for the purchaser to request a discount on the price in order to take into account the transfer of this deferred tax charge, often some 50% of the tax sum.
Ultimately, selling the company is often not the best solution and will involve difficulty unless the company in question is a fiscally transparent SCI.
(c) Wealth tax:
France is one of the few countries to have retained an annual tax on the wealth of individuals. Because of the very "political" nature of this tax, it is very hard to forecast its abolition. This tax applies to the worldwide assets of persons resident in France, but for non-residents is limited to real estate assets located in France (held either directly or via companies).
The law governing the wealth tax (impôt de solidarité sur la fortune) makes an important distinction between, on the one hand, real estate assets held directly or through a company (which are regarded as similar to the building itself, unless otherwise provided for) and, on the other, financial investments:
- real estate and shares in real estate companies are subject to wealth tax in France (from 0.55% to 1.8% above €790,000, according to the scale below) if the property is located in France, irrespective of the residence for tax purposes of the person liable to pay the tax;
- receivables due by French debtors are only subject to wealth tax if the creditor is a French resident for tax purposes.
In addition, it is quite rare for tax conventions to provide any effective help as regards wealth tax, as they seldom refer to this tax. Even if they do, they generally provide that the real estate assets held directly or otherwise (with some exceptions for indirect holdings, e.g. in the Netherlands) are taxable in the country where they are located.
Consequently, if the French real estate asset belongs to a company whose shares are held by a non-resident, but the company is mainly financed by debt, including loans from partners, the investor will only be subject to wealth tax in France on the net value of the company, i.e. the value of the real estate minus the total value of the debt. In other words, if the real estate and its operating costs are financed by debt, only the future capital gain on the real estate will actually be subject to wealth tax.
Lastly, holding a property via one or more companies will generate the application of the annual 3% tax on the commercial value of the building. Fortunately, there are several provisions offering exemption from this tax, with the most common one affecting real estate used for leisure purposes being based on the revelation of the identity of the individuals ultimately holding the shares. This is provided that the companies involved are established in countries that have concluded a tax convention with France[3].
Wealth tax sliding scale for 2010:
Click here for table
d) Asset transfers:
Under French domestic law (in this case too, the applicable tax conventions are not especially advantageous), transfers made for no consideration (e.g. gifts, inheritances) of French real estate or of a qualified company holding the majority of its assets in real estate will be taxable in France, irrespective of the tax residency of the owner and the beneficiary of such transfers.
The tax rate is progressive with, for direct descendants, the scale below being applied following application of an allowance of €156,974:
Click here for table
If the asset is transferred as a gift, these rates may be reduced by 50% according to the age of the donor[4]; this reduction is only of 35% if the gift relates to the bare ownership of the asset[5] (see Section 3. below, Subdivision of ownership).
As in the case of wealth tax, when the transfer is of a company holding the majority of its assets in real estate, only the value of the shares is subject to tax as a transfer made for no consideration. On the other hand, as regards inheritance and gift taxes, since a receivable due by a French debtor is regarded as a French asset, it is preferable for the debt to be owed to a bank rather than to partners.
Qualification of real estate companies as regards wealth tax/inheritance and gift taxes
This relates to:
- companies or legal entities whose French assets consist mainly of buildings or real-estate rights located on French territory,
- legal entities or bodies that own buildings located in France where the donor/deceased/taxpayer, alone or with his/her family, holds more than half of the shares or rights, directly or via a chain of holdings.
N.B.: this definition, codified in Articles 750 ter and 885 L of the General Tax Code, is specific to taxes on transfers made for no consideration and to wealth tax; the qualification of real estate companies for other taxes (capital gains tax affecting private individuals, capital gains tax of companies subject to corporation tax, the annual 3% tax, etc.) is different.
2. Benefits of using a real estate company
The only advisable route is to make the acquisition through a company constituted under French law of the "société civile" type (SCI). Such companies are intended for holding real estate assets, either for the purpose of renting them or of making them available to the company partners.
One alternative (or complementary) option is to subdivide the ownership of the real estate or shares of the company, with one person having the right to use it (the "usufructuary") and another having the rights to the capital (the "bare owner").
The main advantage of using a company is that the legal ownership (in this case, indirect ownership) of the real estate, via the holding of partnership shares, can be disconnected from the economic ownership which, to a large extent, takes the form of the creditor's rights if the company has largely used debt to finance its acquisition.
Therefore, while in general the use of a company will not avoid the application of the French tax regulations by qualifying the company as a French company whose assets largely consist of real estate, it will considerably reduce the French taxable base, i.e. to that of the value of the company, equivalent to the value of the building reduced by the debt on acquisition, rather than the gross value of the building.
Obviously, the effectiveness of such structuring will be reduced over time as the real estate increases in value, with the debt in principle remaining at the same level or being repaid.
In general, it is preferable to use a fiscally transparent company of the SCI type to make it possible to benefit from the taxation applicable to partners. However, if the partner is an individual, the taxation on rental income (in general zero if the asset is not rented) and on resale (33#% or 16% with a progressive allowance allowing complete exemption after a holding period of 15 years) is relatively attractive.
The scheme could thus appear as follows:
Click here for diagram
Caution is however advisable with regard to holding schemes whose purpose is solely to reduce the applicable taxation. In fact, under French law, the tax authorities have the power to redefine a legal situation if they can show that this was purely motivated by tax reasons (procedures for combating abuses of the law). In this particular case, the existence of a debt must correspond to the economic reality and not simply be intended to reduce the tax payable in France.
Avoid the acquisition of a foreign company that directly or indirectly owns the real estate:
In addition to the fact that such acquisitions are now subject to registration fees in France, if the foreign company has existed for several years the following particular problems arise:
- the risk of annual 3% tax for the last three or six years,
- the commercial value of the real estate will be higher than the company's debt,
- existence of a significant deferred capital gain on the asset (which will become taxable in the event of a subsequent disposal of the asset itself),
- etc.
3. Subdivision of ownership
Applicable principles
French civil law envisages the possibility of dividing the rights of ownership into three parts, with two different holders[6]:
- the usus (right to use the asset),
- the fructus (right to receive income from the asset, e.g. rent),
- the abusus (right to dispose of or gift the asset).
The usus and the fructus may be owned by one person, the "usufructuary", while the abusus is held by another, the "bare owner".
This subdivision of the right of ownership may result either from a sale or a gift (in general of the rights of the bare owner, with the initial owner reserving the rights of the usufructuary).
Where the usufructuary is an individual, the subdivision may be for a fixed duration or cease on the death of the usufructuary; where the usufructuary is a legal entity, subdivision may not exceed a period of 30 years.
As regards inheritance and gift taxes, the value of the bare ownership corresponds to the value of the freehold, reduced by an allowance fixed by law[7]:
Click here for table
On the other hand, in the case of a gift by a donor aged under 70 years, the 50% allowance is reduced to 35%.
No tax is due when transferring the reconstituted freehold to the bare owner on the death of the usufructuary, as this transfer is the result of the previously established subdivision. Attention must nevertheless be paid to two aspects: (i) the presumption contained in Article 751 of the General Tax Code (see below), (ii) the legislation of the state of residence of the bare owner, making sure that there is no taxation of the value transferred on cessation of the subdivision (e.g. in the Netherlands).
As regards wealth tax, only the usufructuary is taxable on the value of the asset in freehold.
Application to holdings of real estate assets/real estate companies
In order to avoid significant inheritance taxes, it may be worthwhile for the purchaser to transfer, on acquisition, the rights of bare ownership to his or her children. As a consequence, at the time of the inheritance, no tax will be due in France. However, if the asset is sold before it is inherited, the selling price will normally be transferred to the bare owners (the children), which is not always desirable. There may be a right of inspection regarding the use of such capital known as "quasi-usufruct", but it is a delicate operation, especially in an international context.
An alternative solution may therefore be to form a company to acquire the real estate, with the shares of this company being largely subdivided to the benefit of the children. In this case, the parents can, under certain conditions, continue to manage the company. They can therefore, if the building is sold by the company, retain the option for example of acquiring a new asset via this company (this is only really worthwhile if the new purchase relates to another French asset).
The subdivision can be carried out upon acquisition of the asset or creation of the company by giving the children the necessary means outside of France to enable them then to acquire the rights of bare ownership upon acquisition of the asset or creation of the company.
The scheme could therefore appear as follows:
Click here for diagram
As indicated previously, given the procedure for combating abuses of the law available to the tax authorities, it is advisable to take care with regard to holding schemes where their purpose is solely to reduce the tax charge. Adding to this is the risk arising from Article 751 of the General Tax Code. This article introduced a presumption whereby the estate of the deceased will include those assets that he or she held in usufruct while the bare ownership belonged to his or her heirs. Care should therefore be taken to ensure that the scheme used deflects any such presumption, which is possible subject to certain conditions.
Moreover, where the subdivision of ownership relates to the shares in a company, the partner in law is the bare owner, and it is therefore advisable to be very careful when drafting the company articles of association as regards the distribution of powers between the usufructuaries and the bare owners.
The difficulties of using a trust:
The trust is an entity that is completely foreign to French law, and it is right that this should remain the case, as trusts are based on principles of property rights under common law that do not exist in French civil law.
This situation is, however, a source of insecurity in tax terms, as the tax liabilities of the various parties involved depend on an interpretation of the provisions of the contract governing the trust with regard to French law. Given the difficulty of this task and the underlying financial sums involved, the results of such analyses often differ depending on the author (the taxpayer or the tax authorities).
This need to analyse each trust according to the prerogatives of the person establishing it and the beneficiaries of the trust persists. This is despite the fact that the Court of Cassation has in the past ruled on disputes regarding inheritance and wealth taxes, and certain provisions of French domestic tax law and tax conventions expressly address the issue of trusts. In fact, the solutions adopted are in each case subject to the provisions of the contract governing the trust in question.
Nevertheless, as an illustration, mention can be made of the decision of the Court of Cassation dated 31 March 2009 (07-20.219) which ruled that a French tax resident, having set up an American trust, was liable to wealth tax in France as, among other things, the settlor had retained the right to receive the income generated by the assets placed in trust and had the power to revoke the trust.
4. Tax residency of the investor/user of the real estate asset
French law takes a very broad view of tax residency. This may lead the French tax authorities to consider that a person holding real estate of a certain value and frequently residing in France is in fact a French resident for tax purposes, with the consequence that his or her worldwide income will be liable to income tax in France and his or her worldwide assets will be liable to wealth tax and inheritance or gift taxes.
This risk varies considerably and to a large extent depends on the family and economic situation of the person concerned.
Criteria for tax residency
The French criteria for tax residency are as follows[8]:
- the domicile or principal place of residence,
- the exercise of a non-ancillary professional activity,
- the centre of the person's economic interests.
It is sufficient for one of these criteria to be met for a person to be regarded as domiciled in France for tax purposes.
However, if the person concerned can show that he or she is a resident of a state that has concluded a tax convention with France, the criteria contained in this convention will apply. In general (but such criteria must be verified on a case-by-case basis), the criteria of the international tax conventions based on the OECD model are as follows:
- the place of permanent domicile,
- the centre of vital interests (the country where personal and economic ties are strongest),
- the usual place of residence,
- the country of nationality of the individual,
- the resolution of the question by mutual agreement between the two states.
Finally, certain conventions contain a condition permitting the application of income tax in the state in which tax residency is claimed (e.g. Switzerland, where the tax convention does not apply to beneficiaries of the basic "forfait fiscal" (fixed-sum tax)).
Practical position
Understanding the above criteria as regards the law and tax conventions can be a complex task. For persons who regard themselves as non-residents of France for tax purposes, a change of status to that of French tax resident will mean particularly significant liabilities if the assets involved are considerable.
There are many examples of case law that provide certain lessons, above and beyond the particular aspects of each case. Therefore, within the context of several decisions made at the beginning of 2010, the Conseil d'Etat (the French Supreme Court) offered a clarification of certain situations:
- for an unmarried taxpayer with no dependants, the Court ruled that the residence was the place where he or she normally lives and represents the centre of his or her personal life, not including close family members (parents, brothers and sisters);
- in the case of a living taxpayer who is cohabiting, the Court held that the capital gain on the place of residence within the meaning of Article 4 B of the General Tax Code included the partner (whereas for the calculation of income tax, the two partners are regarded as two different households for tax purposes);
- in determining the centre of economic interests, the Court ruled that sources of income should take precedence over assets that do not produce any income.
In practice, while the risk involved in owning a property in France in determining tax residency should not be overestimated, it is nonetheless advisable to take particular care if:
- the user of the real estate spends more than six months a year in France, and
- spends the same or more amount of time in France than in any other country, and
- does not have close family living with him or her (spouse, children) outside France.
Such care involves reducing all other ties (personal, legal or economic) with France to a minimum , while being in possession of material proof of the places of residence throughout the year and of ties with the foreign country in which tax residency is claimed. All forms of evidence are permitted: energy (electricity, heating) and telephone bills in the various residences, restaurant bills, train or plane tickets proving entry into and exit from French territory, registration with various authorities of the foreign state, membership of local bodies, magazine subscriptions, etc.
