The French administrative Supreme Court (“Conseil d’Etat”) has just rendered a decision (CE, 6 July 2016, n°377904, Sté Lupa) whereby it clarifies its Quemener case law of 2000 (CE, 16 December 2000, n°133296, SA Ets Quémener) and prevents real-estate investors from achieving a tax-free step up in basis of the real-estate asset upon the acquisition of shares in a pass-through SCI (“société civile immobilière”, real-estate company). This decision goes against the decisions rendered by the lower courts, the administrative lower court and the administrative court of appeal which were both in favour of the taxpayer. We do not have the conclusions of the public rapporteur yet, but the decision follows her recommendation.
As a reminder, the Quemener case law provides for a calculation method for computing the capital gain derived from the sales of shares in an SCI by tolerating adjustments to the acquisition price of such shares in order to take into account the fact that profits derived through a pass-through SCI are taxed as they are earned by its shareholders.
In Lupa, a Luxembourg joint-stock company (“société anonyme”) sold to its subsidiaries, two French companies, its shares in seven Luxembourg joint-stock companies, whose assets were composed of shares in seven French SCIs holding each a real-estate asset in France. Following the acquisition, the French companies decided the winding-up of the seven Luxembourg joint-stock companies (transfer of all their assets and liabilities to the French companies) after the revaluation of the shares (tax exempt under the French-Luxembourg tax treaty). They then decided the winding-up of the seven French SCIs, being noted that the day prior to their winding-up, those SCIs had performed a revaluation of their real-estate assets. Such revaluations triggered a capital gain at the level of the SCIs, equal to the difference between the fair market value of the real-estate properties owned and their net accounting values at the date of the revaluations. Yet, such capital gains were offset by the capital losses generated by the cancellation of the SCIs shares in the French companies’ books further to the winding-up of the SCIs, calculated according to the Quemener principles by the French companies. As a result, the restructuring was tax free.
However, according to the Lupa decision of the French administrative Supreme Court, the rectification of the tax basis of the shares which are cancelled upon the merger - in order to increase the tax basis by the amount of the gain made upon the revaluation of the asset - applies only to avoid a double taxation of the entity implementing the merger. The French administrative Supreme Court overturns the administrative Court of Appeal’s decision which had applied the Quemener rectification of the tax basis of the shares without checking whether this double taxation condition at the level of the entity implementing the merger was met. In practice, this condition is not met whenever shares in the SCI have just been acquired since there is no gain made on the cancellation of the shares. Therefore, under the new decision, no capital loss can be made upon the merger to be offset against the gain made upon the revaluation of the asset, leading to the taxation of such gain.
One could put forward that (i) the facts are very specific and aggressive since it concerns an intragroup sale in 2006, prior to the first amendment to the French-Luxembourg tax treaty which made taxable in France capital gains derived from the sale of real-estate assets held by Luxembourg companies, and that (ii) the decision is not rendered in a plenary session. This being said, it is an important decision as it is to be published in the digest of the Supreme Court’s decisions (“recueil Lebon”). Moreover, its wording seems to be very general so that it should not only be applicable in particular cases like the one which was reviewed by the court.
This decision is very surprising as it goes against the Revenue ruling published in 2007 by the French tax authorities confirming the Quemener restructuring (RES n°2007/54 (FE), 11 December 2007) and against private rulings that could be granted by the tax authorities before 2007.
As the facts of the Lupa case law take place in 2006, prior to the publication of the 2007 Revenue ruling, there might be arguments for Quemener restructurings implemented from 2007 to now, to consider that such Revenue ruling is binding so that no tax reassessment can be made. However, in our view, it could probably be debatable as well, as the Revenue ruling reviews the case of a revaluation of a real-property asset prior to a merger of the SCI, but does not refer expressly to the situation whereby the shares of the SCI were acquired just before the restructuring.
However, it raises a lot of uncertainty for new transactions as the French tax authorities may review their guidelines to take into account the new case law. Moreover, even if the Revenue guidelines are not modified, the debate remains whether the 2007 Revenue ruling may be binding in circumstances where the shares of the SCI which is to be merged are just acquired prior to the restructuring.
Therefore, in new transactions, discussions will now obviously include the latent capital gain situation between the purchaser and the seller and thus a negotiated reduction of the purchase price, as it is the case usually in sales of real-estate companies subject to corporate income tax in France. For now, a prompt reaction of the real-estate market to the Lupa case law is to be expected, sellers involving French SCIs held by Luxembourg companies being willing to transfer shares in the SCIs by 31 December 2016 to benefit from the tax exemption on the capital gain. This will no longer be the case as from 1 January 2017 under the amended tax treaty between France and Luxembourg.