Henry Lazarski looks at the tax and legal implications of French property purchases by foreign investors – especially pension funds.
In spite of its parlous state, the French commercial property market nevertheless throws up interesting investment opportunities from time to time. A number of UK investors, including pension funds, are known to be studying opportunities in France. The properties targeted can be split into two main categories:
- office buildings situated in central Paris let to a tenant with a good covenant; and
- shopping centres.
When acquiring commercial property it should be noted that, if an investment is purchased by a UK pension fund through a French vehicle which is fiscally transparent, the rental income may escape tax altogether in France.
The first hurdle – registration taxes
It is well known that the French rate of registration tax on the purchase of real property is one of the highest in Europe. Thus commercial property bears registration tax at the rate of more than 18%, assessed on the consideration or the market value, whichever is higher.
The sale of “new” property, ie property the construction of which has been completed for less than five years, will, in the case of the first sale after completion, be subject to VAT at the current rate of 18.6 % (this rate will also apply to the second sale if the first was made to a property dealer). In such a case, the only registration tax which may be due will be a land registry publication tax of 0.615% payable on the consideration. VAT will also apply to the sale of property not yet completed or to be built, for example, on a “turnkey” basis.
Whereas registration tax can be deducted from the gross profits of the owner before tax, VAT can be totally recovered shortly after purchase, provided, among other conditions, that the tenant pays VAT on the rents.
It should be noted that French pension funds can, on application to the Ministry of Finance, benefit from a total exemption of registration tax, but, to our knowledge, this exemption has been granted only to certain French pension funds. It is possible, in the light of Common Market legislation which prohibits discrimination on the ground of nationality, that the French tax authorities may grant such exemption to a foreign pension fund.
Overcoming the obstacles – purchase of shares
In order to avoid the payment of registration tax at the said rate of 18%, it is not uncommon for purchasers to seek alternative methods of buying property – by acquiring the shares of the company which owns it, for example.
The purchase of shares does result in a substantial saving in registration taxes. Thus, if the owning company is one of the types which are commonly used to hold real property, societe & responsabilite limitee, societe civile, or societe en nom collectif, the transfer of shares will be subject to a registration tax of 4.8%, assessed on either the sale price or the market value of the shares, whichever is higher. An even greater saving can be effected if the owner of the property is a societe anonyme, since transfers of shares in this type of company are subject to a registration tax of 1%, with a maximum of FFr20,000 per transfer (and in some cases may escape even this modest amount of tax). Therefore, as regards property which is not subject to VAT, a considerable saving in registration taxes will be effected by purchasing shares as opposed to the property.
Since it is frequent in France to set up one company per property, a number of property investments are offered for sale in a corporate form. Provided suitable documentation is entered into and certain precautions taken, the disadvantages of acquisition of shares over the purchase of the property outright can be easily overcome.
If the vendor company owns a number of properties, it is not uncommon for each property intended for sale to be transferred to a special purpose vehicle (SPV) and the shares of that SPV offered for sale. Then, again, if the transfer is made by way of contribution of the property to the capital of the SPV, the only registration tax due could be as low as FFr500 (approximately £60), to which will be added the registration tax duty on the transfer of the shares.
Such an operation consisting in a contribution of the property to an SPV and the immediate sale of its shares clearly results in a loss of a great deal of registration duty for the French Treasury. Therefore, it is likely to be scrutinised by the tax authorities and challenged on the grounds that the operation has no legal substance, but was set up only to avoid the tax due. Whether the tax authorities would be successful will, in particular, largely depend on the length of time that the property has been held by the SPV before all its shares are transferred to a third party.
Taxation of rental income
General principles
Rental income received from property situated in France will be taxed at the corporation tax rate of 33.3% if the owner is a company subject to corporation tax or, again, if the owner is fiscally transparent and its shareholders are subject to such tax. From the gross rents before tax, not only may interest on loans contracted for the purchase, construction, repair, maintenance or improvement of the property be deducted but in addition the following deductions can be made:
- sums spent for maintenance and management of the property;
- sums excluding capital expenditures spent on repairs, maintenance and improvement of the property;
- local taxes, except those which are normally paid by the tenant;
- depreciation on the construction part of the property (land cannot be depreciated).
The net income calculated after to the above deductions will be subject to corporation tax.
Special position of pension funds
Pension funds benefit from a reduced rate of corporation tax at 24%. As a result, however, of an omission of the Tax Code, a pension fund which owns the property through a shareholding in a societe civile may escape taxation altogether on the rental income received. This position was confirmed in a parliamentary reply which, although it dates back to 1975, is still in force. There are no plans at present to change this position.
The French tax authorities are prepared to extend this privileged tax treatment to pension funds. In practice, foreign pension funds intending to invest in France make a specific application to the tax authorities for confirmation that this tax regime will apply to them if the property is owned through a soci
