Failure to adopt the right structure of ownership on French properties can have costly tax consequences.
In order to limit these, it is essential to consider the tax aspects during the early stage of the acquisition process and definitely before completion. Further, depending on the structure of ownership, the owner might face various tax issues (including, among other things, corporation tax when a company is used and trusts issues when a trust is involved). Our French tax experts address some of the main issues that individuals owning French residential property should consider.
Properties owned through a French or Monegasque Société Civile Immobilière (an SCI)
For French tax planning purposes, a French property can often be owned through a French or Monegasque SCI. This is a type of company most commonly used to own residential properties.
In particular, the use of a Monegasque SCI might help to mitigate French Inheritance tax which can reach a rate of 45% on transfers in the direct line of inheritance (i.e. transfers to children). Death transfers between spouses are not taxed.
For some tax technical reasons, residents of countries which have not signed a Treaty with France which covers inheritance tax should own their French properties through a Monegasque SCI (rather than a French SCI) to mitigate or avoid their potential French inheritance tax exposure. Indeed, when a French SCI is used, it has to be structured with a bank loan to reduce the potential French inheritance tax liability. However, if using a Monegasque SCI such a bank loan is not strictly necessary.
In addition to the tax benefits, an SCI allows for a simple structure of ownership which is not formality or costs heavy. Indeed, an SCI which does not generate any income and whose sole activity is to provide its shareholders with the free use of the French residential property, is without doubt the most simple and least expensive company to run.
Provided that some tax formalities are undertaken on constitution of the company, the ongoing filing obligations can be minimal (or even non-existent). There is, in principal, no need to annually file an income tax return for the SCI and a 3% tax return. In addition, it is not necessary to appoint a separate director to manage the SCI (this can be done free of charge by one of the shareholders of the SCI).
In practice, the main important formality which should be carried out is for the SCI to have its annual financial accounts regularly prepared, however the cost of having them is quite negligible. These accounts are crucial to establish on an annual basis the financial situation of the company for French tax purposes.
However, it is important to note that the running costs and the tax consequences can be much higher when the property is owned through an offshore company.
Properties owned through an offshore company
A consequence that non-French tax residents are often unaware of is that the use of a foreign company to own French residential property can trigger unpleasant French corporation tax issues.
It is not usually advisable for corporation tax to apply to residential property for two main reasons.
Firstly, corporation tax is due on the deemed profits derived from the free use of the property.
Secondly, and more importantly, capital gains realised by the company on the sale of the property would be computed and taxed under the French corporation tax regime which would be less favourable than the private capital gains tax regime.
Indeed, when the corporation tax rules apply depreciation of the property must be taken into account when computing the taxable gain. Given the effects of the depreciation rules, the longer the company owns the property the higher the corporation tax liability at 33.33% on any future sale would be.
Furthermore, the use of an offshore company (and any other entities) to own a French residential property might also trigger the application of the annual tax of 3% on the market value of the French property. This tax is not usually levied if some formalities are undertaken provided that the company is located in a country which has signed a tax treaty with France.
These formalities involve providing the French tax authorities with certain information. It is crucial to comply strictly with these tax formalities as failure to do so might give rise to the payment of the tax for at least the three previous years (and sometimes more).
We are aware and involved in some tax reassessment cases where the French tax authorities are asking for substantial amounts of tax just because the taxpayers have failed to comply correctly with the filing requirements. Having said this, as mentioned before, we should stress here that the requested filing requirements do not require a 3% tax return disclosing the market value of the property to be filed every year.
French Capital Gains Tax (CGT)
French CGT has considerably increased over the past couple of years.
Generally speaking, French CGT applies at a flat rate of 19% (for EU residents) and 33.33% (for non-EU residents) on a gain made on the sale of French real estate (including the sale of shares of a French or foreign company owning French real estate).
In addition to CGT, "social contributions" (not to be confused with national insurance contributions) are due at a rate of 15.5%. In total, the following global rates apply depending on the residence of the seller: 34.5% for EU residents or 48.83% for non-EU residents.
The difference between the purchase price and the sale price of the property (or the shares) is taxed and relief is available (at various rates) depending on the length of ownership of the property. Under the current regime, no tax is due if the property (or shares) is sold after an extended period of ownership of 30 years. After 22 years of ownership, CGT is not due but the "social contributions" remain payable (but with a higher taper relief available).
This CGT regime only applies when the property is owned directly by individuals or by certain companies (such as a French or Monegasque SCI), provided that the SCI does not fall within the corporation tax regime.
In respect of CGT, it should be noted that on 5 September 2014 France and Luxembourg signed an amendment to their Double Tax Treaty to ensure that any gains made on the sale of shares of a French real estate company (e.g. a French or Monegasque SCI) by a Luxembourg company would be taxed in France (at the moment such gains are not taxed in France and thus are not taxed at all).
If both countries manage to ratify the amendment before the end of 2014, it will apply as of 1 January 2015. Therefore, before the end of this year some owners might consider the option of selling their shares to purge any latent capital gains.
Although a sale to a third party should not raise tax issues, an internal restructuring, if it can be implemented, should be done carefully to avoid any risk of the French tax authorities challenging the restructuring on the grounds that it constitutes an abuse of law (i.e. the general French tax anti-avoidance legislation) and thus ask for the payment of very high penalties in addition to the capital gains tax liability.
French wealth tax
French wealth tax applies if the value of the French assets (including the property and the shares of a French or foreign company owning the property) exceeds €1,300,000. Shares of foreign companies owning French real estate are considered as French sited assets under French tax law. The tax liability can be very high. A property in excess of €10,000,000 can be taxed between 1% and 1.5% per year.
Wealth tax is a self-assessment tax. When the €1,300,000 threshold is reached, taxpayers must lodge a return disclosing the value of their assets and pay the tax due.
As for French inheritance tax, solutions exist to avoid or mitigate wealth tax, such as using debts (third party loans and not shareholders' loans) or splitting the ownership of the property between different shareholders (e.g. adult children of the same family). In some cases, when the property has already been purchased and has substantially increased in value, restructuring the ownership and/or the debt may be envisaged to reduce future tax liabilities (including wealth tax and inheritance tax liabilities).
However, unlike French inheritance tax, only bank loans and true third party loans might help to reduce the wealth tax liability. Therefore, when a Monegasque SCI is used, while a mere shareholder's loan will help to mitigate the potential Inheritance tax liability, a bank loan is still required for the wealth tax liability. Taxpayers will have to do some maths and deicide what is the most cost-effective solution.