Current issues in the taxation of real estate

25 minute read
06 January 2015

Wragge Lawrence Graham & Co's tax experts bring you the latest tax law issues and provide action points to help you and your organisation.

The main tax issues for 2014 can be divided into three groups:

  • the increasing internationalisation of the tax rules, including those applicable to the real estate sector, which had hitherto been fairly well protected;
  • the "enlistment" of the real estate sector (like other sectors) into helping to reduce the government's budget deficit, leading to certain tax increases, most of which were expected;
  • a repeated determination to support the construction sector, which is seen as a key element for a return to growth.

Internationalisation or real estate taxation

  • France-Luxembourg tax treaty: amendment of 5 September 2014
  • Transfer pricing: new information obligations
  • Horizontal integration: new option to consolidate results of French companies forming part of an international group
  • Tax representatives: simplification
  • Capital gains realised by individuals who are not resident in France: prospect of tax reduction

1.1 - France-Luxembourg tax treaty: amendment of 5 September 2014

The tax treaty between France and Luxembourg is one of the oldest in existence. As such it did not contain any special arrangements concerning disposals of companies owning mainly real estate.

Capital gains realised by a Luxembourg company on disposals of shares in a French company that held real estate assets in France were only taxable in Luxembourg and might in fact be exempt there.

The amendment of 5 September 2014 has now put an end to this state of affairs by providing that capital gains realised on disposals of shares in companies owning mainly real estate will be taxable in the state where the properties are located.

This provision is to apply from 1 January 2016 (subject to approval, followed by notification, by the legislatures of the two countries before end-November 2015).

Taxation Now 2016
On sale of a property 33⅓% in France (CT) 33⅓% in France (CT)
On sale of Company A 0% in France Exemption possible in Luxembourg 33⅓% in France (article 244 bis A of the GTC)

Some lessons can be drawn from the past (see the previous amendment to the France-Luxembourg treaty, concluded in order to put a stop to the situation whereby capital gains realised by Luxembourg companies on disposals of French properties were not taxable in France) and, in particular, from the opinions of the Committee on Abuse of Tax Law in 2014.

These include the meeting of 22 May 2014 of the above Committee on cases nos. 2013-32 and 2013-29 to 31. Without relating the context of the operations criticised - whether restructuring operations just before or at the same time of the treaty changes to avoid the taxation of capital gains with no effect in economic terms (e.g. transfer of residence, change of accounts closing date) or without having any other reason than to avoid tax - the transactions in question risk being deemed an abuse of the law, with taxation of capital gains and penalties (charged at 80% plus late-payment interest).

1.2 - Transfer pricing

This term covers all transactions between companies in the same group, generally located in different countries. The French tax authorities (like their foreign counterparts) consider that such operations are aimed at transferring profits that should be taxed locally (France, in this case) to entities located in countries where taxes are not so high. A whole set of rules has been gradually introduced in France to control such operations. This has not really concerned real estate until now, but matters are changing.

In fact, additional obligations were imposed as of December 2013, with companies required to submit documentation on their transfer prices in the event of an accounting audit. Such companies must spontaneously and annually (within six months of the deadline for filing their results) notify the French tax authorities of the principles underlying their transfer pricing policy. Moreover, the obligation to keep for the authorities "complete" documentation relating to transfer pricing tax since this date includes the decisions of foreign tax administrations regarding associated enterprises.

The tax authorities have recently commented on this regime, stating among other things that the following are exempted from making a declaration:

  • companies not conducting transactions with related entities that are established abroad;
  • companies conducting transactions with related entities that are established abroad where the amount is less than €100,000 by type of transaction.

These two relaxations of the rules mean that:

  • purely French groups are not subject to tax that is not aimed at them; and
  • transactions involving small amounts do not have to be declared.

In real estate terms, therefore, this mainly affects international groups, in particular investment funds, mainly in respect of internal funding arrangements as well as management fees.

The applicable penalties have been reinforced by article 78 of the 2015 finance law: for failing to keep the transfer pricing documentation will now be the highest of the following amounts:

  • €10,000; or
  • 0.5% of the amount of transactions conducted with related foreign entities where documentation is lacking, or;
  • 5% of the profits transferred pursuant to article 57 of the General Tax Code (GTC).

These heavier penalties will apply to checks where an audit notice is served following the introduction of the law.

1.3 - "Horizontal integration": new option to consolidate results of French companies forming part of an international group

In its ruling of 2 December 2014, the Administrative Court of Appeal of Versailles confirmed the option for French companies to benefit from a recent European ruling regarding the introduction of "horizontal integration".

Until 2014 French law permitted companies that were at least 95% either directly or indirectly owned, by a French holding company, or a permanent establishment in France of a foreign holding company, to form a tax group in France subject to certain conditions, thus allowing the results of the various entities to be consolidated for tax purposes. French sister or cousin companies held by a parent or grandparent company located abroad with no permanent establishment in France could not however constitute such groups.

This regime was considered contrary to the principle of freedom of establishment, as it discriminates between French companies held by a parent company established in France and French companies held by a parent company established abroad.

This non-compliance with Community law has had two results:

  • one was the incorporation into article 63 of the second amending Finance Law for 2014 of the option - for financial years ending as of 31 December 2014 - to form a tax group between French companies subject to CT that are at least 95% owned by a company located in the European Union (EU) or the European Economic Area (EEA), provided such country has concluded an Administrative Assistance Agreement with France (in practice Iceland, Norway and Liechtenstein). The other conditions specific to the group regime must also be met, notably that all companies concerned must have the same financial year and be subject to CT. If this option is chosen, the "head" company of the tax consolidation group may not be the foreign parent company that holds the French companies involved, but rather one of the French companies designated for this purpose;
  • the other is that companies that meet the conditions set down by the ruling may claim the benefit of "horizontal integration" for those years that are not time-limited, i.e. 2012 and 2013. For 2014, the above law provides that such applications may be made without the need for litigation.

This regime will primarily benefit real estate investment funds whose structure includes one or more foreign holding companies that own French companies subject to CT that in turn own one or more real estate assets.

This regime permits French companies to consolidate their tax results, allowing losses incurred by one or more companies to be charged against the profits of others. However, before taking such a decision, the full consequences should be weighed up, in particular:

  • opting for the horizontal integration regime may jeopardise an existing tax group where the parent company is a French company holding a sub-group of subsidiaries: this group would disappear and become part of the "horizontal integration" group to be established, with all the consequences this implies (conversion of joint losses into own losses for the former integrating company, querying of certain intra-group transactions for the previous five years, etc.) ;
  • creating a tax group entails the application of certain rules to the consolidated taxable result, not to the individual results of each company, particularly in the case of the thresholds for deducting financial costs (especially the threshold of €3 million above which 25% of net financial costs may not be deducted).

Before introducing horizontal integration and identifying the French companies that will become members, costed simulations are required as necessary to determine the full consequences in order to ensure that the operation will be worthwhile in tax terms.

1.4 - Tax representatives

Previously, when a person (an individual or a company) who was not resident in France realised a capital gain on real estate in France, such person had to designate, in France, an accredited tax representative who was responsible for calculating and paying the tax related to the capital gain. This requirement entailed significant costs and applied even in the event of losses.

The ECJ has ruled against this regime (as regards Portugal in the case in point), and the obligation to appoint a tax representative is now abolished for individuals and companies whose registered offices are located in a member state of the EU or the EEA (Iceland, Norway and Liechtenstein) (article 62 of the second amending Finance Law for 2014).

This relaxation of the law will apply to natural persons as of 1 January 2015 and, for legal persons, to financial years closed as of 31 December 2014.

1.5 - Capital gains of individuals who are not resident in France: prospect of a tax reduction

The tax regime governing capital gains on real estate realised by non-residents hereto provided:

  • on the one hand, the charging of a withholding tax of 33⅓% on capital gains, reduced to 19% if the person making the disposal was domiciled within the European Union;
  • on the other, the application of social security charges of 15.5% (general social contribution (CSG), social debt reimbursement tax (CRDS) and other social levies).

This regime has been challenged from two angles:

  • first, by several court rulings (in particular the 20 October 2014 ruling of the Conseil d'Etat, no. 367234, 3rd and 8th sub-sections), which held that the application of a rate of 33⅓% to capital gains realised by individuals residing outside the EU (compared to the rate of 19% applicable to French or EU residents for tax purposes) was contrary to the free movement of capital: article 60 of the second amending Finance Law for 2014 will thus reduce the rate to 19% as of 1 January 2015, regardless of the place of residence of the person making the disposal;
  • several cases are pending before the European courts regarding the application of social security levies to capital gains realised by non-residents (as well as to income derived from land), particularly where the non-resident is a national and a resident of the EU. It is likely that such charges will be considered contrary to Community rules, which state that EU nationals shall only pay social security contributions in the state in which they will receive benefits.

It should be noted that the ECJ Rapporteur took this position in the Conclusions dated 21 October 2014 regarding case C-623/13 de Ruyter, which had been brought against France.

To date the French legislation on this second point has yet to be amended.

  1. Impact of the French budget deficit: real estate enlisted to contribute
    1. Registration fees on sales of real estate: two contrasting developments
    2. Non-deductibility of the tax on offices in the Ile-de-France region: sharp increase for owners (except for individuals)
    3. New tax on car parking areas in Ile-de-France
    4. Tax in addition to land tax and levy based on company land (CFE) in Ile-de-France

2.1 Registration fees on sales of real estate: two contrasting developments

2.1.1 Increase in land registration duty (TPF) on real estate sales now made permanent

The Finance Law for 2014 allowed departmental councils to raise the departmental share of TPF on sales of buildings from 3.80% to 4.50%, increasing the total burden from 5.09% to 5.81%. This had been a temporary option, with most departments nevertheless making use of it. Article 116 of the Finance Law for 2015 makes permanent all rate increases decided prior to February 2016. Almost all departments will have raised the TPF rate to 4.50% before that date, so that the total amount of TPF applicable to disposals of real estate assets will be standardised at 5.81%.

2.1.2 Assessment base of registration fees on disposals of companies owning mainly real estate

Article 726 of the GTC sets out a rate of 5% on disposals of shares in companies owning mainly real estate. In 2012 the base of assessment for fees applicable to disposals of shares in such companies was modified: it would no longer be the sale price of the shares (or their sale value if greater), but was calculated according to the following formula:

  • the sale value of the real estate assets owned by the company being sold;
  • plus all other assets of the company being sold;
  • minus solely the debts of the company being sold that financed the acquisition of its real estate assets;
  • with the total related as a percentage of the shares being sold.

This highly complex base, in particular as regards the concept of debts to be deemed "acquisition debts", has now been abolished (article 55 of the second amending Finance Law for 2014).

The base for registration fees applicable to disposals of shares in companies dealing mainly in real estate is now once more the disposal price of the shares (or their sale value if greater).

2.2 Non-deductibility of tax offices in Ile-de-France

Article 26 of the second amending Finance Law for 2014 provides that the tax on offices in the Ile-de-France region is no longer deductible from the CT base.

This regime, aimed at professional investors, is particularly harsh as it indirectly increases the tax offices on real estate by 1/3 and prevents the increase from being rebilled to tenants, thus reducing the profitability of the real estate investments concerned.

2.3 Annual tax on parking areas in Ile-de-France

From 2015 onwards an annual tax will apply to parking areas in the Ile-de-France region. The taxable areas are those already subject to the tax on offices in Ile-de-France, principally:

  • premises or covered or uncovered parking areas attached to buildings used for office, commercial or storage purposes where the surface exceeds 500 m2 ;
  • this tax is thus akin to an increase in the tax on offices in Ile-de-France as regards the proportion applicable to parking areas;
  • the rate, determined by the same zoning rules, is as follows:
    • zone 1 : 4,22 € / m2
    • zone 2 : 2,42 € / m2
    • zone 3 : 1,22 € / m2
  • the tax is declared and paid in the same way as the tax on offices, i.e. before 1 March of each year. By way of derogation, payment of tax for 2015 may be made up until 1 September 2015.

2.4 Tax in addition to land tax and levy based on company land (CFE) in Ile-de-France

In order to finance the Greater Paris area and to offset the final repeal of the so-called "Grenelle 2" tax, a tax in additional to land tax and the CFE is being created in the Ile-de-France region.

The rate will be determined by the Regional Council, with revenues capped at €80 million.

  1. Construction and urban planning : tax incentives

Several measures have been passed with the aim of encouraging the construction industry, either by direct aid or through simplification measures.

  • Fee for creating offices in Ile-de-France: reconstruction operations
  • Simplification of procedure for deliveries to oneself
  • Incentives for operations on land for building
  • Modification of the "Duflot-Pinel" regime

Fee for creating offices in Ile-de-France: reconstruction operations

Article 45 of the second amending Finance Law for2014 provides for the restoration of the temporary regime that existed until the end of 2013, waiving the fee for creating offices in the Ile-de-France region via reconstruction operations on pre-existing office surfaces.

This exemption is reintroduced for collection notices issued as of 1 December 2014.

The fee would only apply to those reconstruction operations for which a building permit was issued as of 1 January 2014 and for which a collection notice was issued before 1 December 2014.

3.2 Simplification of the procedure of self-delivery

For the record, a self-delivery is an operation whereby VAT is applied to the cost price of an asset realised by the taxpayer itself and which has not been acquired from a third party.

Self-delivery has the effect of making the entire cost price subject to VAT, although certain elements would not have been liable (e.g. the various urban planning fees or financial costs for a building), while establishing the base and start date for the payment deadline applicable to the VAT charged on fixed assets. VAT due in respect of self-delivery is deductible according to the VAT status of the owner and the assigned purpose of the asset.

The law aimed at simplifying matters for enterprises (article 32) abolishes the various forms of self-deliveries, in particular:

  • self-deliveries of buildings constructed by a company that are not sold within two years of completion, which affects developers in particular;
  • assets (including buildings) realised by a company for its own use where, in the case of self-delivery, all VAT would be deductible, namely for companies all of whose activities are subject to VAT and thus entitled to 100% VAT deduction: in such cases the self-delivery is deemed "blanche" (transparent) and there is no VAT payment (but there is an administrative formality).

3.3 Incentives for operations on land for building

3.3.1 Relief for individuals on capital gains on land for building (article 4, Finance Law 2015)

There is an exceptional 30% reduction on the capital gains on disposals of land for building, extended to disposals of buildings subject to an agreement to sell in 2015, where such gains are realised within areas with a strong demand for housing and the transferee gives a commitment, contained in the notarial deed of sale, to demolish the existing buildings in order to build and complete dwellings within a period of four years from the date of acquisition.

3.3.2 Exemption from transfer taxes of transfers of land for building for no valuable consideration (article 8, Finance Law 2015)

The regime governing gifts of land for building is being aligned with the regime for gifts of new buildings for residential purposes, by providing for a degressive reduction based on the relationship between the donor and the beneficiary. The notarised deed must be signed between 1 January and 31 December 2015 in order to benefit from this exemption.

The exemption of up to €100,000 for gifts of new dwellings will be limited to buildings that are actually new at the time of the gift (i.e. they must never have been occupied or used in any way). The donee may have to make a commitment binding him/herself and his/her successors to realise and complete new premises for dwelling purposes within a period of four years from the date of the notarised deed.

Donee Maximum exemption
  • direct descendent / antecedent
  • spouse / partner established by civil solidarity pact
100, 000 €
  • brother or sister
45, 000 €
  • other persons
35, 000 €

3.3.3 Extension of the exemption of capital gains on real estate to disposals aimed at the construction of social housing (article 9, Finance Law 2015)

This exemption for capital gains is applicable to disposals realised by private landlords in proportion to the social housing completed. It takes the form of a commitment by the transferee, contained in the notarial deed of sale, to realise and complete social housing within a period of four years.

3.4 Modification of the "Duflot-Pinel" regime

3.4.1 Relaxation of the "Duflot-Pinel" regime (article 5, Finance Law 2015)

The "Duflot-Pinel" tax regime aims to reduce the income tax burden by encouraging investment in new buildings. To benefit from the reduction, investors must agree to rent a bare property to an individual as their main home for a minimum period, which before the reform was 9 years.

The reduction is also subject to a number of conditions related to the environmental quality of the dwelling, the level of rent and certain conditions regarding the tenant's resources.

Article 5, Finance Law 2015 eased this regime by introducing an optional period of commitment of 6 or 9 years. The option must be exercised when filing the income return in the year of completion of the building, or of its acquisition if this is later.

The commitment may now also be extended. If the dwelling continues to be rented on a 3-year basis following the period covered by the commitment to rent, the taxpayer may continue to benefit from the tax reduction provided the original commitment is extended. This extension may be renewed once for a 6-year commitment and the exemption may not exceed 12 years in total.

Duration of commitment Rate of reduction Additional reduction if new commitment made for 3 years
9 years 18% of amount of investment +3% of sale price of dwelling
6 years 12% of amount of investment 1st period: +6% of sale price of dwelling
2nd period: +3% of sale price of dwelling

As of 1 January 2015 it has also become possible to rent to an antecedent or a descendent (provided the conditions regarding the tenant's resources are met).

In addition, for taxpayers who make a "Duflot-Pinel" investment in the form of shares in a SCPI (real estate investment fund), the tax reduction is now calculated on 100% (rather than 95%) of the amount subscribed, up to a limit of €300,000. This change applies to subscriptions with a closing date subsequent to 1 September 2014.

The "Duflot-Pinel" regime is still subject to the general cap of €10,000 on tax breaks.

3.4.2 Relaxation of the Duflot-Pinel regime overseas (article 5, Finance Law 2015)

The optional 6- or 9-year period has also been introduced for this regime and the rate of reduction is amended. In the same way as the Pinel law in metropolitan France, the commitment to rent may be extended by 3-year periods.

Duration of commitment Rate of reduction Additional reduction if new commitment made for 3 years
9 ans 29% of amount of investment +3% of sale price of dwelling
6 ans 23% of amount of investment 1st period: +6% of sale price of dwelling
2nd period: +3% of sale price of dwelling

A French version of this alert is available here.

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