Pierre Appremont and Egalantine Lioret of Lefèvre Pelletier & associés highlight recent changes to the annual tax charge affecting property investments in France.

Introduction

The annual 3% tax, introduced to prevent property investments made in France via foreign entities from allowing individuals to evade wealth tax and transfer tax (by means of gift or inheritance), has become a real constraint on the organisation and management of real estate investments. The annual 3% tax has been significantly reformed as from 1 January 2008.

All French or foreign companies whose assets, whether directly or indirectly, consist primarily of French real property are, in theory, subject to an annual tax equal to 3% of the market value of such property assets. However, there are several ways whereby companies whose assets consist essentially of real estate may be exempt from the 3% tax, provided they comply with certain declaratory formalities that are often extremely cumbersome.

The tax consistently causes problems in relation to real estate investment funds because it makes it difficult for certain foreign entities to invest. The problem also frequently arises in connection with acquisitions of property companies and liability warranties, given the significant financial stakes involved and the extremely broad nature of the joint and several liability for payment.

In the “Elisa” ruling of 11 October 2007, the ECJ considered that the 3% tax constituted an unjustified obstacle to the free movement of capital. Nevertheless, the practical scope of the ruling is limited to EU resident entities.

This is the context of the reform: the scope of the 3% tax is extended and the exemptions are significantly modified, while for the moment limiting the easing of declaratory formalities that investors and practitioners had been hoping for.

Since the tax authorities have yet to publish any statement of practice commenting on the new rules governing the 3% tax, it has been decided to postpone the deadline for filing declarations initially set at 15 May 2008, to 15 September next.

1. Extension of the scope of the 3% tax

In addition to bodies corporate, the tax now concerns “legal entities, organisations, trusts or similar institutions”, which means that it henceforth extends to investments made through the intermediary of trusts and new property investment vehicles such as OPCIs (REITs).

Entities which will benefit from the tax exemption through disclosure of information to the tax authorities (whether through a commitment or the annual tax return) remain subject to the 3% tax. The reworking of the texts may mean that investors whose interest is less than 1% and whose identity need not be disclosed by the declaring entity will still fall within the scope of the 3% tax (provided the tax authorities can identify them).

2. Modifications of exemptions from the 3% tax

2.1 Exemptions where no condition exists relating to the location of the establishment: the entities concerned are -

i) Non-property entities, i.e. entities that directly or indirectly hold property assets that account for less than 50% of the entity’s French property assets;

Properties dedicated to a professional activity (excluding real estate activities) are not taken into account, even if they are held via an affiliated entity. Operating companies that own their plant or offices will no longer be penalised where the properties are held via a subsidiary. Properties recorded as stock by real estate dealers (“marchands de biens”) and property developers are also excluded from the ratio.

ii) Entities whose securities are admitted to trading on a regulated market, with significant and regular trades;

Among others, SIICs (listed property investment companies) fall into this category. The French tax authorities have yet to specify what is meant by significant and regular trades, but the objective is clearly to exclude listed “sleeping” companies from the exemption, which is now more restrictive since the sole condition previously was to be listed.

iii) States and international bodies.

2.2 Exemptions that depend on the location of the establishment:

Entities likely to benefit from the exemption must be established (1) in France, (2) in a Member State of the European Union, (3) in a country or territory that has concluded with France an administrative assistance agreement in order to combat fraud and tax evasion, or (4) that contains a non-discrimination stipulation. Such an entity must also meet one of the following conditions:

• it holds, directly or indirectly, real estate or rights in rem in France whose market value is less than 5% of the market value of all of the property assets, or less than €100,000. The thresholds specified are significantly below actual market values, notably because the indebtedness situation of the property entity is not taken into account. The French tax authorities have yet to specify if the property assets held abroad by a real estate fund will be included in the denominator of the ratio;
• or it was set up in order to manage retirement plans, it is a public utility grouping or an entity whose management operates on a not-for-profit basis and whose activity or financing justifies the ownership of real estate or real property rights;
• or it is an open-end property-based unit trust (SPPICAV) or real estate investment fund (FPI) governed by Articles L 214-89 et seq of the Monetary and Financial French Code or is subject to equivalent regulations in the state or territory where it is established. The tax authorities have yet to specify the criteria that foreign real estate investment funds must meet in order to benefit from the OPCI regime. According to our understanding, foreign real estate open-ended funds should be considered as comparable to the French FPI(s). German investment funds are the main parties concerned;
• or it discloses every year, or makes and abides by a commitment to disclose to the tax authorities at their request, the status, substance and value of the real estate owned on 1 January, the identity and address of all of the shareholders, partners or other members that hold, in any way whatsoever, more than 1% of the rights, as well as the number of shares, units or other rights held by each of them. This will therefore exonerate members whose interest fall below 1% and entities established in countries such as Luxembourg, that is, states whose treaty does not contain a non-discrimination clause and which thus could not sign a disclosure undertaking. The undertaking must be met on the date of acquisition or, in the case of property already owned, no later than 15 September 2008. The tax authorities will have to specify whether the above holding threshold applies to the entity that owns the French assets or to the entity that is subject to the declaratory obligations or the commitment. The considerable caution shown in determining the thresholds is also worthy of note.
• or, it declares each year. no later than 15 May, the status, substance and value of the real estate owned on 1 January, the identity and address of the shareholders of which it is aware on that date as well as the number of shares held by each of them, in proportion to the number of shares held on 1 January by the shareholders whose identity and address have been declared. Only the identity of the shareholders holding more than a 1% interest must be disclosed. Otherwise, the 3% tax due by the declaring company is proportional to the non-disclosed shareholders’ interest, not to its total amount as was previously the case. Although the disclosure obligation does not apply to members holding an interest of less than 1%, they are still potentially liable for the 3% tax provided that the French tax authorities can identify them.

3. Declaration and Payment of the 3% Tax

If the tax is due, irrespective of whether some or all of the requisite information is disclosed or some or all of the shareholders are established in states that are not covered by a tax treaty, a 2746 return must be filed no later than 15 May each year.

All intermediate legal entities between the person(s) liable for the tax and the property are jointly and severally liable for payment of the tax. This joint and several liability causes difficulties with due diligence operations relating to the acquisition of property companies. These difficulties may be increased through non-disclosure of members holding an interest of less than 1% if this subsequently makes it impossible to verify the entire participation chain.

The tax representatives that must be designated by vendors established outside the EU are liable for the 3% tax in the same way as the special 33 1/3% withholding tax, as applicable.

The limitation period for incomplete returns expires on 31 December of the third year following the year in which the tax was payable. If no return is filed, the current limitation period is 10 years, to be reduced to 6 years in the event of a tax audit after 1 June 2008.

Conclusion

The easing of declaratory formalities is a step forward (particularly for entities that were excluded from the commitment mechanism, cf. Luxembourg), but is still not enough: the thresholds stipulated in the text do not reflect the real evolution of the property market.

Some of these modifications are intended to create new exemptions for certain categories of investor (listed companies, open-ended investment funds, investors whose real estate investments in France can be considered non-significant, etc…). However, the definitions of these exemptions are open to wide interpretation and need to be clarified.

In particular, if a look-through approach is being favoured by the French tax authorities, the situation of the real estate investment funds which currently benefit from a tax ruling regarding the 3% tax could be significantly modified, since the 3% tax exemption for unit holders could be terminated.

About Lefèvre Pelletier & associés

Lefèvre Pelletier & Associés is one of France’s leading law firms, with a major involvement in real estate, mergers & acquisitions, private equity, banking / finance and litigation. THe firm has more than 150 lawyers, including 33 partners, and four overseas offices (Hong Kong,Guangzhou, Algiers and Casablanca) the firm pools the skills of its teams in all areas of business law to provide advisory and litigation services to its French and international clients. Lefèvre Pelletier & associés covers all areas of real estate from investment to commercial leases as well as financing, construction, taxation and environmental issues.

Lefèvre Pelletier & associés, Avocats
136, avenue des Champs-Elysées - 75008 Paris
Tél. : +33 (0)1 53 23 12 09
Fax : +33 (0)1 53 93 30 30
http://www.lpalaw.com/

Article Added Saturday, 28 June 2008 | 2118 Hits

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