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Everything you always wanted to know about France - from France |
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TAXATION OF FRACTIONAL VACATION
PROPERTY IN FRANCE OWNED BY NON-FRENCH RESIDENTS (12/14/07) By D. Andrew Sirkin Sirkin Paul Associates 33 (0)8 72 90 76 34 dasirkin@earthlink.net This article will provide an overview and summary of tax issues which should be considered by non-French purchasers of fractional interests in real estate located in France. I will begin by introducing certain key concepts of French real estate transactions, ownership entities used for real estate in France, real property taxation in France and the associated tax treaties, and fractional ownership. I will then discuss the nature and extent of taxation of fractional vacation properties located in France, with particular emphasis on the tax effects of various fractional ownership structures, allowance versus prohibition of rentals of the French property, and characterization of the fractional ownership arrangement as “commercial”. 1. Executive Summary......................................................................................................................... 2 2. Key Aspects of Real Estate Transactions In France: Notaire and SCI............................................. 3 3. Commercial Characterization of French Property.......................................................................... 3 4. France Real Estate Ownership By Offshore or Foreign
Companies............................................... 4 5. Real Estate Company Taxation in France and Associated
Tax Treaties....................................... 4 5.1 France Transfer/Registration Tax............................................................................................. 4 5.2 France Capital Gains and Income Tax...................................................................................... 5 5.3 France Inheritance Tax............................................................................................................. 5 5.4 France Value Added Tax (TVA)................................................................................................... 6 5.5 France Annual 3% Tax on Properties Owned By
Entities......................................................... 6 6. Key Aspects of Fractional Ownership: Efficient
Enforcement and Transferability........................ 6 7. Tax Consequences of Fractional Ownership in France.................................................................. 7 7.1 Tax Consequences of Direct Deeded
Fractional Ownership in France.................................... 7 7.1.1 Transfer Tax......................................................................................................................... 7 7.1.2 Capital Gains Tax................................................................................................................. 7 7.1.3 Income Tax........................................................................................................................... 7 7.1.4 Inheritance Tax................................................................................................................... 7 7.1.5 Value Added Tax (TVA)......................................................................................................... 7 7.1.6 Annual 3% Tax..................................................................................................................... 7 7.1.7 Fractional Ownership Agreement
Enforcement/Foreclosure............................................ 7 7.1.8 Transfer of Fractional Interests.......................................................................................... 8 7.1.9 Summary of Advantages and Disadvantages of
Direct Deeded Fractional Ownership in France 8 7.2 Tax Consequences of Direct SCI Fractional
Ownership in France.......................................... 8 7.2.1 Transfer Tax......................................................................................................................... 8 7.2.2 Capital Gains Tax................................................................................................................. 8 7.2.3 Income Tax........................................................................................................................... 8 7.2.4 Inheritance Tax................................................................................................................... 9 7.2.5 Value Added Tax (TVA)......................................................................................................... 9 7.2.6 Annual 3% Tax..................................................................................................................... 9 7.2.7 Fractional Ownership Agreement
Enforcement/Foreclosure............................................ 9 7.2.8 Transfer of Fractional Interests.......................................................................................... 9 7.2.9 Summary of Advantages and Disadvantages of
Direct SCI Fractional Ownership in France 9 7.3 Tax Consequences of Direct Foreign Company
Fractional Ownership in France................... 9 7.3.1 Transfer Tax....................................................................................................................... 10 7.3.2 Capital Gains Tax............................................................................................................... 10 7.3.3 Income Tax......................................................................................................................... 10 7.3.4 Inheritance Tax................................................................................................................. 10 7.3.5 Value Added Tax (TVA)....................................................................................................... 10 7.3.6 Annual 3% Tax................................................................................................................... 10 7.3.7 Fractional Ownership Agreement
Enforcement/Foreclosure.......................................... 10 7.3.8 Transfer of Fractional Interests........................................................................................ 10 7.3.9 Summary of Advantages and Disadvantages of
Direct Foreign Company Fractional Ownership in France............................................................................................................................... 11 7.4 Tax Consequences of Indirect Foreign
Company Fractional Ownership in France............... 11 7.4.1 Transfer Tax....................................................................................................................... 11 7.4.2 Capital Gains Tax............................................................................................................... 11 7.4.3 Income Tax......................................................................................................................... 12 7.4.4 Inheritance Tax................................................................................................................. 12 7.4.5 Value Added Tax (TVA)....................................................................................................... 12 7.4.6 Annual 3% Tax................................................................................................................... 12 7.4.7 Fractional Ownership Agreement
Enforcement/Foreclosure.......................................... 12 7.4.8 Transfer of Fractional Interests........................................................................................ 12 7.4.9 Summary of Advantages and Disadvantages of
Indirect Foreign Company Fractional Ownership in France............................................................................................................................... 12 9. Conclusion...................................................................................................................................... 13 10. About the Author............................................................................................................................ 13 1. Executive Summary Ownership of
property in France, whether as an individual or as part of a fractional
ownership group, will trigger liability for French taxes. The types of taxes
likely to be payable, transfer tax, capital gains tax, income tax (if the
property is rented), and inheritance tax, are similar to those associated with
property ownership in most western democracies, and the tax rates tend to be
only slightly higher than the average among these countries. Many nations have
tax treaties with France, allowing residents to offset French capital gains,
income and inheritance taxes against tax otherwise payable in their home
country. Under current French law, no ownership structure, regardless of the
type and number of intermediary offshore entities involved, will avoid or
significantly diminish taxes owned in France, and some ownership structures may
substantially increase French tax. Buyers who are uncomfortable with French
real estate taxation should not buy property in France, fractionally or
otherwise, regardless of ownership structure. Fractional
ownership and usage arrangements require a non-judicial enforcement mechanism
which allows the co-owners to quickly resolve any disputes and, following a
fair hearing and opportunity to cure any default, to foreclose upon the
ownership interest of a non-paying or non-compliant co-owner. If the fractional
ownership agreement can only be enforced through a long and expensive judicial
process conducted in a foreign language in a faraway place, the fractional
ownership may devolve into a source of constant frustration and endless
dispute-related costs, and the owners may be unable to use, rent, or sell their
property for periods of months or even years. Fractional owners of property
located in a country where the owners do not reside also need to be able to
sell, gift or inherit their fractional interests without enduring a long and
expensive legal process in a foreign country. Generally, the
owner of a fractional interest in property located in France will be subject to
the same types of French tax, and the same French tax rates, as she would if
she owned the entire property herself. If the fractionally-owned property is
never rented, the legal structure of the fractional ownership arrangement has
no bearing on the tax treatment, and the best structure is the one that best
serves the twin needs of efficient enforcement/foreclosure and quick and
inexpensive transferability. These typically involve a company formed in a
country, like the U.S., with a highly developed and reliable non-judicial
dispute resolution and foreclosure mechanism. This foreign company owns a
French SCI (a type of French company described below) which, in turn, owns the
French property. This is the most common
fractional ownership structure currently used for France property by non-French
fractional owners and developers. If the
fractional French property is used for vacation rentals, even occasionally,
certain fractional ownership structures may trigger “commercial”
characterization. Unfortunately, the only structure under which vacation rental
will not risk “commercial” characterization is direct deeded ownership, and the
enforcement/foreclosure and transferability problems associated with direct
deeded ownership outweigh any potential tax advantages. The potential adverse
tax consequences of allowing rental within more practical fractional ownership
structures may be less likely if rental by the ownership association or company
is prohibited, and rent pooling is avoided in favor of individual rentals by the
fractional interest owners. But the only
way to definitively eliminate the problem is to prohibit all rentals. In the
end, purchasers of fractional interest must weight the economic benefits of
rental income potential against the possible adverse tax consequences of
“commercial” characterization and, based upon the outcome of this analysis,
choose between projects that allow rental and projects that do not. 2. Key Aspects of Real Estate Transactions In France: Notaire and SCI In general, each
French real estate transaction must be facilitated by a Notaire whose job is to research the ownership history of the
property, determine the validity of title, prepare transaction documents
including the equivalent of deeds and mortgages, and ensure that governmental
requirements are fulfilled and taxes paid. Real estate sales and other
transfers handled by a Notaire
typically take about 90 days, and the Notaire
receives a percentage of the price or value of the property transferred. Although France
allows individuals to own real estate in their own names, many people form a Société Civile Immobilière (or “SCI”),
which is a form of French entity specifically intended to hold title to real
property. The most common reason to own as an SCI is to eliminate certain
restrictions relating to inheritance and succession following death. A
collateral benefit of SCI ownership is that shares of the entity can be
transferred without a Notaire. 3. Commercial Characterization of French Property As discussed
below, the characterization of real estate ownership as “commercial” has a
significant negative impact on real property taxation in France, including the
imposition of additional tax, an increase in tax rate, and automatic
depreciation to create an artificial profit on which tax is imposed. Generally
speaking, where an individual or group owns real property directly (as opposed
to through an SCI or other entity), they can rent the property furnished or
unfurnished without triggering “commercial” characterization. Where ownership
is held in an SCI, unfurnished rental can avoid “commercial” characterization,
but furnished rental automatically causes the SCI to be deemed “commercial”. SCI owners
sometimes try to escape “commercial” characterization by leasing the property
to an intermediary unfurnished, then having the intermediary provide the
furnishings and sublease the now furnished apartment to the occupant. An
alternative variation has the SCI leasing the property to the tenant without
furniture, and another entity leasing the furniture to the same tenant. Special
care must be taken with either of these structures to ensure that (i) none of
the furnishings are owned by an SCI shareholder or a related entity or person,
(ii) the tenant signs one rental agreement for the unfurnished apartment and a
separate rental agreement for the furniture, and then pays rent separately
under each rental agreement each month, and (iii) most importantly, that the
SCI owners are not benefiting economically from the presence of the furnishings
in the property. 4. France Real Estate Ownership By Offshore or Foreign Companies Entities formed
outside France may own French real estate directly or through an SCI. France
recognizes a distinction between sociétés
de personnes, which are transparent, or “pass-through”, entities for tax
purposes, and companies which have a tax identity separate from their owners.
Entities which are not sociétés de
personnes are always deemed “commercial” with all of the resulting negative
tax effects, and also pay corporate tax in addition to tax on funds distributed
to the shareholders. Entities which are sociétés
de personnes can be either “commercial” or “non-commercial” depending on
the content of their governing documents and their activity. When considering
or discussing French taxation, it is potentially confusing to describe all
entities formed outside France as “offshore companies”. Within France, this
phrase is generally understood to apply only to entities formed in a country
that does not have a tax treaty with France. The distinction between
treaty-country entities and non-treaty-country entities is significant because
a long history of tax avoidance schemes involving non-treaty-country entities
has created a high degree of suspicion of such entities among French tax
authorities. This suspicion may make it more difficult for such an entity to
achieve sociétés de personnes
treatment and/or trigger automatic characterization of the non-treaty-country entity
as “commercial”. It is best to use the term “offshore company” only in
connection with entities formed in non-treaty countries. Some authors
have opined that ownership of an SCI by an entity formed outside France will
automatically trigger “commercial” characterization of the SCI. I have been
unable to locate any legal authority to support this opinion. Rather, it
appears that the “commercial” characterization of the SCI cited by these
authors is attributable either to the rental activities of the owner, or to the
failure of the foreign entity to qualify as a sociétés de personnes. 5. Real Estate and Real Estate Company Taxation in France and Associated
Tax Treaties French real
property taxation can by grouped into four categories: (i) transfer/registration
tax; (ii) income tax, including tax on capital gains; (iii) inheritance tax;
(iv) value added tax, or TVA, payable in some cases if a real estate holding is
characterized as a “commercial” enterprise; and (v) the annual 3% tax on
properties owned by entities. In an
effort to end various tax avoidance schemes, many French tax laws and treaties,
including those related to transfer/registration tax, capital gains tax, and
inheritance tax, have recently been expanded to include the concept of the
“Real Estate Company” which is considered, for tax purposes, exactly the same
as real estate. Although the definition of Real Estate Company varies somewhat
by context, in general a “Real Estate Company” is an entity with at least 50%
of its assets in either (i) real estate in France, and/or (ii) one or more
other Real Estate Companies. In practice, this means that a company formed to
hold title to real estate in France, or formed to hold shares of another
company formed to hold title to real estate in France, will be deemed a Real
Estate Company, and the transfer of its ownership or shares will be treated for
tax purposes exactly like the transfer of the underlying real estate. For an owner who
lives in a country that has a tax treaty with France, some of these taxes may
be offset against tax otherwise due in the country of residence. This means
that when French tax exceeds what is owed in the residence country, the
taxpayer will pay only the French tax; when French tax is less than what is
owed in the residence country, the taxpayer will pay the French tax plus the
amount by which the residence country tax exceeds the French tax. In other
words, for treaty-country residents, the total payable on tax within the scope
of the treaty will always be the greater of the tax owed in either France or
the residence country. Treaty countries include the United States and virtually
all of Europe. 5.1 France Transfer/Registration Tax France real estate transfer/registration tax is approximately 5% of
the value of the property, and is payable each time French real estate, SCI
shares, or Real Estate Company shares, are transferred. The inclusion of Real
Estate Companies within the transfer/registration tax regime means France’s
real estate transfer/registration tax is due on sale of shares in a foreign
entity which owns an SCI. While it may be difficult for French tax authorities
to discover such a share transfer, it is prudent to report transfers and pay
the associated French transfer/registration tax voluntarily.
Transfer/registration tax is not due when an individual or group transfers
property from their own name to an SCI owned by them in identical proportions.
French transfer/registration tax is payable at the same rate regardless of
whether the ownership is characterized as “commercial”, and generally cannot be
offset against tax otherwise due in a treaty country. 5.2 France Capital Gains and Income Tax France capital gains tax is payable whenever French real estate or
SCI shares are sold. Under most French tax treaties, including the U.S. treaty,
French capital gains tax is also payable upon a sale of shares in a Real Estate
Company. This means French capital gains tax is due on sale of shares in a
foreign entity which owns an SCI. Here again, while it may be difficult for
French tax authorities to discover such a share transfer, it is prudent to
report transfers and pay the associated French capital gains tax voluntarily. France’s capital gains tax is payable on the difference between the
cost basis and the sale proceeds of the property or shares. The tax rate begins
at 33 1/3% for non-EU residents, and 16% for (non-French) EU residents. For
property not characterized as “commercial”, the “taper rule” reduces the rate
10% per year beginning after five years of ownership, meaning that no capital
gains tax is payable upon sale of property held fifteen years or more. Property characterized as “commercial” fares considerably worse from
a capital gains tax perspective. First, the “taper rule” does not apply,
meaning that the same tax rate is payable regardless of how long the property
or shares have been owned. Second, a corporate rate (higher than those
described in the preceding paragraph) will apply if an entity which is not a sociétés de personnes is involved in the
ownership. Finally, the cost basis of the property will be reduced 2% for each
year of ownership based upon presumed depreciation, resulting in a higher capital
gain on which tax is due. Separate from capital gains tax payable on sale, income tax is
payable on net rental income regardless of whether a property is characterized
as “commercial” and regardless of the way ownership or title is held. Where the
property is owned directly or by a sociétés
de personnes (including an SCI), the income tax rate is based on the
taxpayer’s taxable income from French sources. Where the property is owned by a
non-transparent company, rental income tax is paid by the company at the
corporate rate and again by the shareholders to the extent profits are
distributed. Non-transparent companies owe tax on rental income which could
have been derived from the property even if it is rented only occasionally or
not at all, but the negative effect of presumed rental income is mitigated
somewhat by the ability of non-transparent companies to take depreciation
deductions and to carry all expense deductions forward indefinitely. Capital gains tax and income tax can generally be offset against tax
otherwise due in a treaty country. For U.S, taxpayers owning non-“commercial”
properties, French capital gains tax will generally be greater than U.S.
capital gains tax on a sale during the first 8-10 years (depending on the
taxpayers U.S. state of residence), and less than U.S. capital gains tax on a
sale that occurs later. 5.3 France Inheritance Tax France inheritance tax is payable when a death causes succession of
ownership of real estate or SCI shares. Most French tax treaties, including the
U.S. treaty, also make this tax payable on succession of shares in a Real
Estate Company. France’s inheritance tax rates range from 20-60% of the value
of the real estate or shares, and these taxes can generally be offset against
tax otherwise due in a treaty country. 5.4 France Value Added Tax (TVA) France value added tax (TVA) at the rate of 19.6%, is generally
payable on gross rental income if the property is characterized as “commercial”
regardless of whether the property is owned by an individual or a company, and
regardless of whether a company is or is not a sociétés de personnes. TVA generally cannot be offset against tax
otherwise due in a treaty country, but may be deductible against operating
income or gain on sale in the country of residence. 5.5 France Annual 3% Tax on Properties Owned By
Entities France imposes an annual tax of 3% of the value of real estate
owned, directly or indirectly, by most foreign companies (regardless of type or
transparency), unless the entity is hosted by a treaty country and a form is
filed annually providing information about each of the natural persons who
ultimately own and control the company. This tax is intended to discourage the
use of foreign companies to launder money. Assuming the form is filed annually,
the 3% tax is not payable. Note that the annual filing will effectively inform
at least one government agency when shares in the company have been sold,
gifted, inherited or otherwise transferred. It remains unclear how broadly this
information is disseminated among French tax authorities, but it is prudent to
assume that transfer of shares in a foreign entity owning French real estate
(directly or through an SCI) will be evident to such authorities, and to pay
tax due on such transfers. 6. Key Aspects of Fractional Ownership: Efficient Enforcement and
Transferability In any
arrangement involving shared ownership and use of real estate, detailed
agreements are essential to ensure fairness and avoid disputes. Each owner must
be sure that she will have the usage opportunities and/or income she expects,
that the property will be properly managed and maintained, and that the other
co-owners will contribute their respective shares of operating costs. In
addition to being thorough, detailed and well-organized, agreements for
fractional ownership and usage arrangements must be enforceable in a relatively
predictable, inexpensive and rapid manner. In most
countries, including France, Britain and the U.S., enforcement through the
judicial system will not satisfy a fractional ownership group’s needs because
it will take too long and be too expensive. Fractional ownership and usage
arrangements require a non-judicial enforcement mechanism which allows the
co-owners to obtain final resolution of any disputes through mediation or
binding arbitration and, following a full and fair hearing and opportunity to
cure any default, to foreclose upon or otherwise force sale of the ownership
interest of a non-paying or non-compliant co-owner. The U.S. has by far the
most developed and reliable non-judicial dispute resolution and foreclosure
mechanism, and this feature makes the U.S. an ideal place in which to locate
the legal structure and enforcement system of a fractional ownership
arrangement, regardless of where the shared property is located and regardless
of whether some of the fractional owners reside outside the U.S. If the
fractional ownership agreement can be enforced only through a long and
expensive judicial process conducted in a foreign language in a faraway place,
the co-ownership may devolve into a source of constant frustration and endless
dispute-related costs, and the owners may be unable to use, rent, or sell their
property for periods of months or even years. Beyond a
detailed agreement and an efficient enforcement and foreclosure mechanism,
fractional owners need to be able to sell, gift or inherit their ownership
interests relatively quickly and inexpensively. Situations often change in
unexpected ways, and owners who did not expect to transfer their co-ownership
interests in the foreseeable future sometimes find that they no longer use the
property as planned, prefer a different location, need to liquidate to generate
funds, get married or divorced, become ill, or even die. If these situations
trigger a long and expensive legal process in a foreign country, the affected
co-owner or her heirs will be frustrated. All fractional
ownership structures involving property located in a country where the
fractional owner does not reside must meet the twin needs of efficient
enforcement/foreclosure and quick and inexpensive transferability.
Unfortunately, structures meeting these needs can sometimes result in less
desirable tax consequences than structures that do not. When structural goals
conflict with tax goals, it is important to carefully weigh the likelihood and
consequences of adverse tax treatment against the likelihood and consequences
of the inability to use, rent or sell the property due to a protracted co-owner
dispute, or the cost and inconvenience of a long and complex transfer or
inheritance process. In the vast majority of cases, the potential adverse tax
consequences are minor in comparison. 7. Tax Consequences of Fractional Ownership in France 7.1 Tax Consequences of Direct Deeded
Fractional Ownership in France In a direct deeded fractional ownership arrangement, each fractional
owner will be listed on the deed as the owner of a specified percentage
interest in the property, and will sign a co-ownership agreement detailing her
rights and duties in relation to the other co-owners. The tax treatment and
enforcement/transfer consequences of this type of fractional ownership
arrangement are as follows. 7.1.1 Transfer
Tax: Transfer tax will be payable at the rate of 5% of the value of the
fractional interest each time a fractional interest is transferred. Transfer
tax generally cannot be offset against tax in the co-owner’s country of
residence, even if that country has a French tax treaty. 7.1.2 Capital
Gains Tax: Capital gains tax will be payable following each sale of a
fractional interest, based on the difference between the cost basis and net
sale price of the fractional interest sold. The capital gains tax rate begins
at 33 1/3% for non-EU residents, and 16% for (non-French) EU residents, but the
“taper rule” reduces the rate 10% per year beginning after five years of
ownership, and no capital gains tax is payable upon sale of property held
fifteen years or more. The “taper rule” will not apply if the fractional
ownership is characterized as “commercial”, but such characterization is
unlikely with direct deeded ownership even if the property is periodically
rented furnished when not being used by the fractional owners. Capital gains
tax generally can be offset against tax in the co-owner’s country of residence
if that country has a French tax treaty. 7.1.3 Income
Tax: Each fractional owner will pay French income tax on any net rental
income he/she receives, at the tax rate applicable based on the recipients
total income from French sources. Residents of non-treaty countries may
be subject to an income tax based on three times the rental value of the
property. Income tax generally can be offset against tax in the co-owner’s
country of residence if that country has a French tax treaty. 7.1.4 Inheritance
Tax: France inheritance tax will be payable upon the death of a
fractional interest owner, at the rate of 20-60% of the value of the deceased’s
fractional interest. Inheritance tax generally can be offset against tax in the
co-owner’s country of residence if that country has a French tax treaty. 7.1.5 Value
Added Tax (TVA): France value added tax (TVA), at the rate of 19.6%, is generally
payable on gross rental income only if the property is characterized as
“commercial”, but such characterization is unlikely with direct deeded
ownership even if the property is periodically rented furnished when not being
used by the fractional owners. TVA generally cannot be offset against tax in
the co-owner’s country of residence, even if that country has a French tax
treaty. 7.1.6 Annual
3% Tax: Direct deeded fractional owners are not subject to France’s annual
3% tax on properties owned by entities. 7.1.7 Fractional Ownership Agreement Enforcement/Foreclosure |