|
Everything you always wanted to know about France - from France |
|
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: With direct deeded fractional ownership, the fractional ownership
agreement must be enforced in France. This means it must be written in
compliance with French law, and enforced by French lawyers using the French
judicial system. Fractional owners will need to be willing to travel to France
repeatedly to propel the enforcement procedure, and to participate in an
enforcement process conducted in French. Non-judicial dispute resolution and
foreclosure is generally inefficient and/or unavailable in France, meaning that
enforcement is likely to take years and legal costs are likely to be high. 7.1.8 Transfer
of Fractional Interests: Sale, gift and inheritance of direct deeded fractional ownership
interests will require the services of a Notaire
and payment of Notaire fees. Sale and
gift processing through a Notaire
typically takes a minimum of 90 days, and inheritance often takes much longer.
French law dictates who can inherit real estate even when the deceased owner is
not a French resident, and this law may prevent an owner from controlling who
will inherit her share following death. Inheritance may also involve procedures
in the deceased owner’s country of residence. 7.1.9 Summary
of Advantages and Disadvantages of Direct Deeded Fractional Ownership in France: Direct deeded fractional ownership offers more advantageous tax
consequences than any other form of fractional ownership of property located in
France, but the difficulties of enforcing the fractional owner’s agreement are
formidable. Transfer of a direct deeded fractional interest is time-consuming
and expensive, and French inheritance law dictates who can inherit the
fractional interest. 7.2 Tax Consequences of Direct SCI Fractional
Ownership in France In a direct SCI fractional ownership arrangement, the property is
owned by an SCI and each fractional owner purchases a share of the SCI. The SCI
statut, or bylaws, specify the rights
and duties of the fractional owners. The tax treatment and enforcement/transfer
consequences of this type of fractional ownership arrangement are as follows. 7.2.1 Transfer
Tax: Transfer tax will be payable at the rate of 5% of the value of the
fractional SCI interest each time an SCI share 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. 7.2.2 Capital
Gains Tax: Capital gains tax will be payable following each sale of an SCI
share, based on the difference between the cost basis and net sale price of the
SCI share 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” may
reduce the rate 10% per year beginning after five years of ownership in which
case no capital gains tax is payable upon sale of property held fifteen years
or more. If the SCI is characterized as “commercial”, the “taper rule” will not
apply (resulting in a higher tax rate), and the cost basis of the property will
be reduced 2% for each year of ownership (resulting in a higher gain amount
subject to tax). “Commercial” characterization is automatic if the SCI rents
the property furnished. SCIs sometimes try to escape “commercial”
characterization by leasing the property unfurnished and having another person
or entity provide the furnishings, but this approach is unlikely to be successful
in a fractional ownership situation (see discussion above). It may be possible
to avoid “commercial” characterization if the SCI itself is prohibited by its statut from renting the property, and
the only rental permitted is individual fractional interest owners renting out
their own allotted usage and retaining all rental income (net of any rental
agency fees). This approach is inconsistent with rental income “pooling”, where
rental income is commingled and shared by the fractional interest owners according
to an allocation formula. The ability of the individual rental approach to
avoid “commercial” characterization is unknown, and the only way to
definitively avoid the adverse tax consequences of “commercial”
characterization is to prohibit rental of the property. 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. 7.2.3 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, regardless of whether the SCI is
characterized as “commercial”. Income tax generally can be offset against tax
in the co-owner’s country of residence if that country has a French tax treaty. 7.2.4 Inheritance
Tax: France’s 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
SCI 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. 7.2.5 Value
Added Tax (TVA): France’s value added tax (TVA), at the rate of 19.6%, may be
payable on gross rental income if the SCI is characterized as “commercial”. TVA
generally cannot be offset against tax in the co-owner’s country of residence,
even if that country has a French tax treaty. 7.2.6 Annual
3% Tax:SCI owners are not subject to France’s annual 3% tax on properties
owned by foreign entities. 7.2.7 Fractional
Ownership Agreement Enforcement/Foreclosure: With direct SCI fractional ownership, the SCI statut must be enforced in France. This means it must be written in
compliance with French law, and enforced by French lawyers using the French
judicial system. Fractional owners will need to be willing to travel to France
repeatedly to propel the enforcement procedure, and to participate in an
enforcement process conducted in French. Non-judicial dispute resolution and
foreclosure is generally inefficient and/or unavailable in France, meaning that
enforcement may take years and legal costs are likely to be high, although the
process should be slightly more streamlined with direct SCI ownership that with
direct deeded ownership. 7.2.8 Transfer
of Fractional Interests: Sale or gift of SCI interests does not require the services of a Notaire, but does require recording of a
notarized deed of conveyance. Accomplishing this without a French attorney or Notaire is very difficult. Inheritance
of SCI interests requires a French attorney or Notaire, and may also involve procedures in the deceased owner’s
country of residence. The cost and delay associated with selling or gifting SCI
shares is likely to be about the same as that of direct deeded fractional
interests, but the cost and delay associated with inheritance of SCI shares
should be less than that of direct deeded fractional interests. French law does
not dictate who can inherit SCI shares, and this is one of the principal
advantages of this form of ownership as compared with direct deeded ownership. 7.2.9 Summary
of Advantages and Disadvantages of Direct SCI Fractional Ownership in France: Where rental of the fractional property is absolutely prohibited,
direct SCI fractional ownership offers tax consequences as beneficial as those
of direct deeded fractional ownership. But where rental of the fractional
property is permitted, either explicitly or through lack of direct prohibition,
“commercial” characterization is possible and would create significant adverse
tax consequences. These adverse consequences may be less likely if rent pooling
is avoided in favor of individual rentals by the fractional interest owners.
Direct SCI fractional ownership has the same formidable enforcement
difficulties as direct deeded fractional ownership. Transfer of SCI shares is
less time-consuming and expensive than transfer of direct deeded fractional
interests, but much more time-consuming and expensive than transfer of shares
in most foreign entities used in indirect SCI fractional ownership
arrangements. 7.3 Tax Consequences of Direct Foreign Company
Ownership in France In a direct foreign company fractional ownership arrangement, the
property is owned by an entity formed in a treaty country (the “Host Country”)
and recognized under French law as a sociétés
de personnes (meaning transparent or “pass-through” for income tax
purposes). Each fractional owner purchases a share of the foreign company, and
the bylaws of the entity specify the rights and duties of the fractional
owners. The difference between direct and indirect foreign company fractional
ownership is that, in the direct arrangement, the foreign company holds title
to the French property, whereas with the indirect arrangement, the foreign
company owns shares in an SCI which holds title to the French property. The tax
treatment and enforcement/transfer consequences of this type of fractional
ownership arrangement are as follows. 7.3.1 Transfer
Tax: Transfer tax will be payable at the rate of 5% of the value of the
interest each time a foreign company share 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. 7.3.2 Capital
Gains Tax: Capital gains tax will be payable following each sale of a foreign
company share, based on the difference between the cost basis and net sale
price of the share 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” may
reduce the rate 10% per year beginning after five years of ownership in which
case no capital gains tax is payable upon sale of property held fifteen years
or more. If the foreign company is characterized as “commercial”, the “taper
rule” will not apply (resulting in a higher tax rate), and the cost basis of
the property will be reduced 2% for each year of ownership resulting (resulting
in a higher gain amount subject to tax). “Commercial” characterization is
automatic if the foreign company rents the property furnished. It may be
possible to avoid “commercial” characterization if the foreign company itself
is prohibited by its bylaws from renting the property, and the only rental
permitted is individual fractional interest owners renting out their own
allotted usage and retaining all of the rental income (net of any rental agency
fees). This approach is inconsistent with rental income “pooling”, where rental
income is commingled and shared by the fractional interest owners according to an
allocation formula. Qualification of the foreign company as a nonprofit entity
should provide still greater protection from “commercial” characterization,
because such qualification will generally necessitate a prohibition of all
commercial activities, including rentals, by the foreign company.
Significantly, for projects being marketed in the U.S., prohibiting rentals by
the foreign company and rent pooling, and qualifying the foreign company as a
nonprofit entity, will also avoid characterization of the fractional ownership
interests as “securities” requiring special governmental approvals and sales
licenses. But the extent to which these measures avoid “commercial”
characterization in France is unknown, and the only way to definitively avoid
the adverse tax consequences of “commercial” characterization is to prohibit
rental of the property. 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. 7.3.3 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, regardless of whether the foreign company is
characterized as “commercial”. Income tax generally can be offset against tax
in the co-owner’s country of residence if that country has a French tax treaty. 7.3.4 Inheritance
Tax: France’s 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
foreign company 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. 7.3.5 Value
Added Tax (TVA): France’s value added tax (TVA), at the rate of 19.6%, may be
payable on gross rental income if the foreign company is characterized as
“commercial”. TVA generally cannot be offset against tax in the co-owner’s
country of residence, even if that country has a French tax treaty. 7.3.6 Annual
3% Tax:Foreign company owners will be subject to France’s annual 3% tax on
properties owned by entities 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 entity. The tax generally cannot be
offset against tax in the co-owner’s country of residence, even if that country
has a French tax treaty. 7.3.7 Fractional
Ownership Agreement Enforcement/Foreclosure: With direct foreign company fractional ownership, the fractional
ownership agreement can be enforced in the Host Country. This is a significant
advantage if the Host Country is one, like the U.S., with a highly developed
and reliable non-judicial dispute resolution and foreclosure mechanism, 7.3.8 Transfer
of Fractional Interests: Sale, gift or inheritance of direct foreign company fractional
ownership interests involves procedures in both the Host Country and France,
and may also involve procedures in the deceased owner’s country of residence.
The actual transfer of shares occurs in the Host Country, and may or may not
require the assistance of an attorney (depending on the country). A notarized
deed of conveyance must also be recorded in France, and accomplishing this
without a French attorney or Notaire
is very difficult. The cost and delay associated with selling or gifting shares
in a foreign company which holds direct title to French real estate is likely
to be greater than the cost and delay associated with selling or gifting of SCI
shares or direct deeded fractional interests. The cost and delay associated
with inheritance of shares in a foreign company which holds direct title to
French real estate is likely to be about the same as the cost and delay
associated with inheritance of SCI shares but much lower than that of direct
deeded fractional interests. French law does not dictate who can inherit shares
in a foreign company which holds direct title to French real estate. 7.3.9 Summary
of Advantages and Disadvantages of Direct Foreign Company Fractional Ownership
in France: From a tax standpoint, properly structured and reported direct
foreign company fractional ownership offers consequences similar to direct SCI
fractional ownership. Where rental of the fractional property is absolutely
prohibited, tax consequences are the same as those of direct deeded fractional
ownership, but where rental is permitted, either explicitly or through lack of
direct prohibition, “commercial” characterization can create significant
adverse tax consequences. These adverse consequences may be made less likely if
rent pooling is avoided in favor of individual rentals by the fractional
interest owners, and if the foreign company is formed as a nonprofit entity.
From an enforcement standpoint, direct foreign company fractional ownership is
significantly superior to both direct SCI fractional ownership and direct
deeded fractional ownership because it allows the fractional interest owners to
avail themselves of the non-judicial dispute resolution and foreclosure
mechanism of the Host Country. But from a transfer standpoint, direct foreign
company fractional ownership combines many of the cost and delay disadvantages
of both SCI fractional ownership and direct deeded fractional ownership, and is
therefore generally less desirable than indirect foreign company fractional
ownership (discussed below). 7.4 Tax Consequences of Indirect Foreign Company
Ownership in France In an indirect foreign company fractional ownership arrangement, an company
is formed in a treaty country (the “Host Country”) and recognized under French
law as a sociétés de personnes
(meaning transparent or “pass-through” for income tax purposes), but the
foreign company does not hold title to the property in France. Rather, the
transparent foreign company owns the shares of an SCI, which, in turns, holds
title to the French property. Each fractional owner purchases a share of the
foreign company, and the bylaws of the entity specify the rights and duties of
the fractional owners. When fractional owners transfer shares of the foreign company
through sale, gift or inheritance, there is no change in the ownership of the
SCI shares or the property. The tax treatment and enforcement/transfer
consequences of this type of fractional ownership arrangement are as follows. 7.4.1 Transfer
Tax: Transfer tax will be payable at the rate of 5% of the value of the
interest each time a foreign company share 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. 7.4.2 Capital
Gains Tax: Capital gains tax will be payable following each sale of a foreign
company share, based on the difference between the cost basis and net sale
price of the share 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” may
reduce the rate 10% per year beginning after five years of ownership in which
case no capital gains tax is payable upon sale of property held fifteen years
or more. If the foreign company is characterized as “commercial”, the “taper
rule” will not apply (resulting in a higher tax rate), and the cost basis of
the property will be reduced 2% for each year of ownership resulting (resulting
in a higher gain amount subject to tax). “Commercial” characterization is
automatic if the foreign company or its SCI rents the property furnished. It
may be possible to avoid “commercial” characterization if both the foreign company
and its SCI are prohibited by their respective bylaws from renting the
property, and the only rental permitted is individual fractional interest
owners renting out their own allotted usage and retaining all of the rental
income (net of any rental agency fees). This approach is inconsistent with
rental income “pooling”, where rental income is commingled and shared by the
fractional interest owners according to an allocation formula. Qualification of
the foreign company as a nonprofit entity should provide still greater
protection from “commercial” characterization, because such qualification will
generally necessitate a prohibition of all commercial activities, including
rentals, by the foreign company. Significantly, for projects being marketed in
the U.S., prohibiting rentals by the entities and rent pooling, and qualifying
the foreign company as a nonprofit entity, will also avoid characterization of
the fractional ownership interests as “securities” requiring special
governmental approvals and sales licenses. But the extent to which these
measures avoid “commercial” characterization is unknown, and the only way to
definitively avoid the adverse tax consequences of “commercial”
characterization is to prohibit rental of the property. 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. 7.4.3 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, regardless of whether the foreign company is
characterized as “commercial”. Income tax generally can be offset against tax
in the co-owner’s country of residence if that country has a French tax treaty. 7.4.4 Inheritance
Tax: France’s 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
foreign company 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. 7.4.5 Value
Added Tax (TVA): France’s value added tax (TVA), at the rate of 19.6%, may be
payable on gross rental income if either the foreign company or its SCI is
characterized as “commercial”. TVA generally cannot be offset against tax in
the co-owner’s country of residence, even if that country has a French tax
treaty. 7.4.6 Annual
3% Tax:Foreign company owners will be subject to France’s annual 3% tax on
properties owned by entities 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 entity. The tax generally cannot be
offset against tax in the co-owner’s country of residence, even if that country
has a French tax treaty. 7.4.7 Fractional
Ownership Agreement Enforcement/Foreclosure: Fractional Ownership Agreement Enforcement/Foreclosure: With
indirect foreign company fractional ownership, the fractional ownership
agreement can be enforced in the Host Country. This is a significant advantage
if the Host Country is one, like the U.S., with a highly developed and reliable
non-judicial dispute resolution and foreclosure mechanism, 7.4.8 Transfer
of Fractional Interests: Sale or gift of indirect foreign company fractional ownership
interests occurs entirely in the Host Country; inheritance also occurs in the
Host Country, but may involve procedures in the deceased owner’s country of
residence. The actual transfer of shares may or may not require the assistance
of an attorney in the Host Country (depending on the country). Significantly,
transfers of indirect foreign company fractional ownership interests by sale,
gift or inheritance do not involve any procedure in France except the filing of
required tax declarations and the payment of associated tax. Consequently, the
cost and delay associated with selling, gifting or inheriting shares in a
foreign company which owns an SCI is likely to be much lower than the cost and
delay associated with selling, gifting or inheriting France property fractional
ownership interests held in any other structure. French law does not dictate
who can inherit shares in a foreign company which owns an SCI. 7.4.9 Summary
of Advantages and Disadvantages of Indirect Foreign Company Fractional
Ownership in France: From a tax standpoint, properly structured and reported indirect
foreign company fractional ownership offers consequences identical to direct
foreign company fractional ownership and direct SCI fractional ownership. Where
rental of the fractional property is absolutely prohibited, tax consequences
are the same as those of direct deeded fractional ownership, but where rental
is permitted, either explicitly or through lack of direct prohibition,
“commercial” characterization can create significant adverse tax consequences.
These adverse consequences may be made less likely if rent pooling is avoided
in favor of individual rentals by the fractional interest owners, and if the
foreign company is formed as a nonprofit entity. From an enforcement
standpoint, indirect foreign company fractional ownership is significantly
superior to both direct SCI fractional ownership and direct deeded fractional
ownership because it allows the fractional interest owners to avail themselves
of the non-judicial dispute resolution and foreclosure mechanism of the Host
Country. From a transfer standpoint, indirect foreign company fractional
ownership is superior to all the other French property fractional ownership
structures discussed in this article because all transfers occur entirely
outside of France, and only tax declarations and payment need occur there. 8. Conclusion France imposes
somewhat greater tax burdens than other countries on non-resident real estate
owners, but the owner of a fractional interest fares no worse than if she owned
the entire property. Owners who are uncomfortable with French real estate
taxation should not buy property in France, fractionally or otherwise,
regardless of ownership structure. If the 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 foreign company formed
in a country, like the U.S., with highly developed and reliable non-judicial
dispute resolution and foreclosure mechanism. This foreign company owns a
French SCI which, in turn, owns the shared property. 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. 9. About the Author D. Andrew Sirkin is a recognized
expert in fractional ownership and other real estate co-ownership arrangements
including TICs, equity sharing, and legal subdivisions such as condominiums.
Mr. Sirkin has specialized in fractional ownership 1985, and has prepared
fractional ownership documents for over 6000 clients. His practice areas
include vacation fractional ownership planning and structures, offering
materials, governing documents for fractional projects, entity formations,
regulatory approvals, fractional lending and mediation. Mr. Sirkin regularly
works on fractional ownership projects located throughout the United Sates, and
in France, Italy, Argentina, Nicaragua, Dominican Republic, Panama, Costa Rica,
Belize and Mexico. He is an accredited instructor with the California
Department of Real Estate, and the co-author of The Condominium Bluebook, published annually
by Piedmont Press, and The Equity Sharing
Manual, first published by John Wiley and Sons in November 1994 (download
the current edition in PDF). He has written numerous articles on related topics, all
of which are available at www.andysirkin.com. He is now in the process of
compiling a resource to feature a quick research summary plus the full text of
all the laws, regulations and requirements (including filing requirements) for
fractional and timeshare real estate sales and projects for all 50 U.S. states,
to be offered for publication in March 2007. He can be contacted via email at DASirkin@earthlink.net, or by telephone at
1-415-738-8545 (U.S.) or 33-(0)8-72-90-76-34 (France). There are over 2,000 features and articles on this site about French life and living in France. You can search from the search box above. Do browse through our website and please use the advertising links, they help pay for the site. I do try to reply to all mail - Contact Me - most is about property or living in France. I publish comments in this newsletter which I believe are of interest and may help find answers for people wanting to come to France. I hope readers will go to the adverts which help support our overheads. |
|