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The New Real Property Wealth Tax

9 JANUARY 2018

The new real property wealth tax...   

The new real property wealth tax: impacts on non-French tax residents? 

Since 1st of January 2018, the wealth tax has been replaced by the real property wealth tax.

Pursuant to the new sections 964 to 983 of the French Tax Code (FTC), the tax applies to non-French tax residents owning directly or indirectly French real property assets whose total fair market value exceeds € 1.3 M on 1st January each year.

This reform aims at reducing the wealth taxation by restricting its scope to real property assets. However, the definition of the taxable French property assets has been broadened and several anti-abuse provisions applicable on debt deduction have been adopted.

Hence, it is expected that non-French tax residents may face a greater tax exposure !

The contemplated investments in French properties have to be structured appropriately, while the existing holding structures should be reviewed and, where possible, adjusted.

Main features

The main features of the real property wealth tax can be summarized as follows:

  • non-French tax residents are liable to the tax on their French property assets only but on all their French property assets held directly or indirectly;
  • tax rates remain the same (ranges from 0.50% to 1.5% after an allowance of € 800K);
  • business related assets are excluded from the taxable basis;
  • minor shareholding (< 10% - in operating entities, <5% in listed REIT) are excluded from the taxable basis;
  • debts deductibility is subject to strict rules.

Taxable assets

The scope of the real property wealth tax is wide.

Non-residents are subject to the tax on all the French property assets they own directly or indirectly (whatever the number of intermediary entities, their nationality, or place of establishment).

Naturally, shares are only taxable on the portion of their value related to French real property assets.

With respect to their indirect investment, it has to be recalled that, under the previous wealth tax regime, non-residents were liable to the tax only if they were owning:

  • shares in entities predominantly invested in French real properties (i.e. whose French real property assets’ value represent more than 50% of their total assets’ value);

or

  • majority stakes in entities owning (directly or indirectly) French real properties.

Hence, as shown in the diagram hereunder, it is expected that some non-French tax residents will face greater tax exposure!

Applicable exclusions

The new regime provides for various exclusions from which non-French tax residents may benefit, inter-alia:

  • properties directly or indirectly held by an operating entity which assigns them to its business;
  • properties directly or indirectly held by an operating entity in which the taxpayer holds directly less than 10% (assessed at the tax household level);
  • properties directly or indirectly held by a listed REIT in which the taxpayer holds directly or indirectly less than 5%;
  • properties held indirectly through an entity in which the taxpayer hold less than 10 % and where he demonstrates that he is unable to obtain the information necessary to assess the taxable value of its shares (i.e. bona fide clause). 

Debt deduction

Debts incurred by a taxpayer can be offset from the taxable value of the asset to which they relate. Subsequently, debts incurred by interposed entities and related to taxable assets are taken into account in calculating the taxable value of the shares.

However, several anti-abuse provisions have been adopted to prevent tax-driven leveraged acquisition!

Debt incurred by the taxpayer

Are not taken into account the debts related to loans granted directly or indirectly: 

  • by the taxpayer (or any member of its household); 
    Safe harbor:  none. 
  • by a member of the taxpayer's immediate family (i.e. parents and siblings);  
    Safe harbor: the limitation does not apply where the taxpayer justifies that the loan has been granted under normal market conditions (inter alia: actual reimbursement, compliance with the terms agreed…) (“normal market conditions test”). 
  • by any entity controlled directly or indirectly by the taxpayer (alone or with the members of its household or of its immediate family);
    Safe harbor: normal market conditions test. 

In addition: 

  • when the aggregated market value of the taxable assets held by a taxpayer exceeds € 5M and that the related tax deductible debts incurred by this latter exceeds 60% of the taxable assets’ market value, only 50% of the debts exceeding the € 5M threshold are tax deductible. 
    Safe harbor: the limitation does not apply where the taxpayer justifies that the debts have not been primarily contracted for tax purpose (“principal purpose test”). 
  • bullet loans (repayable at maturity) are treated as amortizing loan. 
    Safe harbor: none. 

Debt incurred by interposed entities

Regarding shares valuation, are not taken into account:

  • debts incurred by any interposed entity for the acquisition of a taxable asset from the taxpayer (or any member of its household) which controls such interposed entity (alone or with the member of its household);
    Safe harbor: principal purpose test.
  • loans granted directly or indirectly by the taxpayer (or any member of its household) in proportion to his stake in the borrowing entity (assessed at the level of the taxpayer’s household);
    Safe harbor: principal purpose test. 
  •  loans granted directly or indirectly by the immediate family of the members of a taxable household in proportion to their stake in the borrowing entity;
    Safe harbor: normal market conditions test.
  • loans granted directly or indirectly by any entity controlled directly or indirectly by the taxpayer (alone or with the members of its household or of its immediate family) in proportion to his stake in the borrowing entity (assessed at the level of the taxpayer’s household);
    safe harbor: principal purpose test.

Comments:

Although the exact effect of these provisions is still debated by tax practitioners, it appears likely that non-French tax residents may be positively impacted in some cases. Indeed, under the previous wealth tax regime, shareholders’ loans granted by non-resident taxpayers were already not taken into account for shares valuation whereas no safe harbor provision was applicable.

Please note however that:

  • the Principal purpose test consists in a subjective test (what is the aim of the taxpayer contracting directly / indirectly the loan?) giving French tax authorities discretion.  The fact that has been chosen “primarily contracted for tax purpose” instead of “sole tax purpose”, or “predominant tax purpose”, makes it relatively hard for the taxpayers  justifies that the debts have not been primarily contracted for tax purpose;
  • regarding the Normal market conditions test, in the absence of a specific definition of the “normal market conditions”, the French tax authorities may require the taxpayer to obtain an appropriate quotation issued by a third-party (e.g., financial establishment) in order to sustain that the loan has been granted under normal market conditions.

→Thus, direct and indirect leveraged acquisitions require careful reviews prior to being performed!


Case study

Case n°1:


 Previous wealth tax regime: no tax liability for A.

Real property wealth tax:

  • safe harbor (principal purpose test) applies: € 1.75M [35% x (25 – 15 – 5)] tax base resulting in a tax liability of circa € 6K.
  • Safe harbor (principal purpose test) does not apply: € 7M [35% x (25 – 5)] tax base resulting in a tax liability of circa € 61K.

Applicable progressive tax rates: 

Taxable basis

Tax rate

€0 - €800,000

0%

€800,000 - €1,300,000

0.50%

€1,300,000 - €2,570,000

0.70%

€2,570,000 - €5,000,000

1%

€5,000,000 - €10,000,000

1.25%

€10,000,000+

1.50%

Case n°2:  

 Safe harbor applies (i.e. normal market conditions):

  • A is not liable to the tax since the value of the taxable he owns is < € 1.3 M [8% x (20 – 6 – 7)]. However, provided that such value would be > € 1.3M, bona fide provision could also apply (i.e. < 10 % shareholding in LuxCo). 
  • B, C & D are respectively liable to the tax on € 2.8 M: [40 % x (20 – 6 – 7)] and € 1.82M [26 % x (20 – 6 – 7)].

The related tax burden amounts to circa € 14K for B and € 6K for C & D!

Safe harbor doesn’t apply:

  • A is not liable to the tax.
  • B, C & D are respectively liable to the tax on € 3.4M [40 % x (20 – (6 x 74 %) – 7)] and € 2.2M [26 % x (20 – (6 x 74 %) – 7)].

The related tax burden amounts to circa € 20K for B and € 9K for C & D.

Applicable progressive tax rates: see above.

 

From Pierre Appremont 

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