The new wealth tax on real estate (impôt sur la fortune immobilière), introduced by France's Finance Act 2018, considerably changes the tax situation for non-resident owners of second homes in France, whether owned directly or indirectly through a French or foreign company or entity. Unlike the previous (ISF) wealth tax, the new tax will fall on any such company, whether or not it can be regarded as French, and irrespective of the proportion of the equity held by the taxpayer's family. The rules for debt deductibility have also changed.
What changes for non-French tax residents owning or purchasing French residential properties?
The 2018 French Finance Act was finally approved by French Parliament on 30 December 2017.
Amongst various measures (notably the introduction of a 30% flat tax on financial income earned by French tax residents), the abolition of the Wealth tax and the introduction of a new Wealth Tax on Real Estate (“impôt sur la fortune immobilière”) constitutes a little tax revolution (at least for French tax residents). We will call this new tax the “Real Estate Wealth Tax”.
The Real Estate Wealth Tax is codified under articles 964 to 983 of the French Tax Code (“FTC”). As far as non-French tax residents are concerned, the new tax might considerably change their situation. As we will see below, the new legislation provides restrictions regarding the deductibility of debts and fundamentally changes the territorial limits of tax when French real estate is owned through a company. Current property ownerships might need to be reviewed now taking into account the new rules.
Let us consider the main consequences of the Real Estate Wealth Tax for non-French tax residents wishing to purchase, or who are already owners of, French residential properties. This article will not address the new legislation in detail but limits itself to the impact of the new tax on non-French tax residents.
Scope
The Real Estate Wealth Tax applies to real estate but not to all real estate. Broadly speaking, only French real estate which is not used for the purposes of a business activity is treated as a taxable asset. This tax mainly concerns residential properties: secondary homes in France of non-French tax residents.
Furnished letting activities are not regarded as a business activity unless the property is used for the purposes of carrying out the professional activity of the taxpayer (rare situation in respect of non-French tax residents). Real estate owned by a company for the purposes of its own business activity is also excluded from the scope of the tax. We will not comment further on any of these exclusions as the main purpose of this article is to focus on pure residential properties.
Unlike the previous Wealth tax, any other assets located in France are excluded from the scope of the tax (e.g. furniture located in a French property, a French registered car or boat etc)
Under Article 965 II 2° of the FTC, the tax applies to French residential properties owned directly by the taxpayer and also owned indirectly through a French or foreign company or entity (regardless of the number and the location of the companies or entities in the chain of ownership).
When a French residential property is owned by a company (or entity) the shares are only taxable to the extent that their value is attributable to real estate assets or rights held directly or indirectly. However, the new law has changed the territoriality rules applicable to company/entity shares.
Under the previous Wealth tax legislation, shares of a foreign company owning French real estate could be regarded as being subject to tax in the following two cases:
- where the foreign company could be regarded as a French real estate company: i.e. shares of non-quoted foreign companies owning, directly or indirectly, French real estate or rights over French real estate, the market value of which exceeded 50% of the total market value of any other French assets (including the French real estate);
- where French real estate was directly or indirectly owned by a foreign company the majority of the shares of which were owned by members of the same family: this was the case when more than 50% of the shares of the company were owned, directly or indirectly, by an individual on his own or together with members of his family (spouses, children, parents and siblings).
The new legislation no longer refers to these concepts.
The new legislation no longer refers to these concepts.
The legislation only refers to the concept of indirect ownership. It is now enough to own indirectly a French residential property for taxation to apply (no matter if the company owning the French residential property can or cannot be regarded as a French real estate company and no matter the percentage of shares owned in the company by the taxpayer and his family). Situations which did not fall within the scope of the previous Wealth tax regime might become taxable under the new legislation.
This change in wording should not be underestimated.
The territorial scope of the Real Estate Wealth Tax as defined by the new French tax legislation applies subject to the provision of any relevant Double Tax Treaty (“DTT”) which might state otherwise. Most of the DTTs signed by France applicable to the previous Wealth tax referred to the concept above of French real estate company to enable France to levy taxation. However, the new territorial rule of indirect ownership does not appear in most of DTTs signed by France. If one can say that DTTs previously applicable to Wealth tax can still apply to the Real Estate Wealth Tax, France might then lose the rights to tax shares of companies owning indirectly French residential properties. This change in the definition of the territorial limits could therefore lead to some very interesting and unexpected tax benefits to some non-French tax resident taxpayers owning French real estate indirectly (depending, of course, on their state of residence). The scope and the provisions of each relevant DTT will need to be analysed.
We will keep an eye on this interesting issue….
Valuation of company shares
When a French residential property is owned through a company, taxation applies to the shares of the company (provided that they can be taxed…) and not to the property. The value of the shares then needs to be determined. The new legislation has made substantial changes to the rules of valuation of company shares.
Broadly speaking, the principle remains that the value of the shares is equal to the market value of the residential property less any qualifying debts (which gives the net value on which tax is applied).
As far as qualifying debts are concerned, new Article 973 II of FTC provides a list of debts which cannot, in principle, be taken into account when assessing the net value of the shares of a company. These debts are as follows:
- loans granted for the acquisition of real estate from the taxpayer or a member of his tax household when the company purchasing the property is controlled by the same taxpayer or a member of his tax household;
- loans from the taxpayer or a member of his tax household. This restriction would also seem to include the previous exclusion of shareholder loans;
- loans made by a company or entity directly or indirectly controlled by the taxpayer on his own or together with members of his family (spouses, children, parents and brothers and sisters).
As these three restrictions refer to taxpayers liable to the new Real Estate Wealth Tax (and not the previous Wealth tax), they should only apply to debts created as of 1 January 2018. Furthermore, it should be noted that the new law provides that the three restrictions shall not apply if the taxpayer can prove that the loan has not been granted mainly for a tax purpose (“objectif principalement fiscal”). This subjective concept will probably raise issues in the future.
Finally, Article 973 II of the FTC provides for another restriction in respect of loans made by another family member of the taxpayer (outside his household) unless the loan has been granted under normal conditions.
As we can see the legislation is opened to particular situations to avoid the application of the various restrictions. This might lead to some tax planning opportunities when structuring debts.
Definition of deductible debts
The new legislation provides for a definition of deductible debts. Debts in this context refer to loans directly taken out by the individual taxpayer and not loans granted to a company (as mentioned above).
Article 974 I of the FTC provides for a general condition of deductibility of debts. In order to be deductible, a debt must, as previously, be linked to a taxable asset; exist at 1 January of the tax year; and be the personal charge of the taxpayer. Debts must also be substantiated.
There are no other conditions regarding the deductibility of debts. In particular, there is nothing in the French tax legislation which says that to be deductible, a debt in the form of a bank loan, must be secured by a mortgage over the property it finances.
In addition, the new law indicates that only debts incurred for the acquisition, improvement, renovation, construction and renovation of taxable real estate may be allowed as a deduction (this is not really new).
Taxes due in relation to the ownership of a residential property are deductible. This concerns, for instance, the property tax (“taxe foncière”) but not the occupation tax ("taxe d’habitation") which is due by the occupant and not by the owner of the residential property.
The new legislation also provides a restriction in respect of interest-only loans which are no longer fully deductible. The legislation provides for a formula to be used to determine the deductible annuities of the loan. A similar restriction applies to loans which do not provide for a period of time for the reimbursement of the capital. It should be noted that these two restrictions apply in respect of loans already in place on 1 January 2018.
These restrictions do not apply to loans granted to companies and to loans entered into for the purchase of company shares.
The new legislation provides similar restrictions to the ones applicable to companies in respect of family loans and loans taken from controlled companies unless these loans have been granted under normal/commercial conditions.
Finally, the FFA provides a limitation to the deduction of loans when the value of the taxable asset exceeds €5,000,000 and the amount of the loan exceeds 60% of the taxable value. The part of the loan exceeding this limit would only be deductible to the extent of 50%. For instance, an individual purchases a property for €8,000,000 with a loan of €6,000,000. The loan exceeds 60% of the value of the asset, i.e. €4,800,000. The part of the loan exceeding this amount (i.e. €1,200,000) would only be deductible for an amount of €600,000. The total amount of the loan which would be deductible would then be equal at €5,400,000. This limitation does not apply if the taxpayer can prove that the loan has not been created mainly for a tax purpose.