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3% ANNUAL TAX ON FRENCH REAL PROPERTY

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July 2003

French 3% annual tax assessed on French/foreign real estate companies

By Me. Francis MASSON, Avocat à la Cour

Caution: this note dates back to early June 2003 and will be shortly updated of recent changes. The author therefore declines any liability for any obsolete legal references.

No French legal provisions or case law would expressly exonerate a forward real property sale (vente en l'état futur d'achèvement) from the French 3% annual tax applicable to the direct or indirect ownership of real property assets bought in Paris by a UK Co. on a forward sale basis .

At this stage, this note will focus on the main provisions of the law and will not address all its technicalities.

This 3% annual tax on legal entities, which directly or indirectly hold real property or real property rights, is assessed, when due, upon the fair market value of said real property or real property rights as of January 1 of each year and is payable before May 15.

The tax was introduced by Article 4-II of the Law 82-1126 dated December 29, 1982 and amended in 1989 and 1993 (Articles 990 D through H of the French Tax Code), which defines legal entities subject to it, exemptions, the nature of property rights subject to it, obligations of legal entities, the penalties, sanctions and guarantees offered to legal entities.

1/ Legal entities subject to the tax

Article 990 D of the French Tax Code provides as follows:

"Legal entities which, directly or through an interposed entity, possess one or several real properties in France or hold real property rights on these assets are liable to pay an annual tax equal to 3% of the fair market value of said real property or real property rights.

Is deemed to possess real property or real property rights in France through an interposed entity, any legal entity, which holds a participation, whatever its form or percentage, in a legal entity owning said real property or real property rights or holding a participation in a third legal entity, which owns said real property or real property rights or which is interposed in the chain of participations. This provision applies whatever the number of interposed legal entities."

This provision is interpreted by the French tax authorities as applying to all legal entities, whether they have their registered office in France or abroad, whatever their legal form (corporations, companies with limited liability, civil or other companies, partnerships, Anstalten, Stiftungen, etc...).

However, the tax is due by the legal entity (ies) nearest to the property or real property rights, which do not benefit from the exemptions provided for by Article 990 E 2° or 3° of the French Tax Code (see below).

2/ Legal entities not subject to the tax

Article 990 E of the French Tax Code provides as follows:

"The tax provided for by Article 990 D shall not apply to:

1° Legal entities, whose real property assets as defined in Article 990 D, located in France, represent less than 50% of French assets. For the implementation of this provision, assets, which legal entities stated in Article 990 D or interposed entities use for their own professional activity other than a real estate activity, shall not be included into real property assets;

2° Legal entities, having their registered office in a country or territory, which entered with France into an agreement providing for administrative assistance in view of fighting against tax fraud or evasion, which declare each year, no later than May 15, to the place stated by Article 990 F, the situation, composition and value of real property assets possessed as of January 1st, the identity and address of their shareholders as of the same date and the number of shares or similar rights held by each of them;

3° Legal entities which have in France their effective place of management ("siège de direction effective") and other (foreign) legal entities, which, under a tax treaty, shall not be subject to a heavier taxation, when they communicate each year or commit themselves to and comply with such commitment to communicate to the tax administration, upon its request, the situation and composition of real property assets possessed as of January 1st, the identity and address of their shareholders, partners or other members, the number of shares or similar rights held by each of them and the justification of their tax residence. The commitment must be taken as of the date of purchase of the property or real property rights or the participation referred to in Article 990 D by the legal entity...."

This Article includes other exemptions, which are not relevant (listed companies, international organizations, States and public institutions, pension funds and charitable entities).

For the purpose of Article 990 E 2° above of the French Tax Code, the tax treaty between France and the United Kingdom provides for administrative assistance in view of fighting against tax fraud or evasion, which does not however include Gibraltar, Hong-Kong, the Channel Islands and the Isle of Man.

So did many other countries, such as Russia, Kazakhstan, Switzerland, etc... Subject to meeting the other conditions provided for by said Article, the 3% tax exemption may apply.

For the purpose of Article 990 E 3° above, the tax treaty between France and the United Kingdom provides a clause for equal tax treatment (non discrimination). Subject to meeting the other conditions provided for by said Article, the 3% tax exemption may apply.

3/ Taxable assets, basis and rate of the tax

Taxable assets are defined as real property located in France or related real property rights (usufruct, right of use, etc...). It does not matter whether the real property is land, forest, real property rented or not, the nature of the rent or use of the real property.

The basis of the 3 % tax is the fair market value (valeur vénale) as of January 1st. According to French case law, it corresponds to the price, which normal offer and demand for a specific assets would allow to obtain at a certain date, depending from its physical and legal characteristics and its location...

Debts, including loans, contracted for the acquisition of real property are not deductible from the fair market value.

4/ Commitment provided for by Article 990 E 3° of the French tax Code

None of the two notarised deeds of purchase include a commitment of the company to communicate to the tax administration the information stated in said Article.

Under Article R.23 B-1 of the French Code applicable to Tax Proceedings (LPF), the tax administration may request the legal entity to communicate the information provided under Article 990 E 3° and in the absence of answer within 60 days of said request, as well as in case of insufficient answer (additional delay of 30 days), immediately assess (Taxation d'office) the legal entity, should the latter not file the 3% tax return for the year concerned and the years not covered by the statutes of limitations.

5/ Obligations to declare, payment, assessment, control and sanctions

Legal entities subject to the tax must file the tax return nr. 2746 in 2 copies with and make the related payment to the relevant administration (Recette des Impôts) before May 15, if they do not benefit from the exemptions stated in paragraph 2/ above and do not declare the identity and address of their shareholders, the number of shares, etc...

In the absence of declaration and tax exemption, the tax administration may directly assess the legal entity after a 30 days summons, claim late payment interest at the monthly rate of 0,75%, plus a 5% increase of the taxes, whose payment has been differed (except in case of late, but voluntary filing with simultaneous payment). It may also take a mortgage on the real property.

Interposed legal entities are deemed jointly liable for the payment of the tax after a 20 days summons by the tax administration.

The latter may also invite the legal entity subject to the tax to appoint a tax representative within 90 days of its request in order to receive communications relating to the commitment provided for by Article 990 E 3° of the French tax Code.

If due, the tax is not deductible for the determination of the corporate or personal income tax due by the legal entity or its shareholders (in case the real property is rented).

Under tax administration comments dated October 22, 1993, when the real property is used without compensation by one or more physical shareholders, it is admitted that the related advantage in kind shall not be added back to other income of the legal entity, for the purpose of determining its corporate income tax, nor to the normal income of its shareholders.

6/ Rough estimated risks for 2001, 2002 and 2003

Subject to verification of cumulated payments made to the seller for the purchases as of respectively January 1, 2001, 2002 and 2003 (the notarised and other deeds do not specify dates of payments), the tax risks may be appraised as follows (for simplification, we have converted French Francs into Euros for 2000 and 2001) :

(a) estimated value, including acquisition costs, as of January 1, 2001: € 457 000 x 3% = € 13 710;

(b) estimated value of 2/3 of price, including acquisition costs, as of January 1, 2002 (FF or € figures are missing - does not include second notarised purchase signed on March 6, 2002 for flat 156, nor the related guaranty deposit) : € 988 000 x 3% = € 29 640 ;

(c) estimated value, as of January 1, 2003 (does not include last 2 payments made in 2003) : € 1 335 760 (FF 8 762 000- flat nr. 155) + € 1 151 000 = € 2 486 760 x 3% = € 74 603.

Estimated 3% tax in principal for the 3 years, not including the 5% penalty nor late payment interest starting from the date of either the filing of the tax return without payment or the tax assessment: about € 118 000.

Unless The Co. Ltd. reorganizes its shareholding and complies with the provisions of Article 990 E 2° or 3° mentioned above, it was, is and will be subject to the 3% tax on an annual basis.

7/ Other taxes related to French real property

We understand that the flats will not be rented, but used from time to time and therefore no income would be generated, which could give rise to either corporate or individual income tax.

(a) French residential real property is normally subject to an annual real property tax called "taxe foncière", except for new constructions, which benefit from a 2 years tax exemption after the year of completion, as will be the case for Co. Ltd. for 2004 and 2005.

Said tax is assessed in a very complex manner on the basis of a deemed rental value determined in each city ("valeur locative cadastrale"). In year 2006, it could amount to an estimated € 5-8 000 for the 2 flats.

(b) The use of French residential real property is also subject to an annual housing tax due by in principle by the tenant as of January 1st of each year (it may be alternatively the user or owner, if it is not rented or used). Its amount depends from the number of parents and children who entitle to reductions. Its amount is often not far from the taxe foncière.

(c) Residential premises vacant for a period of more than 2 years in cities of more than 200 000 inhabitants may be subject to a tax on vacant residential premises, except if the owner may prove that the flat was occupied more than 30 consecutive days during the 2 years. The tax goes from 10% (first year) to 15% (3rd. year) of the gross deemed rental value.

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