What is new for foreign property owners after the reform of last year?
In the 2018 finance bill, the old French wealth tax (Impôt de Solidarité sur la Fortune or ISF) was abolished and replaced by a new tax (Impôt sur la Fortune Immobilière or IFI) which is limited to real estate assets. On the surface one may think that the reform has not been a substantial change for foreign property owners in France. They still have to pay the tax at the same rates (1.5% maximum) on their French properties or shares in the interposed company (i.e. a French or Monegasque SCI in most cases) holding such properties if their net value is €1.3 m or more.
However, whereas there is nothing really new in terms of assets, major restrictions were brought in concerning the deduction of debts with respect to 2018 and subsequent years. Those restrictions have been extended by the 2019 finance bill. The new deduction rules may have a significant impact on property holders who finance their acquisition either by means of bank credit facility structured as a bullet loan (loan repayable at maturity) or out of their own funds by means of a shareholder loan to the SCI used for the purchase.
A point to note is that those rules apply to both new loans and existing loans.
What are the implications of the reform on the deduction of bullet bank loans?
The 2018 Finance Act introduced a specific rule aiming at cracking down on bullet loans schemes and whereby those loans are subject to a deemed straight line “amortization” to progressively reduce the amount of deductible debt over the years. Initially, such amortization mechanism was intended to apply to loans taken out directly by individual property holders only. The 2019 Finance Act has extended it to loans made to companies (such as SCIs) and other legal entities to fund the acquisition of a taxable property, with effect from 2019 on.
Technically, a bullet loan is now deductible to the extent/within the limit of a portion determined by application of the ratio between (a) the remaining number of years before the end of the loan and (b) the total duration of the loan.
Example. - In 2016, Mr. Smith and his wife (both UK-resident) purchased a French leisure property for a price of €10 m through their wholly-owned Monegasque SCI. The purchase was 100% financed by an interest-only bank loan with duration of 5 years (renewable).
For the period 2017-2018, the bank loan was fully deductible for the calculation of the taxable value of the shares in the SCI with the consequence that Mr. and Mrs. Smith were not liable to wealth tax (excluding gain in value of the property throughout the period). After 2 full years, the loan is deemed to be 40% (2 years out of 5) amortized for the 2019 wealth tax so that only 60% of the loan may be deducted from the value of the property to assess the taxable value of the shares which is €6 m, leaving the property owners with a wealth tax liability with respect to 2019.
Considering the above, would the shareholder loan be a better deal? That is not certain.
What about shareholder loans?
Until 2012, funding the transaction by means of a shareholder loan to the SCI used for structuring the purchase offered wealth tax benefits given that the loan was deductible without restriction to calculate the net taxable value of the shares in the company, whilst the corresponding asset (debt) was exempted from wealth tax in the hands of the shareholders. The 2012 budget disallowed the deduction of the shareholder loans, so eliminating the tax “loophole”.
The 2018 reform may have re-opened the shareholder loan route as a tax-efficient solution. Pursuant to the 2018 reform, loans made by the shareholders (or a member of their tax household) to the company became deductible again from 2018 onwards. However, the deduction is now subject to the condition that the loan has not been put in place “mainly for tax purposes” (i.e. for avoiding wealth tax), the onus of the proof falling on the taxpayer.
Last year the French tax authorities (FTA) published guidelines relating to IFI whereby they have interestingly advised that the circumstances in which the debt was taken out prior to the introduction of the new wealth tax can be a reason to prove that the loan has not been made mainly for tax purposes. In other words, shareholder loans existing as at 1 January 2018 should be deductible for determining the wealth tax liability for 2018 onwards, with the exception of very particular cases.
Does it mean that loans contracted on or after this date (e.g. for property purchases closed in 2018 or thereafter) should be more questionable to the FTA? Presumably yes, although one can hardly imagine which arguments they could put forward to deny deduction of a cash advance made by a purchaser to his company instead of contributing to its share capital, as it has been the usual standard practice for decades for obvious reasons of flexibility (irrespective of how much the property is worth and whether or not it may trigger wealth tax liability). This issue might give rise to a many disputes with the FTA going forward.
In both cases, although deductible, shareholder loans must be amortized in the same way as for bank loans (see comments above). If it is a non-fixed term cash advance without maturity, the amortization period is deemed to be 20 years.
Possible additional comments on the 2019 finance bill will be issued in the next few months. The subject is high on the media agenda at the moment in France. However, considering the timeframe for submitting the wealth tax returns for the 2019 year (see below), foreign property owners must already review their position for 2019 and also consider rearranging the financing of their real estate asset for planning purposes.
|The deadline to file the return is 16 May 2019 for non-French tax residents and for those with French taxable income filing online, the deadline is 21 May 2019. Under certain conditions, it could be later by electronic filling (no later than 25 June 2019).|
For further information on these matters or assistance with wealth tax planning issues, please contact Nicolas Trucco, Tax Manager, at firstname.lastname@example.org.