France: New Tax Regime Applying to Real Estate Companies Listed in France: Recent Comments by the French Tax Authorities

Originally published October 24, 2003

Article by Paris Partners Xavier Renard and Pierre Descheemaeker and associate Olivia Rauch-Ravisé

Article 11 of the Finance Law for 2003, codified under Article 208-C of the French Tax Code (FTC), provides for a new tax regime to the benefit of real estate companies which are listed on a French stock exchange. This tax regime (the SIIC Regime) exempts from French corporate income tax, subject to certain distribution requirements, rental income earned by such companies as well as capital gains that they realize on the sale of real estate assets, shares in real estate partnerships which are transparent for tax purposes and shares in real estate subsidiaries subject to French corporate income tax but which have also elected for the application of this particular regime. The French Tax Authorities have recently published comments for the application of the SIIC Regime in an administrative circular 4 H-5-03 dated September 25, 2003 (the Circular).

The SIIC regime applies to companies which fulfill the following conditions:

• the company must be listed on a French stock exchange and have a minimum share capital of €15 million;

• its main corporate purpose must be the acquisition or construction of buildings for rental purposes or the direct or indirect holding of shares of companies having a similar corporate purpose;

• the company must formally elect for the application of the new tax regime.

Under the SIIC Regime, these companies and their French subsidiaries in which they hold, directly or indirectly, a 95 percent minimum interest and which meet the two last conditions referred to above, benefit from an exemption from French corporate income tax on:

• income derived, directly or through real estate partnerships, from rental activities;

• capital gains realized (i) on the sale of real estate assets (directly or through real estate partnerships) and (ii) on the sale of shares of French real estate partnerships or of 95 percent held subsidiaries that have also elected for the SIIC Regime; and

• dividends received from subsidiaries that have elected for the SIIC Regime and are distributed by the latter in order to comply with the dividend distribution requirements described below.

The benefit from the SIIC Regime is, in fact, subject to the following dividend distribution requirements at the level of each tax-exempt company. Such company must undertake to distribute:

• at least 85 percent of its tax-exempt rental income (including the rental income realized through real estate partnerships) before the end of the fiscal year following the year in which this income was earned;

• at least 50 percent of its tax-exempt capital gains (including the capital gains realized through real estate partnerships) before the end of the second fiscal year following the year in which such capital gains were realized; and

• 100 percent of the dividends received from tax-exempt subsidiaries before the end of the fiscal year in which these dividends were received.

Election for the SIIC Regime triggers the payment of a 16.5 percent corporate income tax (as compared to current ordinary rate of 35.43 percent including additional contributions) assessed on any unrealized capital gains on the real estate assets and shares in French real estate partnerships held by the SIICs existing at the time of such election. The 16.5 percent corporate income tax is payable in four equal yearly installments. In addition to this 16.5 percent tax, election for the SIIC Regime also triggers the immediate taxation, at the ordinary rate of corporate income tax, of the reserves which had previously been booked by the SIIC in relation to the newly exempt activity.

In the case where the relevant companies would cease to meet the requirements for the SIIC Regime or would decide to waive the benefit from this particular regime within a 10-year period following the date election for its application was made, such capital gains would be subject to the payment of an additional corporate income tax, the purpose of which would be to subject these gains to corporate income tax at a rate equal to the ordinary rate.

Distributions by tax-exempt SIICs of tax-exempt profits fall outside the scope of the précompte (i.e., an equalization tax) and the avoir fiscal (i.e., a dividend tax credit) (the mechanism of the avoir fiscal and the précompte is in any case in the course of being modified by the draft finance bill for 2004). They also do not benefit from the dividend tax exemption provided for by the French parent - subsidiary regime at the level of French corporate investors; French investors holding shares of tax-exempt SIICs are thus fully subject to French corporate income tax at the ordinary rate (or income tax at the progressive rate, in the case of individuals) on the dividends distributed by the latter out of their tax- exempt profits. When paid to non-French investors, such dividends are subject to a 25 percent withholding tax to be reduced under applicable tax treaties (for example, reduction to 5 percent or 15 percent under the France-US tax treaty of August 31, 1994).

Besides their main corporate purpose, SIICs may also carry out other activities without losing the benefit from the SIIC Regime to the extent such other activities remain ancillary. Profits derived from such other activities remain subject to corporate income tax under normal conditions. In this respect, the Circular provides certain guidelines indicating under which conditions such other activities may be considered as having an ancillary nature and how the expenses which are incurred by the SIIC both for the tax exempt activity and the other ancillary activities must be allocated. In principle, election for the SIIC Regime does not trigger any particular tax consequences with respect to the assets used for the conduct of such ancillary activities as well as to the reserves, if any, booked by the electing company in this respect.

The SIIC Regime should provide much-needed flexibility and liquidity to the French real estate market. The absence of any taxation of rental income derived from French real estate properties should increase the rate of return of real estate companies and thus enable them to offer higher prices for their targets. Correlatively and as a result of growing investor interest in SIICs, share prices of real estate companies should also soar and be trading at less of a discount to net assets value. Finally, SIICs may also become preferential investors into French real estate companies and partnerships which they will be able to include in their tax exempt sector subject to the payment of the 16.5 percent tax on the unrealized gains on the properties held by such targets.

This new tax regime should first attract real estate companies that are already listed on a French stock-exchange and could thus more easily elect for such a regime, subject in particular to the level of the immediate tax burden resulting from the election of such a regime and the profile of their shareholders. The opportunity for private real estate funds to elect for the SIIC Regime will also depend upon other factors, among which the obligation for the company to have a certain portion of its share capital listed on a stock-exchange and the costs and obligations resulting from such a listing.

Investment in French SIICs should be of particular interest for foreign investors in the absence, for instance, of any transfer tax on the disposal of SIIC shares and of any disclosure requirements with respect to the 3 percent French annual real estate tax (a tax that may apply, under certain circumstances, to companies holding, directly or indirectly, French real estate).

The Circular provides certain comments with respect to the application of the SIIC Regime in an international context, although certain tax issues still remain unclear.

In this respect, the French tax Authorities have indicated that non-French real estate properties or shares in companies in which assets are mainly composed of non-French real estate properties are not concerned by the application of the SIIC Regime since tax treaties concluded by France generally provide that income or gains derived from such assets are exclusively taxable in the State in which the real properties are located. However, where the applicable Tax Treaty does not provide for an exclusive taxation in the foreign State, the SIIC may elect to subject such income and gains to the SIIC Regime.

As far as dividends received from real estate subsidiaries located in an EU Member State other than France are concerned, the Circular does not provide any particular comments with respect to the possibility for the SIIC to claim the exemption from withholding tax applicable in such State under the EU parent subsidiary directive. In the same way, there arises the question as to whether the SIIC could be considered as a French tax resident under Tax Treaties concluded by France and could thus benefit from the reduction or cancellation of withholding tax at source applicable under such Treaties.

Distribution of tax exempt profits by French SIICs to EU parent companies should not benefit from the exemption from withholding tax provided for by the EU parent subsidiary directive. Reduced rates of withholding tax applicable under Tax Treaties concluded by France remain nevertheless available at the level of foreign investors.

Finally, nothing should prevent non-French companies from complying with the requirements set forth by the SIIC Regime (in particular, the condition relating to the listing on a French stock exchange) to elect for the application of this particular regime.

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