26 JULY 2016
The Lupa ruling: new tax uncertainty regarding sales of real estate companies!
The subject is a quite difficult one as it involves the application of the Quémener ruling1 to restructuring operations carried out after the acquisition of an SCI [société civile immobilière, real estate partnership] (or an SNC [société en nom collectif, partnership]) that is not subject to Corporate Income Tax (CIT) where there is a deferred capital gain on the real estate assets it owns.
This operation is intended to allow the person acquiring the SCI to become owner of the building upon the dissolution of the SCI, recording it on its balance sheet at its actual value without paying tax on the deferred capital gain existing on the day of the acquisition of the shares in the SCI (summary and example of implementation hereunder).
This technique is widespread and has become “market practice” in the last ten years or so.
◊The ruling in question may well put a brake on such practices!
In the particular matter, the Conseil d’Etat (French highest administrative court) held that the Quémener ruling should be applied only in the event of double taxation occurring at the level of the partner in the SCIs who was present on the day of the dissolution of the companies. Consequently, the Quémener mechanism should not be applied to situations where the operation aims:
- either to discharge taxation that does not correspond to an economic profit (as the pre-existing deferred capital gain does not correspond to a profit realised by the purchaser of the shares in the SCI);
- or to avoid the taxation of a taxpayer’s profit where this has already been taxed in respect of another taxpayer (the sellor upon disposal of shares, which in fact depends upon the latter’s own tax situation).
It should be noted that:
- in the conclusions made, the Rapporteur Public stated that the Quémener ruling “does not tend towards economic neutrality” and thus does not aim to avoid “economic double taxation”. As these conclusions were upheld by the Conseil d’Etat, this approach clearly does not match current practice;
- handing down judgment in a matter on a comparable problem (application of the Quéméner ruling), the Conseil d’Etat in 2015 took a different position.
The consequences of this decision of the Conseil d’Etat are as follows:
- There exists real uncertainty regarding the application of the Quémener ruling to future operations on account of:
- this ruling (in particular in view of the conclusions of the Rapporteur Public);
- uncertainty as to the future position of the French Tax Authorities (FTA), which may revise its doctrine.
- Acquisitions made by an OPCI [organisme de placement collectif en immobilier, REIT] are a priori spared as:
- the existence of a deferred capital gain does not generate a tax cost, but simply additional distribution obligations;
- acquiring an SCI with assets concealing a deferred capital gain will thus not have the same consequences;
- a universal transfer of assets from an SCI to a SPPICAV [société de placement à prépondérance immobilière à capital variable, open-ended company investing predominantly in real estate] cannot a priori involve CIT as the SPPICAV is completely exempt.
- The situation is slightly different for a SIIC [société d'investissement immobilier cotée, listed real estate investment company]:
- it is also true that the existence of a deferred capital gain will not generate a tax charge, but rather additional distribution obligations;
- on the other hand, a universal transfer of assets by a SIIC is likely to be taxed, as only capital gains upon the disposal of real estate assets (or similar) to non-associated enterprises will benefit from the SIIC exemption.
- In certain situations, the Quémener ruling should always apply when the revaluation is made at the initiative of the seller of the SCI before the sale because, at its level and upon this assumption, there might well be double taxation arising from the revaluation of the real estate and from the disposal of the shares in the SCI.
The facts underlying the Lupa ruling
In March 2006 two SARLs (limited companies) established in France acquired, from their Luxembourg parent company, shares in limited companies under Luxembourg law.
These limited companies held shares in French SCIs, which themselves each held real estate assets in France.
Over the following days the two companies restructured the group in several stages:
1/ Dissolution of the Luxembourg limited companies with a universal transfer of assets:
- the Luxembourg limited companies carried out a revaluation of the SCI shares before transferring their assets;
- the proceeds generated were not subject to CIT in France as they were taxable in Luxembourg;
- the two limited companies acquired the SCI shares at market value on account of their revaluation.
2/ Revaluation by SCI of the real estate assets (“réévaluation libre d’actifs”), thus generating a profit (namely, the difference between actual value and net book value) for the limited companies, followed by the transfer of all assets:
- the SCI shares were cancelled;
- the taxable income of the limited companies was determined according to the Quémener method, which resulted in the SCI shares producing a capital loss at the level of the limited companies (through application of the Quémener ruling), thus neutralising the capital gain produced by the revaluation of the assets.
During an inspection of the accounts for the financial year closed on 31 December 2006, the FTA challenged the calculation method used and reinstated the deductions applied to the taxable income of the limited companies, citing an abuse of law (as the operation was deemed to be an internal restructuring within the same group).
The companies took their case to the Administrative Court of Paris, which granted their request to remove the additional CIT charges in two rulings of 18 July 20122 confirmed by the Administrative Court of Appeal of Paris in two rulings of 18 February 20143.
The FTA then appealed against the rulings of the Administrative Court of Appeal, with its case no longer based upon an abuse of law, but rather upon the non-application of the Quémener ruling.
This judgment was handed down for a very particular case, as the dissolved SCIs had been “acquired” from a company in the same group located in Luxembourg: the operation as a whole, based upon the Franco-Luxembourg tax convention as it existed at the time, permitted the tax-free revaluation of the real estate even though the capital gain thus “erased” was actually realised by the group.
The FTA initially disputed the operation on the grounds of an abuse of law, but changed this in view of the decision of the administrative court. It was thus undoubtedly difficult for the Conseil d’Etat to allow such an operation to “pass” unchallenged.
In its ruling of 27 July 20154, the Conseil d’Etat held that “if a company removes assets from its balance sheet following a disposal or […] a dissolution without liquidation, with assets merged as set out in article 1844-5 of the Civil Code [and] the shares that it hitherto held in a company are governed by the regime set out in article 8 of the General Tax Code”, the result of the operation must be calculated according to the Quémener method.
The facts of the case are as follows:
- In 2000 the MEA company dissolved its subsidiary, an SNC, without liquidation; it had acquired all shares in the latter one year earlier;
- The universal transfer involved:
- the cancellation of all shares in the SNC;
- the immovable assets held by the SNC were recorded on the balance sheet; the assets were revalued, producing no capital gain for the SNC.
- MEA used the actual value of the real estate to calculate the taxable income for the operation, thus recording a loss.
Following an inspection, the FTA reinstated the capital gain on the real estate to the company’s taxable result.
The company did not dispute this, but held that the capital gain should be taken into account in the calculation of the cost price of the shares in the SNC when determining the capital gain or loss arising from the cancellation of the shares.
The Conseil d’Etat, in this context, confirmed the application of the Quémener mechanism in the event of a universal transfer of assets, stating that “in ruling that MEA was not justified in requesting the recording of the amount of the capital gain realised by this company on account the of revaluation of the real estate asset, as mentioned in point 1, at the cost price of the shares it had held in the property rental company, as this capital gain was not taken into account in the tax base declared by MEA prior to the dissolution of the SNC and the merger of its assets with those of MEA, the court ruling was vitiated by an error of law”.
Doctrine stemming from the FTA
To date, the official tax bulletin (“Bulletin Officiel des Finances Publiques”: BOFIP) contains a ruling dating back to December 20075 (which cannot thus be invoked in the above matter as the facts thereof relate to the year 2006) that validates the application of the Quémener ruling to operations dissolving an SCI where these are preceded by a revaluation of the assets held by the SCI being dissolved.
This ruling states that “in determining the capital gains or losses upon the cancellation of shares in an SCI following its dissolution, their purchase price will be determined by taking account of all taxable results and financial flows (distributions of earnings and accrued losses) arising between the date of their acquisition and the date of their cancellation, including any capital gain realised on the real estate assets of this company at the time of its revaluation”.
This doctrine is normally enforceable against the FTA notwithstanding the decision of the Conseil d’Etat: two uncertainties however remain:
- will the FTA revise their position?
- might the FTA consider that this general position does not relate to post-acquisition operations but presupposes a situation of double taxation? Such an approach could be contested but would generate risks even in the event of the current wording of the bulletin being retained.
Consequences of the Lupa ruling
The Conseil d’Etat has referred the decision on the merits to the Administrative Court of Appeal of Paris.
However, in addition to the time necessary for a decision (probably one to two years), the Court of Appeal appears to have little leeway to depart from the principles established by the Conseil d’Etat.
The real question is thus to determine whether this is a question of a one-off ruling or an evolution of the position of the Conseil d’Etat (the ruling is published in the Lebon collection of decisions of the administrative courts).
Overview: how does the Quémener mechanism function?
An example will provide a better understanding of the problem that the court wished to settle and of how the ruling functions.
- In year N, Company A becomes a 100% partner in an SCI, having contributed 100 to its share capital. This SCI has acquired a real estate asset for 100. The result for year N is 0.
- In N+1, the SCI declares an accounting and tax income of 7, which is not in legal terms distributed to company A.
- In N+2, the SCI declares an accounting and tax income of 9, which is not in legal terms distributed to company A.
The balance sheet of the SCI at the end of N+2 (disregarding any amortisation) is as follows:
|Real estate asset||100||Share capital||100|
|Treasury||16||Result N+1 & N+2||16|
The tax transparency of the SCI means that company A is taxed in N+1 on 7 and N+2 on 9.
If, at the beginning of N+3, the company sells the SCI for 116 (assuming that the real estate has not increased in value), it will realise a taxable capital gain of 16, corresponding to the SCI’s results for years N+1 and N+2, which were not distributed but upon which company A has been taxed.
The Quémener ruling aims to avoid such double taxation by allowing company A to reduce its capital gain on disposal of the shares in the SCI by the amount of the results of the SCI upon which it was taxed but which were not in legal terms distributed to it (and which are thus still contained in the shareholder equity of the SCI).
In this example, the taxable capital gain upon disposal of the shares in the SCI is reduced by 16 and will thus be zero.
◊There will therefore be no double taxation!
Application to acquisitions of SCI's
This is the mechanism applied in the event of a post-acquisition dissolution of an SCI, with the revised profit being that of the revaluation of the real estate.
Thus, company A acquires for a sum of 100 an SCI (for simplification with no debt) that is the owner of a property whose net book value is 60. Immediately following the acquisition the SCI revalues the property and is then dissolved, involving the 100% transfer of the real estate to company A.
In accounting and economic terms, company A does not make any profit and replaces the SCI shares on its balance sheet with the real estate asset (at the same value, i.e. 100).
In tax terms, because of the SCI’s transparency, company A as a partner must at its level record the profit made by the SCI on account of its revaluation, i.e. 40.
Company A must also record a capital gain or loss on the SCI shares being removed from its balance sheet. In accounting terms, this capital gain is 0, corresponding to the difference between the value of the real estate recorded on its balance sheet (100) and the cost price of the cancelled shares (100).
The Quémener correction aims to deduct, from the capital gain or loss on the SCI’s shares, the profit on revaluation upon which company A has been taxed but has not received (no distribution of the revaluation difference in the form of dividends). Consequently, in tax terms, company A realises a capital loss of 40 (0-40).
If the 2 operations are carried out in the same financial year (revaluation of assets by the SCI and dissolution of the SCI), the profit on revaluation of 40 and the capital loss on shares of 40, both taxable at the level of company A, will cancel each other out and no tax will be due (which is economically consistent, as no profit was realised by company A).
1. Conseil d’Etat, 16 February 2000, “SA Etablissements Quémener”, no. 133296.
2. Administrative Court of Appeal of Paris, 18 July 2012 nos. 1105856 and 11055857.
3. Administrative Court of Appeal of Paris, 18 February 2014, nos. 12PA03961, 13PA04246 and 12PA03962.
4. Conseil d’Etat, 27 July 2015, “SA Matériel Electriques Ascenseurs”, no. 362025.
5. Ruling no. 2007/54 (FE) of 11 December 2007, BOI-BIC-PVMV-40-30-20-20140428 no. 90.