29 April 2019
Tax discount on SCI shares: new reversal of Quemener precedent
In its “Fra” decision of 24 April 2019, the Conseil d'Etat overturned the Lupa decision of 6 July 2016 that had refused the application of the Quemener case law to revaluations of real estate following the acquisition of shares in an SCI (property investment company) or an SNC (general partnership) that was not subject to corporation tax (CT) where such company owned the property. These transactions generally took the form of a “universal transfer of assets and liabilities” (with prior accounting revaluation) of the SCI and a transfer of such assets (at market value) and liabilities to the partner who had previously acquired the shares, without actually taxing the latent capital gain existing in the accounts of the SCI thus dissolved.
♦ Such operations made it possible to avoid the application of a discount for latent taxation in the event of disposals of SCI shares, with the purchaser able to revalue the taxable value of the property without being subject to a tax charge.
♦ The Fra decision therefore once more validates the application of the Quemener precedent (and therefore non-taxation) in this specific case by overturning the outcome of the Lupa case of 2016, which had instead held that such application was no longer possible.
♦ As a practical consequence, there should be no discount for latent taxation in the event of a disposal of shares in an SCI that is not subject to CT where the book value recorded in a property company’s balance sheet is much lower than its market value.
But will these repeated changes in the tax position dampen enthusiasm among investors...?
1/ As an overview, prior to the Lupa decision, in the event of the “universal transfer of assets and liabilities” of an SCI (or SNC) that was not subject to CT and where the partner had just acquired the shares, the Quemener decision allowed the property to be entered at its real value in the balance sheet of the partner effecting the universal transfer (in place of the SCI shares being disposed of under the transfer) by not taxing any unrealised capital gain that might exist on the balance sheet of the SCI (the difference between the property’s market and net book values on the SCI’s balance sheet).
Thus, if such a transaction was carried out shortly after the acquisition of the SCI’s shares, the purchaser’s balance sheet would show the property’s market value, whereas this had previously appeared in the SCI’s accounts at an (often-low) historical value, without any tax being due.
2/ Such transactions – which since the 2000s had become market practice – allowed for the sale of SCI shares without any discount on the selling price for any potentially taxable unrealised capital gain at the level of the company being sold. The Lupa decision had challenged this, holding that the Quemener precedent could only apply in cases where the latent gain on the SCI’s balance sheet had arisen if the partner carrying out the universal transfer was already associated with said SCI (the problem is set out in detail below).
3/ The Fra decision overturns this approach, holding that the Quemener precedent is applicable even though the partner in the SCI has just acquired the shares. The Conseil d'Etat based its decision on the fact that this case law is intended to avoid the double taxation of the same economic profit and that it is irrelevant to its application that the double taxation of such profit might or might not affect the same taxpayer: this formed the basis of the Lupa decision, now clearly set aside.
For a better understanding:
A technical recap
1/ Recap of the Quemener case
The Quemener case, dating from 2000, aims to avoid double taxation or double deductions of tax linked to the disposal of shares in companies that are not subject to corporation tax (generally SCIs, and therefore hereinafter “SCI”, although it could equally apply to SNCs). The problem arises from the tax transparency of the SCI: partners are taxed on the profit or deduct the losses of the company even though they do not benefit from these profits or they do not bear in legal terms these losses (in the form of dividend distributions or the allocation of losses in their current account).
If an SCI realises a capital gain on a building, but this capital gain is not distributed to the partners and the partners subsequently dispose of the SCI’s shares,
the capital gain on the property will, owing to the transparency of the SCI, be taxable at the level of the partners, but
it will also constitute a component of the sale price of the shares (as a result of its non-distribution) and will, as such, be taxed once more at the level of the partners in respect of the capital gain on the disposal of such shares.
This situation may also occur in the event of the partner failing to offset the SCI’s accounting losses prior to disposal of the shares (the partner then deducts the same loss twice in tax terms). The Quemener decision was thus handed down in this context, at the request of the tax authorities.
To correct this situation, the Quemener decision provides that, in the event of the disposal of shares in an SCI (or any other company that is transparent for tax purposes), the taxable gain or loss on the sale of the SCI’s shares must be:
reduced by any profits realised by the SCI and taxed at the level of the partner making the disposal without having been distributed and, conversely,
increased by any losses realised by the SCI and deducted by the partner but not assigned to the latter’s current account (therefore reducing the value of the shares sold).
2/ Application to SCI acquisitions involving latent capital gains
This mechanism was then applied in the case of SCI acquisitions followed by a liquidation or universal transfer (together with an accounting revaluation of the building). In this case, the person acquiring the SCI due to a liquidation or universal transfer would be taxable on:
the latent capital gain existing on the property owned by the SCI in question (the liquidation of the SCI and the accounting revaluation leading to any latent capital gains on its assets immediately becoming taxable), but
as the SCI had been liquidated, such capital gains were not subject to any dividend distribution.
As a result, the Quemener remedy should be applied at the level of the capital gain or loss on the “disposal” of SCI shares to the partner receiving the transfer, such capital gain being in principle zero in accounting terms (as the SCI shares have just been acquired for a price that incorporated the actual value of the underlying asset).
This would result in a tax loss on the SCI shares corresponding directly to the capital gain on the property (the capital gain for accounting purposes is assumed to be zero, as it is reduced by the capital gain on the property recorded at the level of the SCI, i.e. a tax loss on the shares of the SCI corresponding to said capital gain on the property),
The capital gain on the building, taxable at the level of the partner (because of the SCI’s tax transparency) and the tax loss on the shares of the SCI recorded at the level of the partner, could then be offset against one another to avoid any tax charge.
Example: an SCI owns a real estate asset with an actual value of €10m, whose net book value is recorded in the balance sheet as €3m, i.e. an unrealised gain of €7m. This SCI has no other assets nor any debt, so its real value is €10m.
Company A acquires the SCI for a price of €10 million. It then performs a universal transfer of the SCI’s assets, with the following consequences in tax terms:
the realisation of the capital gain on the building at the level of the SCI, i.e. €7m, which is taxable at the level of Company A (because of the SCI’s tax transparency);
the realisation of a capital gain or loss in accounting terms of zero on the SCI’s shares, i.e. the difference between the building’s value of €10m and the cost price of the SCI’s cancelled shares (also €10m);
this accounting capital gain of zero must now be reduced by €7m through the application of the Quemener precedent, i.e. a tax loss of €7m on the SCI’s shares;
the tax loss on the SCI’s shares will automatically offset the taxable capital gain on the building owned by the SCI, which is taxable at the level of Company A.
The taxable result for Company A is ultimately zero, but the building now appears in its books at its market value of €10m. It is this value that will then be used for the calculation of depreciation and of the cost price in the event of a disposal of the property.
It should be noted that, while this operation may appear complex, it does not aim to avoid the taxation of a profit, but rather that no tax should be due in the absence of a profit (the partner in the SCI will not make any economic gain from the universal transfer operation).
3/ Position of the tax authorities
For the record, under a 2007 ruling published in the Official Bulletin of Public Finances (and still accessible), the tax authorities validated the application of the Quemener decision to universal transfer operations arising subsequent to the acquisition of an SCI. They moreover issued numerous favourable individual rulings.
The Lupa decision and its consequences
The Lupa decision put a halt to this practice (see our previous newsletter http://www.fiscalimmo.fr/index.php/en/fiscalimmo2/fiscalimmo-actu/208-arret-lupa-quemener-operations-de-restructurations-en), holding that the Quemener precedent could only apply if the double taxation justifying the application of this scheme not only concerned the profit but the taxpayer itself.
Therefore, in the event of the acquisition of an SCI’s shares followed by a universal transfer, the Quemener decision would not prevent the double taxation of the same profit at the level of the same taxpayer; there would only be a “one-off” taxation of a profit that the taxpayer had not made economically (the corollary would be the taxation of the same economic profit at the level of the person disposing of the shares). It followed that the Quemener decision should not apply in this case.
The Lupa decision did not address the enforceability or otherwise of the guidelines of the tax authorities mentioned above, as the operation in question was carried out before publication of said guidelines.
Subsequently, in the context of the Fra case (the subject of the Conseil d'Etat decision of 24 April mentioned above), the Paris Administrative Court of Appeal confirmed the position taken under the Lupa decision, adding that the guidelines of the tax authorities could not be cited by the taxpayer. All ways now seemed blocked.
The tax authorities had also drawn their own conclusions, issuing a number of adjustments aimed at challenging the application of the Quemener decision to such transactions for currently ongoing proceedings.
Curiously, the authorities had not changed their guidelines published prior to the Lupa decision that validated this practice.
The Fra decision and the overturning of the precedent
The Fra decision of the Conseil d'Etat shakes matters up by stating that the Quemener precedent is in fact applicable in such cases. Overturning the 2016 decision, the Conseil d'Etat based its decision upon the view that the Administrative Court of Appeal cannot make the application of the Quemener decision conditional on the fact that the economic double taxation is borne by the same taxpayer.
As a result, the decision of the Administrative Court of Appeal is quashed and the case referred back to the same judges.
It should be noted that the Conseil d'Etat does not rule on the question of the enforceability of the guidelines of the tax authorities, which remains unresolved.
What can now be expected?
It is hard to see how the Paris Administrative Court of Appeal can avoid following the position of the Conseil d'Etat and refuse to apply the Quemener precedent.
More broadly, this decision should allow a return to the former practice and thus, in the event of the acquisition of companies that are not subject to CT, make it possible to carry out a universal transfer (usually preceded by an accounting revaluation) to permit the purchaser to record the building on its balance sheet at its economic value.
The practical consequence would be no discount for latent taxation on the sale price of the shares.
Beware, however, of transactions that might be characterised as an abuse of law (with the scope of application extended to operations mainly, and no longer solely, motivated by tax reasons).
As regards the tax authorities, let us hope that they abandon the ongoing proceedings based on the Lupa decision. Finally, while the tax authorities did not change their guidelines following the Lupa decision (which led to an inconsistency between these guidelines and the practise of the tax services...), let us hope that the tax authorities will this time clarify their view so that investors can be sure of the tax position!