FURTHER LIMITATION RULES TO THE DEDUCTION OF LOANS FOR WEALTH TAX PURPOSES
The Finance Act for 2024 introduced a modification of debt deductibility rules for Real Estate Wealth Tax purposes (“Impôt sur la Fortune Immobilière” – “IFI”).
This amendment aims at eliminating the discrepancy between the treatment of individuals owning their property directly and those owning the real estate property (hereafter “property”) through intermediary companies.
Under section 973 of the FTC (French Tax Code), in the case of direct ownership of a property, the value of the property can only be reduced by debts that are incurred by the taxpayer and are strictly related to the real estate asset, i. e. debts that are linked to the acquisition of the property or works carried out on the taxable property for instance.
Should a property be held through a company, the IFI taxable basis is the net value of the company shares held by the taxpayer. The value of the shares was assessed by deducting the company’s debts from the fair market value of the property without any restrictions.
This meant that even debts not related to the taxable assets (hereafter “non-IFI debts”) were taken into account for the assessment of the net value of the shares. For IFI purposes, special deduction rules are applicable to in fine loans concluded by the company to acquire taxable properties. These loans are subject to a deemed amortization over the full term of the loan. For example, the deduction of a 10-year in fine loan, is reduced by 1/10th each year.
Until 2023, the IFI value of the shares was calculated by the application of a “real estate ratio” that corresponds to the value of the taxable asset / global value of the company’s assets. The application of this ratio served to exclude the non-taxable assets from the IFI basis. Hence, debts related to exempted assets would lower the net value of the shares and as such, the real estate ratio was necessarily reduced by the impact of the said debts.
In some situations, for IFI purposes, the deduction of the non-IFI debts had impact on the net value of the shares. This was notably the case, whenever the companies signed loans e.g. to acquire portfolio assets. The economic impact of such loans was to lower the real estate ratio of the company whereas the value of the taxable property per se remained identical.
From January 1st, 2024, the new law excludes explicitly from the calculation of the real estate wealth tax “debts incurred directly or indirectly by a company that do not relate to a taxable property”. Therefore, only debts linked to the taxable property will be deductible from the value of the company’s shares. In certain cases, these additional provisions would increase the tax basis of the real estate wealth tax.
Article 973 IV of the FTC introduced complex safeguard mechanisms, which, in a nutshell do not allow that these restrictions disadvantage a taxpayer who holds a property through a company.
According to the first safeguard mechanism, the IFI value of the shares calculated according to the new debt deduction rules, cannot exceed the market value of the shares determined in accordance with the rules applicable to gratuitous transfers. In principle, this value is determined by deducting all the company’s debts from the market value of all of the assets.
According to the second safeguard mechanism, the new IFI value may not exceed the fair market value of the taxable asset minus the debt related to this asset.
Practically speaking, the taxpayer may retain the lowest of the three values calculated according to these new provisions.
The safeguard mechanisms aim to align the situation of individuals who hold their assets directly and those who hold the assets through a company.
On one hand, the French lawmaker has sought to prevent the artificial “dilution” of real estate assets held in corporate structures by enforcing the new debt deduction rule. On the other hand, the legislator has also taken care to ensure that the situation of taxpayers is not worsened where they hold their assets through companies.
Questions remain on how to articulate these new deduction rules when assets are held through several levels of corporate structures.
The application of the new law will also open the debate regarding the distinction to be made between debts that qualify as debts related to a taxable asset and those that do not. For example, should the company’s daily expenses or maintenance costs be considered as linked to the taxable asset?
Practically speaking, from 2024, companies will need to keep precise track of the use and the purpose of their loans, especially regarding their shareholder current accounts.
In any case, a detailed analysis of the individual situation of IFI taxpayers is necessary to assess the impact of this new debt deductibility rule on their tax situation.
