Arsene Taxand - Real Estate

Listed companies are currently in fashion

French public authorities and corporate investors have rediscovered the listed real estate sector. Modeled on the big US REITs, France initially adapted the special regime to allow listed real estate companies to elect for tax-transparent status from 2003 onwards.

This tax treatment led to the taxation of the real estate revenues of the SIIC (a listed real estate investment company), resulting from both the rental and sale of property, at the level of shareholders. With relatively favorable distribution obligations (85% for net rental income and 50% for capital gains, with unchanged indebtedness capacity and depreciation possibilities for the company), and encouraged by a final tax rate of 16.5% on unrealized capital gains (the "exit tax"), the SIIC was created under favorable auspices.

The attractiveness of the tax treatment of SIICs was reinforced by the possibility for owners of real estate assets to sell property to such companies under the benefit of a reduction in the rate of taxation applicable to the capital gain on disposal of 33 1/3% plus a tax surcharge of 16.5%.

This preferential tax treatment, which was initially only available for contributions of property and was extended to include outright sales from January 1, 2006 onwards, is justified in particular by the very specific situation in the professional real estate market in France. In fact, unlike most foreign companies, the majority of French companies (70%) own their real estate assets. Outsourcing of property is therefore a topical issue in France, and the French State is well aware of this fact. However, up until now, this was hampered by extremely high taxation of capital gains. This preferential tax treatment should make it possible satisfy both major users who wish to divest of assets that require a lot of equity and SIICs that are looking for new assets to develop in a market where investment products are scarce.
Naturally, skeptics might say that the preferential tax treatment for sales is limited in time as it is due to terminate at the end of 2007, but there is no doubt that the very clever way in which this regime was introduced should make it possible to continue the effects beyond this date, inasmuch as the measure duly takes effect and the first significant operations have taken place.

The consecration of this French-style measure could come, quite unexpectedly, from our friends in the UK. In fact, in its budget for 2007, the UK has in turn proposed the introduction of specific tax treatment for REITs (Real Estate Investment Trusts), which would be comparable to the SIIC regime in France.

In summary, this new regime would apply to listed real estate companies in the UK. These real estate companies – 75% of the total value of these companies' revenue and 75% of the balance sheet value of their assets must concern rental property – would be exempt from taxation of rental income for 10 years, and also from taxation of capital gains on the sale of property falling within the scope of the tax-exempt sector. Finally, the REIT would be subject to an obligation to distribute 90% of its tax-exempt income.

For shareholders, the dividends distributed by the REIT would be subject to withholding tax of 22% withheld directly by the REIT, with the exception of the dividends payable to pension funds or not-for-profit organizations. Finally, election for this treatment would lead to a "conversion charge", applicable based on the gross market value of the REIT's assets – and not the capital gain as is the case for the French model – at a rate of 2%, which may be spread over 4 years.

The approach adopted in the UK bears several similarities to the French regime. It can however be noted at this stage that, overall, it would be more restrictive and less attractive for foreign investors than the French system, du e to two of its main provisions. The first provides that no shareholder may hold 10% or more of the voting rights of the REIT. The second consists in levying withholding tax of 22% on the dividends distributed by the REIT to investors that are not resident in the United Kingdom. This withholding tax would not be able to benefit from the reductions applicable both within the framework of the European Union or pursuant to international tax treaties.

This budget bill, brought before Parliament on April 7, has aroused a lot of skepticism from professionals in London. Although this regime is advantageous for UK shareholders, it also appears to be extremely protectionist, and in contradiction with the highly international position enjoyed by the UK real estate market. However, negotiations are still very open at this stage. This is one more reason to appreciate the flexibility and dynamic of the French SIIC regime.

Article prepared with the assistance of Chiltern Plc in London.

Francois Lugand