Before the decision from the French Supreme Court in the “Lupa case” in 2016 (CE, 6 July 2016, Sté Lupa France, no. 377904), it was common practice in the real estate industry not to request a discount for contingent capital gain tax liability on the purchase price of shares in a French tax transparent company (SCI, SNC). Such discount is otherwise requested in respect of the latent capital gain related to the real estate property owned by the target company (ie, difference between its fair market value and its net book value).
Before Lupa, it was possible for the purchaser to purge such latent capital gain after the acquisition without significant tax costs, by carrying out a step up in the value of the property followed by the liquidation of the target company, by applying the mechanism resulting from the "Quémener" case law (CE, 16 February 2000, SA « Etablissements Quémener », no. 133296).
As a reminder, in order to determine the taxable capital gain upon the disposal (or cancellation) of shares in a tax transparent company, , the Quémener mechanism consists in adjusting the acquisition price of the company's shares by taking into account undistributed profits (and accumulated losses) at the level of the vehicle, which would have already been taxed (or deducted) at the level of the partner as they were earned. The Quémener adjustment aims to eliminate the risk of double taxation or double deduction related to the tax transparency of these companies.
In the context of post-acquisition restructuring transactions, this mechanism led in practice to (i) the purchase price of the target company’s shares being increased by the amount of the revaluation gain related to the property and (ii) a capital loss being crystalized upon the cancellation of the shares following the dissolution of the company, which could be set off against the revaluation gain, so that the step up in value over the asset could be carried out in a tax neutral.
The tax authorities themselves seemed to expressly validate this application of the Quémener case law when they published a tax ruling specifically aimed at the case of the revaluation of a property followed by the dissolution without liquidation of an SCI (RES no. 2007/54 (FE) of 11 December 2007 – BOFIP BOI-BIC-PVMV-40-30-20 § 90).
Through the 2016 Lupa decision, the French Supreme Court had however generated some confusion on the implementation of this mechanism and the viability of a well-established market practice.
In the Lupa case, whose factual circumstances were admittedly, quite specific, the French Supreme Court considered that the adjustment mechanism was only applicable in case of an effective double taxation at the level of the company’s shareholders at the time of the disposal or cancellation of the relevant shares.
In the context of another dispute over a similar restructuring transaction, the Paris Administrative Court of Appeal subsequently made a strict application of the Lupa case law (CAA Paris, 17 May 2017, Société Fra SCI, no. 16 PA01892). The Court thus rejected the possibility for the taxpayer to determine the capital gain resulting from the cancellation of shares in an SCI by increasing their base cost by the revaluation gain, on the grounds that such gain had already been taken into account in the purchase price of the shares and that the taxpayer therefore did not justify having suffered an effective double taxation.
The taxpayer appealed this decision before the French Supreme Court.
On 24 April 2019 ,judging under its highest formation, the Tax Plenary session (CE plénière, 24 April 2019, no.412503, Société Fra SCI), the French Supreme Court finally has revised the restrictive position it expressed under the Lupa case.
The French Supreme Court has now ruled that the absence of effective double taxation does not per se exclude the application of the the Quemener case law, which aims precisely at ensuring the neutrality of the application of the tax law.
In doing so, the Conseil d‘Etat confirms that the adjustment mechanism resulting from the Quémener case law is fully applicable to the share of profits allocated to the partner of a tax transparent vehicle , where such profits result from a step-up revaluation of the company’s assets.
The Conseil d’Etat referred the case to the Paris Administrative Court of Appeal to be once again judged on the facts.
However, considering the prestigious formation that ruled on the case at hand, and the motivational recital of the Supreme Court, it is highly likely that the Court of Appeal will follow the opinion of the Supreme Court.
Practitioners now hope that the tax authorities will not try in the future to challenge this type of step-up transactions, either on the basis of the anti-abuse provisions of the new article 205 A of the French tax code, or on that of the "mini - abuse of law "(article L64 A of the French Tax Procedures Code).
This case law seems to put an end to the uncertainties from the Lupa case law, which had impacted the fluidity of real estate share-deal transactions in tax transparent companies (SCI, SNC). Since Lupa, a large number of players in the sector tended to favor asset deals, despite the additional costs that this type of operations generate (registration fees, notary fees).
It is therefore likely that a rebalancing will occur in the coming months in favor of share deals.