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Legal considerations when buying a French leaseback

View profile for Loic Raboteau
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A “leaseback” property transaction is the purchase of a freehold furnished property in a Service Residential Property. It is a tax discounted investment. In return for the discount the property must be leased back to a management company for a minimum of nine years.

Leaseback schemes are most known to be tourism residencies (“residences de tourisme classées”), designed for those seeking a holiday home for a few weeks each year. They located in popular resort areas, e.g. golf, ski or coastal resorts, where self-catering accommodation is in high demand, and are either new or totally rebuilt properties. Leaseback schemes are available in many parts of France, including the Alps and Pyrénées, Brittany, Côte d’Azur and the Atlantic coast, Normandy and Paris.

The buyer becomes the landlord and qualifies for a refund of the VAT (20 per cent) that was included in the purchase price if the property is new built (less than five year old). In most leaseback property transactions, the developer will advance the VAT for the buyer when the purchase completes. In this case, the price the purchaser will pay will be net of VAT.

In addition, the management company covenants to pay the buyer a fixed annual return (usually from 2 to 5 per cent of the property’s value, adjusted annually for inflation according to rental indexes published by INSEE (National Institute of Statistics).

These should not be confused with timeshare. The buyer owns the freehold of the property and the full price is shown in the title deed.

The Lease Agreement

The purchaser of a lease back investment will covenant to sign a commercial lease agreement with a management company at the time of the signature of the deed of purchase (“Acte de Vente”).

A commercial lease is a contract giving a real estate property owner the right to rent out the property through a property manager over a minimum period of 9 years. The management company will rent the property to tourists for the purposes of its business so it is a commercial lease.

The main characteristics of this contract are the following:

  • It is contracted for a minimum term of nine years;
  • The management company (the lessee) has the right to renew the lease, unless the owner gives 6 months notice (via a bailiff). The management company has the right to renew the lease or to be compensated at the end of the lease if the purchaser refuses to renew. It is important that the renewal conditions are covered and the purchaser is protected in the commercial lease;
  • Annual Rental Income and its revision: rental incomes must be subject to VAT (10%). Owners should check whether the rental figure stated in the contract is inclusive of exclusive of VAT. The annual rent may be revised according to rental indexes published by the INSEE. The way the rental income (index used, cap on increase) will increase shall be checked carefully;
  • The buyer is also given the right to occupy the property for a period each year, usually between two and six weeks, spread over high, medium and low seasons. These weeks can possibly even been exchanged with accommodation in another resort. The period of occupancy must be clearly stipulated in the contract as well;
  • The property will be furnished: it is important that a schedule of furnishings is included in the property description or annexed to the reservation contract. The repairs incumbent on the tenant do not include wear and tear. At the end of the lease, if furniture needs to be replaced it will be at the owner’s cost;
  • The Maintenance Costs: the maintenance costs can be allocated contractually between the two parties. In the absence of specific clauses, the management company is responsible to maintain the property like a tenant. The management company is usually responsible for the maintenance cost and running charges. Owners have sometimes to pay a contribution. The lease agreement must state clearly what the maintenance costs will cover and if it will be deducted from the annual rent;
  • Repairs: repairs incumbent upon the tenant or those of routine maintenance for which a tenant is responsible. Major repairs remain the responsibility of the owner, unless they were occasioned by the lack of repairs of maintenance since the beginning of the lease agreement; in which case the management company is also liable for them;
  • Insurance: the management company must have professional insurance to cover the property against fire, furniture, third parties or other risks linked to its commercial activity;
  • Leaseback properties must maintain their tourist classification in order to retain their tax advantages. The properties must meet certain requirements in order to qualify as “residences de tourisme classées”. The contract must state that the management company will promote the residence overseas and provide hotels services (breakfast, laundering, cleaning and reception). It is therefore important that it is clearly stipulated in the contract that the management company will provide the above services in accordance with conditions imposed by the French Tax Administration. If those services are not provided and the residence lose its tourist classification, the owner might have to refund the VAT of the purchase price.

Tax Regime

With leaseback properties, tax declarations must be made to the French tax authorities and the developers tend to appoint an accountant in France who will deal with such declarations for purchasers of leaseback properties.

In most leaseback property purchases an accountancy firm will be proposed by the seller to reclaim the VAT of the purchase price on your behalf and carry out the purchaser’s annual declarations. Their annual fees amount to around €500.00.

Leaseback property owners are subject to the status of Non-professional Lessor of Furnished Property (“loueur de Meublé Non Professionnel (LMNP). This is the status where the investor earns less than €23,000.00 per year or 50% of his rental income in a furnished property. To benefit from this status, the owner must not be registered at the Trade and Companies Register as a professional lessor.

The total income is taxed under BIC category (“bénéfices industriels et commerciaux”, in other words profits from industrial and commercial assets) and the charges/fees can be deducted from the same revenue. This tax system significantly reduces or even cancels the owner’s tax liability.

There are two different tax regimes to choose from:

-the « micro BIC »: applicable when the rental incomes are inferior to €32,900.00. No expenses are deducted. However the net rental income will be calculated after a reduction of 50% of the gross income;

-the Régime “simplifié d’imposition” gives the right deduct actual expenses incurred in the year of assessment (mortgage interests, council taxes, insurance premiums, repair works…) and you are also entitled to a depreciation allowance on the cost of your property and furniture.

The lease back is for long term investment

Please note that the French tax Code imposes a duration of 20 years for commercial lease contracts to recoup the VAT in full.

The main reason in giving the VAT rebate is that VAT is earned by the French authorities during the period that the property is let out. This is on an understanding that the property will be let out to tourists for a duration of 20 years. If the lease contract was terminated before this time, then a part of the VAT would need to be re-paid the French authorities pro-rata. This works out at being 1/20th per year.

If for example at the end of an eleven year lease the owner decides not to renew, then he will have to pay back 9/20th of the VAT reimbursed initially – (this corresponds to the remaining 9 years).

Fortunately, in 2006 the French Tax code was amended to include a new article 257 bis which provides that an assignment of property between two persons, who are both registered for VAT, is exempt from VAT when there is a transfer of an asset which includes a commercial lease. The French Tax administration confirmed that the assignment of a leaseback fulfils the conditions mentioned in this article, when a leaseback continues to be carried on by the new owner of the property.

This means that if you sell the property to someone who will carry on with the “leaseback”, you will not have to pay the VAT back.

A leaseback is a commercial contract and commercial contracts in France typically include language for automatic renewal. If you do not wish to renew you must notify the management company at least 6 months before the end of the term of the contract.  However, if you do not renew, the management company is entitled to claim an eviction compensation in accordance with the French commercial code. This penalty for non-renewal must be clearly determined in the contract.

Do your Due Diligence Beforehand

Purchasers assume sometimes that because leasebacks have been given tax incentives by the French government the rental incomes are also guaranteed by the French government. They are not. The management company has the contractual obligation to pay you the rents in accordance with the lease agreement.

You should beware of developers offering high annual returns (e.g. 6 or 7 per cent), as there is no guarantee that these will be maintained in the long term or, indeed, achieved at all. There is a risk of the management company becoming insolvent.

Here are some top tips:

  • Location: Having a leaseback in a premium location might reduce the risks of not receiving your incomes and will enhance your chances of obtain a buyer if you decide to sell and the end of the term of the lease;
  • Check if the property will be managed by a reputable management company with a strong position in the rental market;
  • Plan your budget: Do not rely only the annual incomes to pay your mortgage!;
  • Think twice before entering into a leaseback because it is a long term investment! Within the current economic climate, it is difficult to capitalise quickly. Leaseback schemes are long term investments where you will have limited self-use of the property. Furthermore it might be more difficult to sell the property at the end of the leaseback period as the market might be flooded with other properties unless you have invested in a premium location. If you decide to sell the property within 20 years, you will have to repay the VAT prorata, unless the new purchaser carries on with the leaseback.

Conclusions

There are a number of legal considerations that you need to take into account when looking at purchasing a French leaseback property. French leasebacks are a well-regulated framework which offer tax advantages. Due to the longevity of the lease and its restrictions, it will suit lifestyle purchasers seeking to have few weeks use of a fully serviced property in a holiday location (ski station, sea resort) or long-term investors.

Following income tax incentives offered to French residents, there has been a considerable increase in leaseback purchases and a corresponding increase in development schemes to meet demand, but prospective buyers should be aware of the disadvantages and possible problems of the scheme as well as the advantages that are promoted by developers.

For more information on leaseback properties or for legal assistance, please contact Loic Raboteau via email at loicr@bandmlaw.co.uk or tel on +44 (0) 20 7356 0833.

Disclaimer: These articles are for information purposes only and are not intended as legal advice. Professional advice should always be obtained before applying any information to particular circumstances.

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