SCI – SELLING A PROPERTY & CAPITAL GAINS TAX (CGT) IMPLICATIONS. VOLUNTARY DISSOLUTION OR NOT?

More frequently than not, when an SCI sells its property, once the French CGT (Plus-Values) has been paid, the residual sales proceeds tend to be paid into the SCI bank account by the notaire. If there is no intent for the SCI to buy a replacement then these proceeds  tend to be withdrawn and shared between the SCI shareholders (associés) according to their proportionate interest in the SCI (represented by their parts). If accounts (bilans) have been maintained – which in our experience is rarely the case – then the allocation of the withdrawal may also take into account the balance of any loans made to the SCI and agreed between the associés.

This process is then completed in France with the SCI French bank account being closed down and the shareholders assuming that, with the SCI no longer having any assets, it has naturally expired – thereby having no further obligation in France.

If the shareholder is UK tax resident then they may recognise that they have a UK tax liability in some shape or form as a result of the French house sale and so – perhaps with the help of their UK accountant – will complete a UK CGT self assessment return with the CGT computation being based on a proportion of the house sold which reflects their share in the SCI, claiming credit against UK tax for the French CGT already paid.

There are a range of problems with this approach, however, which if not addressed will eventually lead to financial difficulties down the line, either for the ex shareholder or for their estate.

1). The SCI still exists!

2). The above described UK CGT computation would be fine if the SCI was a partnership, however HMRC currently take the view that an SCI is a company!

What are the implications?

1). The Continuing Existence of the SCI: France

The fact that the SCI no longer holds any property assets doesn’t lead to its automatic termination. It remains on the Registre de Commerce et des Societes (RCS) until either action is taken to dissolve the SCI and strike it off the RCS or until it naturally expires on the 99^th anniversary of its registration.

Because – for French resident shareholders - the costs in dissolving the SCI and formally allocating proceeds, terminating the joint and several relationship which otherwise continues to exist between the ex-shareholders might be between 3% and 4% of the net share value and because it is perfectly legal for the SCI to allocate - without tax impact - the net sales proceeds to shareholders as a loan, the notaire responsible for the sale will tend not to propose completing the house sale by also administering the dissolution of the SCI. Instead the SCI lies (informally) dormant as a shell company, with neither tangible property nor cash at bank but nonetheless holding implicit assets in the form of loans to the shareholders, albeit in the absence of any formal set of accounts laid out and approved by the shareholders to provide documented evidence that this is the case.

For better or worse this tends to be standard practice amongst notaires in France and also seems to be acceptable (either through ignorance or explicit consent) to French resident shareholders.

But when the shareholders are all UK (or non French) tax resident the main stamp duties associated with the dissolution – the agreement allocating the proceeds between the ex shareholders – can easily be avoided, reducing the costs to perhaps 1 to 2% of the net share value, most of which comprise the professional fees for drawing up the necessary balance sheet, administering the dissolution and formalising the allocation of proceeds.

Apart from the practical issues surrounding the fact that as far as the administration is concerned, (Tax office, Greffe), the SCI’s centre of management is still at the registered address which has now been sold, (e.g. irate new owner receiving correspondence to the SCI, not knowing where to forward it and taking action to enforce dissolution), there are other practical consequences of such an approach.

Once the SCI reaches the end of its natural life on its 99^th anniversary, the SCI is automatically dissolved and shares cancelled with any assets existing over and above the share capital at that point being deemed held jointly and severally between the shareholders or their inheritors indefinitely or until such time as these loan assets are formally allocated on an individual basis via a share allocation order known as an “Acte de Partage”.

But are there any such assets if there is no property or cash deposits in the name of the SCI?

Well it depends on each SCI case, but if French CGT was paid and SCI bilans were not properly maintained to account for shareholder inputs to the SCI during the property ownership period, then the answer will be YES!

Remember the withdrawal and allocation of the net cash proceeds from the sale? Well these sale proceeds still belong to the SCI. It is important to understand here that an SCI is a separate legal entity to its associés: the funds paid for the shares – the initial share capital - does not belong to the associés, they belong to the SCI. Only the shares belong to the associés and their value can only be realised / encashed as a loan from the SCI to the shareholders or by a disposal (sale or gift)  or cancellation (dissolution and liquidation of the SCI). Without any such action then, in the case of a single property SCI, the allocation of the sales proceeds (an asset of the SCI) will, at least in part, be nothing other than a loan from the SCI to its associés.

The loan needs either to be repaid by returning the proceeds to the SCI or cancelled out as a liability on the associés via SCI dissolution and cancellation (encashment) of the shares – either on expiry of the natural life of the SCI (up to 99 years from incorporation) or earlier if this is actioned by the associés voluntarily.

It is only on dissolution that the SCI is struck off from the Régistre de Commerce (RCS) and no longer exists. Only at this point do the sales proceeds truly belong to the associés. 

But there is more: The "Partage"

Usually, the process of dissolution and liquidation is followed by an agreement allocating the proceeds between the associes. In France this is known as the “Partage”.

Unless formal allocation of the proceeds of liquidation takes place (via an “Acte de Partage” / shareholder allocation agreement) any excess value in those sales proceeds over and above the actual share capital, (and any shareholder loan account balances), is deemed owned jointly and severally by the (now ex) associés. Such continued joint ownership of the proceeds has unsatisfactory implications – notably potential exposure of the full net proceeds to recovery by a creditor of another ex associé where the debt arises by reference to the SCI.

The formal Partage sorts such problems out and is the final hurdle to jump in order to ensure that the proceeds are allocated as intended (normally reflecting proportionate ownership of the share capital) and free from potential recovery by creditors of other associés.

Normally, duties known as “Droits de Partage”, are levied at a rate of 2.5% of any uplift in share value, when registering in France any deed which governs how the uplift is to be allocated between the erstwhile associés. It is not compulsory, however, for the registration of the liquidation – which is needed in its own right to complete the striking out of the SCI at the Régistre de Commerce et des Sociates (RCS) – to include any reference to how the net proceeds should be allocated between the individual associés.

Consequently, if all the associés are UK resident (or at least not French resident), then we recommend creating two separate agreements, both of which are drawn up in the UK.

The first is the deed agreeing to the liquidation and announcing the net value of that liquidation – this needing to be registered in France and subject to a fixed duty of (currently) 375€ or 500€ depending on whether the registered share capital is below or above 225.000€.

The second is the agreement between the shareholders terminating the joint ownership of the net proceeds of the liquidation and governing how they are to be allocated between them, (the “Partage”). However, as long as all the shareholders are not French resident and – as will usually be the case - the proceeds do not comprise assets whose change of ownership must in any event be registered in France, then this agreement does not need to be registered in France and so the 2.5% charge can be avoided. The format of this agreement can be a simple statement (“Sous-Seing Privé”), confirming shareholder agreement to the allocation, the separate, individual and absolute entitlement to the corresponding funds and a termination of any joint and several liability regarding any debts or obligations carried over from the SCI which may otherwise have such a claim on the proceeds.

2. HMRC Tax Position in the UK

On a stand-alone basis the French consequences of a failure to complete the task of SCI dissolution and partage is usually not disastrous – perhaps being more of a potential long term inconvenience when sorting out succession to the shareholder’s estate on their eventual death and again for inheritors of the shares when the SCI reaches the end of its natural life and there are perhaps little or no records remaining to show the state of affairs following the sale of the property many years or decades before.

It is for this reason that notaires form the habit of leaving the SCI in limbo after the sale.

When the shareholders are UK tax resident and domiciled, however, the HMRC interpretation of an SCI introduces more severe potential problems which provide their own, more urgent incentives, to ensure the SCI is dissolved, struck off and proceeds formally allocated via the partage sooner rather than later.

So what is HMRC’s position?[1]

Their view is that an SCI is a company entity which would be subject to Corporation tax treatment if it was resident in the UK.

With this interpretation it is important to understand and recognise that the assets of the SCI (the French property in the main) are not the assets of the shareholders. Rather, the shareholder’s interests are in the shares.

As far as HMRC is concerned, only if the SCI is UK resident would it be assessable to tax in the UK on the sale. In this case the gain would be assessed under UK corporation tax rules and UK corporation tax payable albeit with a credit for the French income tax paid by the shareholders.

In practice however, at the point of the sale the SCI is normally assumed to be French tax resident. Consequently, from the HMRC perspective, the actual sale of the property itself is not taxable in the UK since we have a French resident entity selling a French property.

It is only when the SCI is subsequently sold or – more likely – dissolved that there is a UK capital gains tax assessment; this time on the shareholders in respect to the gains made on the disposal or cancellation of the shares.

If the sales proceeds were to be retained indefinitely within the SCI this wouldn’t be a problem; indeed it could represent a tax advantage since any latent UK CGT liability resting on the appreciation in share value resulting from the gains attached to the sale of the property would be wiped out if the shares are inherited on the shareholder’s death.

However, the usual practice is for the sales proceeds to be withdrawn within a short time of them being made available by the notaire and this causes UK tax problems.