EU's misguided action against France over alleged discriminatory French property tax reliefs

UK and France: are they focussed on just protecting their banks?

The French government, like the UK government, is keen to keep property prices up to protect its banks. The last thing either of the governments wants is a downward slide in property prices, pushing banks towards repossessing properties with insufficient equity to repay the loans secured on them. The risk is that if this starts to happen in any meaningful way a downward spiral will start which will lead to a scenario with increased sellers and repossessions with no buyers at prices which the banks think are reasonable. In fact, this situation already exists in Northern Ireland presently where the drop in property prices is more significant than that in the Irish Republic.

The UK's solution -- quantitative easing

In the UK the government has been helping the banks with “quantitative easing”. In effect, the government prints more money that creates, (hopefully), a mild inflation allowing debts to be devalued and properties to rise in nominal terms. In this scenario, the values of properties may rise in real terms but the borrowers feel better positioned as in nominal terms the value of their property seems to be at a rise in relation to the mortgage debt. The big risk is that foreign investors view quantitative easing as far too addictive a measure for comfort, and they start disposing their UK assets in order to get recover their investments in British currency relatively early on as the Pound, as a result of the quantitative easing is losing value in relation to other currencies, which results in both the market and sterling falling. This consequentially leads to the government pushing up interest rates at a quick pace leading to a further fall in property prices. Thankfully we are not yet in the situation and hopefully such a scenario may be avoided.

The UK has also introduced schemes under which it guarantees borrowers' liability to banks that is currently restricted to new build properties but from January 1, 2014 it will be extended to all properties. This has been very helpful to house builders as can be seen from the stellar performance of the quoted builders' share prices around the time this was announced and the subsequent escalation in sales. There is, at this stage, no suggestion that the UK government should guarantee bank borrowings to purchase new build property elsewhere in the EU. There may be an issue relating to the free movement of capital in the EU.

The French solution -- tax breaks

The French government cannot implement quantitative easing as it is within the Eurozone, where key decisions are influenced by Germany, which is burdened with collective gloomy memories of devaluation, inflation and the wars and hence are not in favour of it. France has accordingly found a pragmatic solution française and has given the French tax payers attractive tax breaks to invest in French property. This has two positive effects: firstly, the French government props up its property market using French taxes and protects its banks; and secondly, it provides an incentive to build properties for the purposes of letting them out on rent. This is a good strategy, which perhaps the UK would also adopt if it were in the Eurozone.

France has historically had several tax breaks that have allowed accelerated depreciation to be applied to new residential properties intended for letting purposes in France. The depreciation has been set off against income tax and it has been a very attractive tax planning tool for the high earners. Similar investments abroad, however, do not enjoy the same treatment. This means that a French tax payer who has purchased a residential property for letting purposes in another EU Member State cannot deduct the depreciation from his or her income and therefore will pay more tax in France as compared to a French investor investing in France. Needless to add, these rules in France dissuaded French residents from investing in residential properties located abroad.

The French approach however is better than the approach taken by the UK as it has led to an increased construction activity of residential properties and it has increased the supply of affordable housing in the country as the rents are reasonable and affordable due to the high supply volumes. On the contrary, in the UK, there is a shortage of residential property and very few properties have been built for residential use and more so, these are only built by the wealthier individuals who have the capacity to pay bigger deposits. This has led to an acute housing property shortage and it has escalated the increase in rents to such an extent, especially in London, that the younger generation spends a large part of income on rents, and so it has been priced out of the property purchase market due to its inability to save up for the deposit simultaneously while prices keep escalating.

The EU's intervention

The European Commission does not perceive this problem in the same way. The EC claims that French tax rules on new residential property are discriminatory and incompatible with the fundamental principle of the free movement of capital within the EU. In February 2011, the Commission formally requested France, to amend its 'discriminatory’ tax rules to ensure compliance with the EU law. The request took the form of a 'Reasoned Opinion’ and represented the second step in the infringement procedure. As no satisfactory response had followed since then, the Commission has now decided to refer France to the European Court of Justice, taking the final step in the infringement procedure.

Essentially, the EU requires France to amend its legislation to ensure that its residents can claim tax relief in France for the purchases of residential property anywhere in the EU on the same terms as if they were investing in France. As such, it clearly favours the free movement of capital within the EU. However, the EU also has a wider social responsibility to ensure that the younger and less well-off people are able to buy houses to raise their families in decent conditions.

Where the EU is going wrong

The EU needs to spot the elephant in the room and identify the real problem, which means that the property market has to be propped up whilst the banks still have the time to recapitalise. This is the root of the problem and the solution does not lie in just the free movement of capital. The EU needs to address this problem by accessing the collective genius of its many financial experts and by refraining from making relatively insignificant and minor changes to France's tax rules.

If one follows the approach taken by the EU thus far, the next step would be for it to require the UK government to guarantee the debts of UK's residential borrowings to buy new build property anywhere in the EU under its latest property flagship scheme. By not doing so, the UK government is impeding UK residents from investing their capital outside the UK and in the EU. This is however clearly not going to happen anytime soon.

This information has been prepared by Sykes Anderson LLP as a general guide only and does not constitute advice on any specific matter. It is recommend that to seek professional advice before taking action. No liability can be accepted by the authors or the firm for any action taken or not taken as a result of any information or advice given or omitted.
David Anderson, Solicitor Advocate and Chartered Tax Adviser
Email: Tel: +44 (020) 3178 3770
Olga Tabenko, Trainee Solicitor
Sykes Anderson LLP Solicitors and Chartered Tax Advisers, London