French property leaseback schemes: what are the main legal and tax consequences of their termination ?

 In Comment, Tax

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We recently had some queries from clients on whether they could terminate the leaseback agreement on their French holiday home. The lockdowns and travel restrictions of the last 15 months have had a negative impact on tourism in France and many touristic residential properties have seen a steep decline in holiday reservations, which, in turn, has affected the profitability of many leaseback schemes.

The leaseback is a commercial lease under which a French property owner rents his furnished holiday accommodation out through a professional holiday residence management company. The lease is usually – although not automatically – part of a wider holiday accommodation scheme commonly referred in France as “ résidence de tourisme classée”,whereby a whole residence or block of flats will have been accredited by the local authority and be specifically designed to provide holiday accommodation for tourist purposes.

The lease is usually signed at the time the property is purchased as a new-build. The management company – the lessee- is granted exclusivity to let out the holiday accommodation as a fully serviced touristic residence. In return, the property owner – the lessor – is guaranteed a rent as well as a number of weeks during which s/he can personally occupy the property for his/her own holiday in the high and/or low tourist season. The rent can be a fixed amount or variable, depending on the annual turnover of the lessee over the property.

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The initial question that arises is whether the property owner is free to terminate the lease as and when s/he wishes.

French commercial leases are subject to public order legislation specifically designed to give lessees a high level of protection and guarantee over the continuity of the lease:-

  • A commercial lease term is for a minimum period of 9 years. Unless the lessor (the property owner) gives notice to the lessee to terminate the lease, it is automatically renewed for a further period of 9 years.
  • The lessor can only give notice to terminate the lease at the end of each period of 3 years from the date of the lease or at the end of the initial period of 9 years. Notice of at least 6 months must be given before the end of each 3-year period, failing which the lease runs for another 3-year period.
  • If the lessor gives termination notice, the lessee is usually entitled to an eviction indemnity to compensate the loss of business. The indemnity can be substantial as it is based on the average turnover and/or profits of the letting business of the last 3 financial years multiplied by a ratio that varies between 60% and 100%, sometimes more in certain areas of France.

Other than stated above, property owners cannot give notice to their lessee to terminate the lease as and when they wish and they must allow the lease to carry on at least until the end of the 3-year period from the date of the original lease or allow the lease to reach its initial 9-year period. The termination of a commercial lease can also be expensive as the lessor must compensate the lessee for its loss of earnings, depending on how successful the letting activity has been over the last 3 financial years.

The only circumstance when a commercial lease can be terminated before its term and without eviction indemnity payable to the lessee is when the lessee defaults on its contractual obligations, for example if the lessee stops paying the rent. However, in this scenario, it is not unusual for the French Courts to grant the lessee a deadline to pay the rent, especially when the absence of rental income is due to an exceptional economic reason, independent from the business’ specific and general viability. The process of termination for inexecution of lessee contractual obligations is often a long and expensive process, with French Courts usually having in mind the core objective of the legislation which is to allow stability of the lessee’s business and allowing repayment plans rather than the immediate termination of the lease.

Many of our clients have been asked recently to approve modifications of the terms and conditions of their commercial leases, to provisionally modify the conditions of payment of the rent by the management company, including delayed payments and/or waiver of all or part of the rent, in return for a guaranteed higher rental income in future financial years. These addendum to the original leases are all motivated by the difficult economic context and sharp decrease of holiday lettings during the successive lockdowns, which necessarily affected the lessees’ profitability and cashflow. Our clients are usually left with the dilemma of either accepting these modifications to the original terms of the lease and, consequently, accepting a waiver of all or part of their rental income, or refusing them and requesting the cancellation of the lease for the lessee’s lack of payment of rent, but with this comes the uncertain outcome of a long and expensive legal action.

The termination of the lease may also have unexpected legal and tax consequences.

As mentioned earlier, the commercial lease is often part of a leaseback scheme set up at the time the residence is built and accredited as a touristic residence by the local authorities. The lessor purchases a holiday accommodation off plan and signs a commercial lease at the same time as the sale deed or as soon as the building work is completed. By entering into a leaseback scheme from the date of completion, the property owner benefits from holdover relief on the 20% VAT payable on the acquisition price.

However, to benefit from a full refund of the VAT, the owner must commit, in the sale deed, to let out the property commercially for a minimum period of 20 years from the date of completion of the building work. If the commercial lease is terminated before the end of this 20-years period, a portion of the VAT initially held over will become payable.

For example, if an apartment in a touristic area of France is bought off plan for €300,000 (excluding VAT) as part of a leaseback scheme and the building work completed on 1st July 2011, the property owner is committed to let out the property commercially for 20 years from that date, and up until 30th June 2031. The 20% VAT on the purchase price or €60,000 is not paid at the time of purchase, subject to the property remaining let out commercially for at least 20 consecutive years. If the commercial lease is terminated on 30th June 2021, then 10/20th of the VAT held over at the date of purchase will become due by the owner, hence €30,000 payable to the local tax authorities within 60 days from the date of termination of the lease.

Many clients also anticipate that, once the lease is terminated, they will be able to let out their property personally and/or use and occupy it as they wish.

However, leaseback schemes usually give the exclusivity of the management, letting and servicing of the residence to the management company and for the whole period of the scheme, hence preventing property owners who are not members of the scheme to let out their own property personally or via another management company or agent. One of my clients was recently denied the right to occupy his apartment, which was previously let out under a leaseback scheme, as his main residence. For as long as the residence remains accredited as a holiday resort residence, the related apartments can exclusively be used as holiday accommodation and cannot be occupied by their owners or a tenant as a main home.

To conclude, if a French property owner wishes to terminate the commercial lease as part of a leaseback scheme, s/he will want first to ascertain from which date the lease can effectively be terminated but also any additional costs associated with the termination: –

  • Will the lessee be entitled to an eviction indemnity and, if so, how much will it be?
  • Will there be a portion of the VAT on purchase price to repay?
  • Will the owner be entitled to let out the property personally or via another management company ?

A thorough review of the terms of the lease and the conditions in which the leaseback scheme was set up will be a very important pre-requisite to any action.

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