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Valuation of real estate companies and properties: valuation methods with significant fiscal issues


The issue of valuing private individuals' or companies' real estate assets is still relevant in a period of crisis where real estate is a safe investment, even though the authorities are applying a great deal of pressure in terms of regards fiscal controls.

In general, the valuation method that the taxpayer must use in order to fulfil his tax obligations must be based on research into the "market value" of properties, a concept for which, paradoxically, tax law does not provide a definition. It is therefore case law and administrative doctrine that have established the principle according to which the market value of a property equates to the price that could be achieved on the basis of supply and demand on an actual market, leaving aside any suitability value.

Although the definition adopted in this manner contributes to an objective view of the market value (exchange value) and not a subjective view (suitability or usage value), it appears that the authorities and certain jurisdictions do not satisfactory apple these principles, which is frequently a source of misunderstanding and uncertainty.

Genereal valuation principles

Traditionally, the preferred method adopted by case law for determining the market value of real estate consists of referring to the prices recorded for recent sales of intrinsically similar properties. Obviously, there is an abundance of the case law relating to the interpretation of what is meant by intrinsically similar properties, in particular where there are none of these. Hence, the Court of Cassation has ruled that if the actual market value of a property cannot be determinde without comparisons being made with sales of intrinsically similar properties, this requirement does not necessarily mean that the real estate examined in this way should be strictly identical, in terms of time, environment and location (Cass. com. 12th January 1993 no. 25 P, SCI du Chemin des Anes).

Nevertheless, this comparison method has its limits in the case of properties generating revenue and, even more so, as regards real estate companies. As this relates to properties, there is a real difference between valuing a private asset, a primary or secondary residence, and valuing a property generating income, for which the income capitalisation method is most frequently used. Although this consists of determining the value of a property by capitalising its revenue, it still borrows from the comparison method in the sense that the capitalisation rate adopted is, in principle, that applied by the market and reflected by the most recent transactions. In doing so, there may be numerous sources of disagreement with the authorities when applying this method.

First and foremost, it is necessary to adopt the same definition of the property's revenue, i.e. gross rent, net rent and event triple A rent, for example.

In addition, the quality of tenants as well as the nature and term of the lease agreed specifically influence in the capitalisation rate used for rents. Finally, physical, geographic, legal and economic factors may also be taken in consideration. Therefore, this may be a question of the state repair of the property and work to be carried out, or a forthcoming change to the property's operating conditions (a change in the urban development environment or even the regulatory environment).

Real estate companies

The issue of valuing private individuals' or companies' real estate assets also frequently arises in relation to property portfolios held via the intermediary of a dedicated company, which is liable for corporation tax of not, where the property generates rental income. In this case, the valuation exercise becomes somewhat more complex as it is a case of valuing a company, but one that largely comprises real estate. This specific aspect means, in general (we are not talking here about listed or publicly traded companies) and except in certain special cases of recent transfers relating to other shares in the company, which could be used as a comparison value, that the classic financial methods for determining the value of an unlisted company only have a minor influence when determining the value of shares in a real estate company, which is primarily undertaken using the restated net assets method, but with the exception of situations involving minority shareholdings where the capitalised value is no longer used. The restated net asset value method (ACV) consits of adding the unrealised gain determined for the real estate held to the company's net assets: in this case the valuation of real estate is undertake as outlined above.

Therefore, by way of an example, the yield (VR) or discounting future cash flow (DCF) methods are seldom adopted when determining the value of shares and frequently only used whithin the framework of standard weighting (VMR x 3 + VR x 1 + VDFC x 1)/5.

Various adjustments are made to the values determined in this manner, in order to take account of the absence of stock liquidity or a minority shareholding or even, in the case of partnerships, of the risk known as "liability", which justifies discounts of the same name.

We will subsequently mention two other tax-related types of adjustments to values, which continue to be discussed with the tax authorities and which, although established in practice, remain disputed, and which may result in theoretical market values that are higher than the values obtained by the taxpayer.

The impact of transfer taxes

One of the true tax-related issues, which arises when determining the value of a real estate asset, is therefore associated with taking account of the cost of transfer taxes, the influence of which is far from negligible within the framework of transactions relating to the assets or shares of real estate companies.

From the point of view of investors or transferees, the price that they are prepared to pay to acquire the assets in generally formulated by taking account of the acquisition costs, foremost among which are registration fees where they are due on a transfer: in this case, the value that investors assign to an asset, equating to the price that they agree to pay, is known as "including transfer taxes". At the same time, from the point of view of property owners, the market value is frequently expressed as "excluding transfer taxes" and, in this case, equates to the net selling price that may hope to retain from the sale of their assets, taking account of the conditions imposed on them by the market and the purchasers. This value known as "excluding transfer taxes" or "net selling price" will form the basis for calculating their capital gain or loss; it is also the market value that will serve as the base for the applicable transfer taxes should the property be sold.

The question arises of the ability that the taxpayer has, as part of the valuation of shares in a real estate company, to retain a valuation approach excluding transfer taxes for shares, even though the value of the underlying asset has been determined excluding transfer taxes. Although this is common practice on the market and may have been confirmed by experts and professional bodies, it has been challenged by the tax authorities in various cases, on the ground that it would result in a kind of "double discount" by taking account of an identical cost twice. The authorites believe that the taxpayer should only adopt the excluding transfer taxes valuation approach on a single level as the former is only transferring a single property. The authorities' rationale turns out to be entirely questionable since, justified or not, the offending method is in current use on the market for actual transactions. The Council of State should be called on to settle this matter soon.

The impact of latent tax liabilites

However, the main discount applied to the value of shares in a real estate company is the discount for latent tax liabilites, which is based on the existence of unrealised tax liabilites deemed to be in existence on the date on which the shares are valued at the level of unrealised gains appearing the company's real estate assets. Buyers actually believe that they will be required to bear the latent tax liabilites in question in the event of a subsequent transfer of the property by the company, even though they do not have the means to absorb the cost of the purchase of rights representing the real estate acquired, as these are company shares.

Therefore, the corresponding discount is liable to amount to the corporation tax on the unrealised gains calculated at a rate of 33.3%. Bear in mind that this discount relates, in principle, to real estate companies liable for corporation tax, insofar as "Quémener" case law allows, under certain conditions, a company liable for corporation tax, which is acquiring shares in a partnership that is not liable for corporation tax, to wind up the company it has acquired and to revalue its assets without bearing the fiscal cost of a gain that is has already paid in the share price.

While market practice has clearly confirmed the existence of this discount, with only the theoretical rate of corporation tax applied being liable to vary, because of negotiations between the parties, the tax authorities and departmental conciliation commissions (in this respect also Cass. com. of 12th June 2012, no. 11-30396) refuse to allow it to be taken into account, in practice, except for shares in estate agents, property developers and companies building and selling properties, on the grounds that, since the business of a real estate company is not to transfer all its assets, no discount to take account of a latent tax liability on assets deemed useful for operations and therefore intended to be retained, would be justified. Here again, it is possible to see the entirely questionable manner in which the theoretical notion of market price may be applied where market practices and customs contribute differently to determining the value of such shares.

The protection offered by case law for the need for a significant difference

It should ultimately be noted that the Council of State, called on to rule on the existence of liberality in the event of a lack of prices, requires the authorites to provide proof of the existence of a significant difference between the market value of a property and the transaction price and that, therefore, ina a Hérail ruling of 3rd July 2009, the Supreme Court deemed that a difference of between 9% and 20% was not significant, with the public rapporteur in this case explaining that it "appears out of the question to view as significant a price that would not differ by less than 20% from the estimated market value".

Apart from the fact that this ruling was issued in relation to the valuation of unlisted, non-real estate shares, recent developments in administrative case law may imply a hardening. Faced with an appeal against a judgement of 21st April 2011 by the Nantes Administrative Appeal Court, which ruled that a difference of 12% between the market value adopted by the authorities and the transfer price of an apartment was sufficiently significant, the Council of State issued a decision to refuse to accept an appeal, with the public rapporteur stating that the judge of cassation should not exercise control over legal classifications relating to the significant nature of the difference but should leave this assessments to the sovereign power of trial judges.

Real Estate Newsletter - Option Finance, 1st June 2015


Picture of Richard Foissac
Richard Foissac
Gerner Frédéric
Frédéric Gerner