For several years, there has been a lot of controversy regarding the valuation of usufruct and bare ownership, not only when they are purchased, but also, more recently, when they are jointly transferred. Specifically, usufruct these days runs for a period of 20 to 30 years, in most cases. In practice, these usufructs never (or at least rarely) reach the expiry of their duration. The property itself is often sold before the end of the usufruct, in other words during the usufruct period. That way, the usufructuary sells their usufruct together with the bare owner, who sells their bare ownership. Of course, the joint price must be divided over the remaining usufruct and bare ownership, and this now seems to be the subject of various discussions with the tax authorities.
There was already case law from Arlon, but we are primarily focusing on the new case law of the Court of Limburg of 26 February 2018 here. More important than this (positive) case law is that these cases are no longer an exception, given that more and more of these checks are being reported. There is no such thing as coincidence, but whether this really is a large-scale, organised effort is still unclear at the present time.
The facts from a specific case
This case related to a property purchased in 2006 for the usufruct (20 years) by the company, and for bare ownership by the manager/company. The total price was €251,350.00 for the purchase, for which the property was in shell condition, divided between the usufructuary 75% and the bare owner 25%. Details of the underlying valuation are not apparent from the judgement. Work was subsequently carried out for an amount of €206,019.57, to transform the property from shell condition to a finished condition. These costs were also divided between the usufructuary and bare owner. The usufructuary bore €148,608.00, or 72.13%. Again, no details of the valuation are available. They apparently had the opportunity to sell the property five years later (in 2011) with a nice capital gain (total selling price €600,000.00). The key question here was of course how this selling price should be divided between the bare owner and usufructuary.The taxpayer had valued the usufruct for its remaining duration. As such, the taxpayer obtained a value for the remaining usufruct of €246,828.20. However, this value was lower than the remaining book value of the usufruct (including finishing costs) which was €261,778.37. The taxpayer therefore chose to determine the compensation for the remaining usufruct in such a way that the company did not have to bear any accounting loss. The balance of the price (€338,221.63) therefore accrued to the bare owner.
The tax authorities want more parity between the usufructuary and bare owner
It is clear in this case that the bare owner got the best deal, as after only five years he got the lion's share (more than half) while he only bore a quarter of the investments. This obviously raises questions, not least for the tax authorities. The inspecting official had requested the advice of the Land Registry, which itself valued the usufruct at the (even lower) amount of €224,521.00. Nevertheless, the inspecting official was still not satisfied, and looked for other angles to express their concerns.
The usufruct was calculated by the inspecting official for its remaining duration as being [(selling price full ownership) x percentage usufruct/full ownership at the initial establishment of the usufruct x remaining duration of the usufruct/initial duration of the usufruct. The residual value of the finishing and furnishing works was first deducted from the sales price before this distribution was made. Two questions remain unanswered:
1) is it a question of the accounting or economic residual value
2) who gets this amount?
A crucial element is that this approach now seems to be the new method of the tax authorities, since it has been found in other inspection dossiers.
A characteristic feature of this approach in previous cases is that part of the added value is attributed to the residual value of the usufruct. As a result, the inspecting official ended up with a higher fee for the usufruct which was more than €100,000.00 higher than the taxpayer himself had calculated.
Courts weighing up the evidence
The courts are very clear in their words. They assert that people can only make a profit on the sale of "their rights". Specifically, the usufructuary can only be compensated for the usufruct, and the bare owner for the bare ownership. As such, it is not authorised for the usufructuary to realise a capital gain on the bare property.
The court emphasises the basic principle that the usufruct must be revalued, taking into account the rental value at that time and based on the remaining duration of the usufruct. The taxpayer did actually calculate it like this, and even envisaged a supplement to at least achieve the remaining net book value. The Land Registry calculated an even lower value. The court also judged that the assertion of the tax authorities that usufructuaries and bare owners need to make the same return is illogical. Indeed, it is not because the actual value of a property rises that the rental value also rises accordingly. As such, the court appears to have judged it fair that it has thoroughly examined the position of the tax authorities, but that the tax authorities fail in their burden of proof to prove the incorrectness of the taxpayer's approach.
Degrees of truth
This double case law is clearly positive for taxpayers and this most recent case law also appears to be well established at first glance. With a number of court rulings, there would clearly be agreement. Specifically, the transfer of a usufruct implies that the usufruct must indeed be valued, based on the characteristics of the right or the economic benefit which a person enjoys from the usufruct (for the remaining duration of this right). Furthermore, it is only logical that the usufructuary cannot in principle claim any capital gains on the bare ownership. Indeed, the requirement to ensure an equal return cannot be imposed, given that each party pursued its own advantage in the initial transaction, and therefore assumed its own risks of profit and loss.
However, in reality, valuations can be rather more complex than described in the above case. After all, this is a very factual story, and it is strongly advised not to rely too much on simple legal concepts or dogmas (e.g.: all the capital gains are for the bare owner). Due to a lack of detail, we couldn't double check the present case. In its essence, it is paradoxically both a simple and a complex exercise: for what amount would a usufructuary, if it was an independent third party, be willing to transfer the usufruct? A number of examples make it clear that this problem is much more than the simple approach suggests:
- If, for example, the usufructuary has carried out works for which at the end he is entitled, as the usufructuary, contractually or under the additional right, to compensation from the bare owner, then the usufruct is worth more than the updated sum of the remaining rental values. This common situation can turn the above-mentioned simple approach completely on its head. In legal terms, it nonetheless involves a lot of fine trawling work, since there are various categories of costs that can be incurred by the usufructuary, although the existence or scope of a compensation arrangement can vary enormously in the end, depending on the category. A good factual inventory of the works, followed by a legal qualification of them, is therefore essential to obtain a correct valuation.
- In addition, various contractual agreements may have been made, which must also be taken into account. Finally, there may also be other elements, such as a current heavy funding loss, for example. Imagine for a moment that large sums have been borrowed for the usufruct and that the compensation for the usufruct is not sufficient to pay back the bank (outstanding capital + funding loss). Which usufructuary would then be prepared to transfer their usufruct in independent circumstances (in return for this compensation)? This should prompt a critical reflection, at the very least.
- Another point is the question of timing. A lucrative exit is not possible whenever the seller so chooses. Especially in real estate, a quick sale is often disadvantageous, as the substantial, additional costs of purchase cannot always be sufficiently recovered in such a short period of time.
False start at the valuation = false finish?
Experience shows that, on expiry of the term, the usufructuary's return is often much lower than that of the bare owner, which was probably also a thorn in the side of the tax authorities in the above case. The culprit is generally not the valuation at sale, but the valuation at purchase. Indeed, it has already been ascertained that the simplified discounted cash flow methods encourage an intellectual overvaluation of usufruct (e.g. the Ruysseveldt method as applied by many practitioners with a discount rate equal to the OLO + 1.00%).
If the initial valuation has an unstable basis, this is irrevocably reflected in the distribution of the selling price and the total return at the moment of sale. If someone pays too much for the purchase, they can't get a good deal later on. Admittedly, too far-reaching distortions at the moment of sale could easily be corrected by manipulating the price distribution (in concrete terms, giving the usufructuary more so that he still earns a decent return). The question is whether people can be obliged to do so. Indeed, the valuation methods used at the time were generally accepted as being normal. As such, in most cases, no-one can say that a person acted rashly, or deliberately in error. And even in extreme cases where the initial valuation was unacceptable even according to the norms of the time, a seller will soon hit the limitation period (both fiscal and non-fiscal).
Have the tax authorities run out of ammunition then?
Although people might wonder whether the 'try out' of the tax authorities failed because they have already suffered two defeats, caution would appear to be advisable. Although in concrete terms the approach of the tax authorities was indeed open to criticism, the exercise appears to be somewhat more nuanced than many people would think, so there is no need to jump to hasty conclusions. Both the learning curve of the tax authorities and the facts of the situation may lead to a different decision in a subsequent case. At any event, the method applied by the tax authorities seems to be too far-reaching in this case. It is too simplistic to be true, and the deviation from a realistic result is likely to be both significant and unpredictable.