Sale with right of redemption is an old legal mechanism, but its subtlety offers financial and asset structuring possibilities that are still relevant today. However, its handling requires a precise knowledge of its tax implications, which can be complex. Far from being a simple temporary transfer of ownership, this transaction is scrutinised by the tax authorities, which seek to detect the true intentions of the parties involved. Inappropriate tax treatment can result in significant tax adjustments. See our complete guide to repurchase agreements for a comprehensive understanding of this financial transaction. This article sets out the tax rules governing the sale of securities under a repurchase agreement, so that you can anticipate the consequences and optimise the structure.
The general framework of the tax regime for sales with right of repurchase
The tax authorities approach the sale with right of redemption with a certain amount of mistrust, aware that behind the legal qualification of sale subject to a resolutory condition may hide a simple loan transaction secured by securities. Tax treatment therefore depends fundamentally on an analysis of the real intention of the contracting parties. For the tax authorities, it is not just a question of reading the contract, but of understanding the economic purpose of the transaction. Find out more about the conditions and legal effects underlying the tax treatment of sales with right of repurchase. This pragmatic approach is the key to understanding administrative decisions and anticipating the risks of reclassification.
The principle of legal analysis respected
In theory, the tax authorities endeavour to respect the legal analysis of the sale with right of redemption as defined by articles 1659 et seq. of the Civil Code. It therefore recognises that this is a sale with a repurchase option for the seller. Exercising this option results in the retroactive cancellation of the sale, which means that the buyer is deemed never to have been the owner. This legal fiction has major tax consequences. However, this respect for civil status is not blind. It depends on the reality of the transaction and the true nature of the agreement between the parties.
The distinction between 'true' and 'false' repurchase by the administration
To assess the situation, the tax authorities apply an accounting and economic logic that distinguishes between "true" and "false" repurchase agreements. The central criterion for this distinction is the probability that the repurchase option will actually be exercised by the seller.
A "true" repurchase agreement is one in which the exercise of the repurchase option remains a simple option, an uncertain possibility for the seller. The economic conditions of the transaction do not make repurchase virtually compulsory. For example, the repurchase price is not set in such a way as to make giving up the option economically irrational.
Conversely, a "false" repurchase agreement, or a transaction treated as a repurchase agreement, is an agreement where, from the outset, there is sufficient certainty that the seller will exercise his right. This may be the result of the terms of the contract, a counter-letter, or the financial conditions of the transaction that make repurchase inevitable. In this case, the tax authorities consider that the transaction is more akin to a secured loan and adjust the tax treatment accordingly, neutralising the effects of the sale.
Tax consequences of transferring shares
There are three stages in the taxation of sales with right of repurchase: when the sale is concluded, during its term and when it is completed. Each stage has its own rules, which vary depending on whether or not the repurchase is exercised, and on how the transaction is classified.
On completion of the sale: capital gains and losses for the seller
As soon as the contract is concluded, the sale with right of redemption is treated as a transfer in its own right. Ownership is transferred immediately, even if a resolutory condition is attached. As a result, the seller must recognise the capital gain or loss for tax and accounting purposes. This is calculated as the difference between the sale price of the securities and their acquisition price.
This immediate taxation may come as a surprise, as the sale may be cancelled. It follows from the principle of annual taxation, which requires income to be allocated to the financial year in which it is generated. The potentially temporary nature of the sale is ignored at this stage. For the purchaser, the shares are entered on the assets side of the balance sheet at their acquisition price. If the transaction is subject to registration duty, the buyer is liable for this.
During the term of the repurchase agreement: tax impact of the proceeds and the nature of the repurchase agreement
The period between the sale and the eventual repurchase also has tax implications, particularly with regard to income from the securities (dividends, interest) and the fate of the capital gain initially recognised.
Legally, the buyer is the owner of the shares. He therefore receives the dividends or interest attached to them. This income is taxable in his hands, according to the rules applicable to his own tax situation. As the seller is no longer the owner, he is not taxed on this income.
This is where the distinction between "true" and "false" repurchase agreements comes into its own. In the case of a "true" repurchase agreement, if the sale straddles the end of a tax year, the capital gain or loss recorded by the seller becomes definitive for that year. The simple option of cancellation is not sufficient to suspend taxation. On the other hand, in the case of a "false" repurchase option, where the repurchase is considered certain, the accounting and tax rules allow the return of the securities to the seller to be anticipated. The capital gain or loss on the sale is then neutralised in the accounts, which means that it has no impact on taxable income for the year.
When the repurchase agreement expires: cancellation or neutralisation of capital gains
The outcome of the transaction determines the final tax treatment of the initial capital gain. The consequences differ radically depending on whether or not the seller exercises his buy-back option.
If the repurchase option is exercised in the same financial year as the sale, the effect is simple: the sale is retroactively cancelled. The capital gain or loss recorded is itself cancelled, as if the sale had never taken place. In accounting terms, the entries are reversed. For tax purposes, the transaction is neutral. Only any registration duties paid are non-refundable, by virtue of article 1961 of the General Tax Code.
If the repurchase takes place in a subsequent financial year, retroactivity cannot wipe out taxation that has become definitive. To rectify the situation, the law allows the seller to recognise a capital loss (or a capital gain) in an amount exactly equal to the capital gain (or capital loss) taxed on the sale. This "offsetting" entry neutralises the tax paid initially. The seller gets back his shares at their original value, which is decisive for calculating future capital gains.
Finally, if the seller does not exercise his right to repurchase, the sale becomes final. Ownership is irrevocably acquired by the buyer. The capital gain initially taxed in the hands of the seller is consolidated. If it had been neutralised (under a "false" repurchase agreement), it must be added back to taxable income.
Tax treatment of the price difference and VAT
In most financial repurchase agreements, the repurchase price is different from the initial sale price. This difference actually represents the buyer's remuneration for making the funds available. The tax treatment is specific.
Product or load qualification
When the repurchase price is higher than the sale price, this price difference is analysed simply. For the seller who buys back his shares, it constitutes a financial expense deductible from his taxable income. This is the cost of the "financing" obtained. For the buyer, the same amount represents financial income, which is therefore taxable. It is the return on his "investment". This tax symmetry ensures consistency in the treatment of the transaction for both parties.
Exemption from vat on securities transactions
The question of whether the remuneration received by the buyer is subject to Value Added Tax (VAT) is a legitimate one. The answer is clear: sale with right of redemption, like most transactions involving securities, is exempt from VAT. Article 261 C of the General Tax Code exempts "transactions" in securities and other securities. The difference in price, which remunerates the transaction, is therefore not subject to VAT. This considerably simplifies the financial structure of these arrangements.
The taxation of sale with right of repurchase is a delicate balance between the legal classification of the contract and the economic reality of the transaction. Analysis of the parties' intentions is central, and the risk of requalification by the tax authorities can never be ruled out. The assistance of a lawyer is essential to ensure that your transactions are secure and that you can manage all the consequences. Take advantage of the expertise of our banking and tax lawyers to optimise the tax structuring of your repurchase agreements.
Sources
- Civil Code: articles 1659 to 1673
- General Tax Code: articles 38 and 261 C
- Monetary and Financial Code
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