German real estate investments – important legislative proposals re the taxa-tion of foreign investors and share deals
Two important German tax law changes have been proposed by the German legislator that will have significant impact on the taxation of investors in German real estate. Existing investment structures will be also affected. Thus, taxpayers concerned and their advisers should deal with the changes at an early stage.
The draft bill also contains changes in German Investment Tax Act that has recently been completely reformed (see hereto world.tax artice dated 24.04.2018). The planned changes will make a qualification as a tax privileged equity fund or real estate fund easier.
Exit from German real estate by way of a share deal shall become subject to German source taxation
On 25 June 2018, the German government published its draft bill for an Annual Tax Act 2018. The bill contains inter alia an important change for foreign investors investing in German real estate via foreign holding companies (eg, LuxCos), which is the typical inbound investment structure for foreign investors.
Under current legislation, non-resident taxpayers with profits from the sale of at least 1% equity participations in corporations are taxable in Germany only if the corporation is a company with seat or place of management in Germany. Since the sale of shares in a foreign corporation without seat and place of management in Germany is not subject to taxation in Germany, an exit from a German real estate investment indirectly via a sale of shares in the foreign corporation (PropCo) could be carried out without German taxation. The fact that the foreign corporation is holding real estate located in Germany is totally irrelevant under current law.
The German government now also seeks to tax a capital gain from the disposal of shares in foreign corporations (eg, Luxembourg holding companies in the legal form of a SARL) by non-resident taxpayers if, the value of the shares was based directly or indirectly to more than 50% on domestic immovable property at any time during the 365 days prior to the sale. Also capital gains upon the disposal of less than 1% equity interests in such real estate companies shall be covered and subject to German taxation.
As a result, German tax authorities will exercise a right of taxation, which has already been granted to Germany in a number of double taxation agreements (eg., DBA Luxemburg), which has so far not been exercised under national regulations. The new rules are to be applied for the first time to profits from the sale of shares, which are sold after 31 December 2018. However, only increases in value realized after 31.12.2018 shall be subject to taxation.
Existing investment structures in German real estate, which were set up with a view to achieving a tax-exempt exit from a German real estate investment by way of a sale of shares in a foreign PropCo should therefore be reviewed. In addition, a share and real estate valuation will be required by 31.12.2018 to comply with the intended grandfathering rule for an increase in value prior to 2019.
Tightening to rules to apply Real Estate Transfer Tax on Share Deals
The new German government already expressed in its coalition agreement of 14 March 2018 that certain forms of mitigating the German Real Estate Transfer Tax (RETT) by means of share deals should be restricted. Background to this is that currently in many situations the triggering of RETT upon the transfer of German real estate can be largely or completely avoided in the case of indirect transfers of real estate through the transfer of shares.
Roughly spoken, under current law no RETT is triggered in the following scenarios
- Less than 95% of interests in a partnership holding German real estate are transferred to new shareholders within a five-year period.
- Less than 95% of shares in a company holding German real estate are unified in the hands of one shareholder.
These norms lead to the following two basic tax planning approaches in the structuring of transactions with real estate companies:
- Time-graded acquisition of partnership interests, i.e. acquisition of 94.9%, leaving 5.1% with the existing shareholder and after five years acquiring of the remaining 5.1%.
- Club deals ín case of corporations holding German real estate: Since the five-year period is irrelevant in case of corporations, immediately 100% of the shares can be transferred to different purchasers. In turn, a share unification is to be avoided permanently, ie. club deals with an unconnected 5.1% co-investor have to be maintained permanently (i.e. until the exit in order to mitigate RETT).
At a Ministerial Conference on 21 June 2018, major tightening of the RETT Act was proposed:
- Reduction of the relevant participation threshold from 95% to 90% for share transfers for real estate-holding partnerships to new partners within (currently) five years as well as in the case of share unifications in one hand of shares in real estate holding companies.
- Extension of the relevant (holding) period from five to ten years (or possibly even 15 years) for real estate holding companies.
A draft bill outlining the details of these changes is expected shortly. However, it is unlikely that generous grandfathering provisions will be introduced.
Real estate developers, portfolio holders and investors should be aware of the intended changes at an early stage. It might make sense that already planned transaction are preferred. In addition, effects on already concluded contracts must be analyzed. This also applies to transactions that have been in existence for some time, which could be affected despite the grandfathering provisions.
Please contact your TAXGATE Team in case of any questions.
Dr Thomas Elser is tax partner at TAXGATE based in Stuttgart and Frankfurt.