This Focussing on Funds looks at recent transfer tax developments in the UK and Germany which will have an impact on the transfer market and acquisition and fund structuring.
A recent English court decision suggests that the stamp duty land tax ("SDLT") general anti-avoidance rule may be of wider application than previously thought and significantly wider than indicated in HMRC's published guidance. In particular, it may apply in some cases where the parties achieve an SDLT saving, even where they are not implementing a tax avoidance scheme. Those involved in complex property transactions, particularly those involving reorganisation of ownership structures, should exercise particular care and not rely on HMRC's published guidance.
The German government is proceeding with legislation which will make it significantly harder to sell companies and partnerships owning German real estate without incurring German real estate transfer tax ("RETT") and this is expected to come into force at the end of 2019. Under current law, RETT is payable on sale of interests in a real estate owning partnership of 95% or more in a five year period, so sellers often retain 5.1% for over five years before selling the retained interest to the buyer. The threshold is to be reduced from 95% to 90% and the time period extended to 10 years if the retained interest is sold to a third party (or 15 years for a tax-privileged sale to the buyer). Therefore, RETT will be payable unless the seller retains over 10% of the shares for over 10 (or 15) years. In addition, a new taxable event is envisaged for the corresponding direct or indirect transfer of 90% or more of the shares in companies within a 10-year period.
See below for further details of both developments.
Stamp Duty Land Tax ("SDLT"): anti-avoidance rule may apply in the absence of tax as main motive
A recent English court decision suggests that the SDLT general anti-avoidance rule (Section 75A Finance Act 2003) may be of wider application than previously thought, and significantly wider than indicated in HM Revenue & Customs' own published guidance. Those involved in complex property transactions, particularly those involving reorganisation of ownership structures, should exercise extra caution and not rely on HMRC's published guidance.
The case of Hannover Leasing Wachstumswerte Europa Beteiligungsgesellschaft mbH & Another v HMRC involved the sale of commercial property in London to a German limited partnership. The ownership structure was relatively common, an English limited partnership whose limited partner was a Guernsey unit trust. The sellers intended to structure the disposal as a sale of their units in the unit trust. This would have been straightforward, free from SDLT and unlikely to be susceptible to challenge under Section 75A. However, the purchaser, a German limited partnership, was not willing to acquire the units while the unit trust still owned the partnership due to concerns about historic liabilities. Therefore the following transactions took place:
- On 22 August 2011 the property was sold by the partnership to the unit trust;
- On 26 August 2011 the unit trust transferred its interest in the partnership to the principal unit holder;On the same day, the unit holders agreed to sell the unit trust, which now owned the property, to the Hannover Company;
- On 31 August 2011, the unit sale was completed and the unit trust immediately distributed the property to the Hannover Company, now the main unit holder; and
- On 15 November 2011, the Hannover Company contributed the property to the German partnership.
These steps involved three transfers of the property but the amount of SDLT paid was minimal as the parties claimed relief under provisions designed to prevent SDLT charges on transfers between partnerships and their partners and distributions by unit trusts where there is no ultimate change of ownership. The commercial change of ownership was the sale of the unit trust which was not subject to SDLT. Compared to the sellers' original intention to sell the unit trust, the SDLT bill was slightly higher, but it was much lower than the amount which would have been paid if the English partnership had sold the property to the German partnership direct. HMRC determined that the transactions were inter-dependent and, applying Section 75A, assessed SDLT on the basis of a sale by the English partnership as notional vendor to the German partnership as notional purchaser.
The Court held, following the Supreme Court's decision in the case of Project Blue (see the article on LawNow) that it was not necessary to identify a tax avoidance scheme exploiting a loophole in SDLT legislation in order for Section 75A to apply. It was sufficient in this case that the transactions were inter-dependent (as clearly shown in the steps paper and heads of terms) and that the SDLT paid was less than it would have been if the property had been transferred from the English partnership direct to the German partnership.
Points to note:
- The result may well have been different if the unit sale had taken place before any of the property transfers. This is because Section 75C states that a transfer of shares or securities (which includes units for this purpose) will be ignored if it would be the first of a series of transactions.
- The Heads of Terms and Steps Plan made it abundantly clear that the transactions were all pre-planned and inter-dependent, thereby making it easier for HMRC to characterise them as "scheme transactions".
- The parties unsuccessfully tried to rely on HMRC's published guidance but this had not been updated to reflect its view that a tax avoidance motive was not necessary for application of Section 75A. At the time of writing it has not yet been updated so should not be relied on.
- The court in question was the First Tier Tribunal whose decisions are not binding on other courts and may well be appealed, but those advising on complex UK property transactions will need to exercise greater caution to ensure they do not fall foul of Section 75A, particularly where property ownership is restructured prior to the sale of a property SPV.
German government expected to submit RETT share deal to Parliament
On 8 May 2019, the German government drafted the 2019 Annual Tax Act bill, which includes amendments to the real estate transfer tax (RETT) for share and partnership deals. Announced at the Conference of the German State Finance Ministers, this RETT will affect transactions that indirectly or directly involve shares in companies and partnerships whose assets include German real estate. See our earlier Focussing on Funds for the background to these changes.
The government is expected to submit this bill to the Bundesrat shortly for debate and eventual passage. The following are its most important features vis-a-vis real estate transactions:
- The threshold is reduced from 95% to 90%: The new 90% threshold applies to RETT-liable "consolidation of shares" in partnerships or companies, including indirect consolidation.
- New shareholders in companies and partners in partnerships are to be taxed: The rules for taxing new shareholders and partners will be tightened. Transfers (including indirect transfers) to new partners of at least 90% of the participation in the partnership’s assets that include real estate will be subject to a real estate transfer tax, and a 10-year monitoring period will apply. A corresponding taxable event will be introduced for the transfer of company shares to new shareholders and the company itself will be the tax debtor.
- The tax-privileged acquisition of a minority interest from an "existing partner" is only possible after 15 years: The acquisition of a minority interest in a partnership from an existing partner is only eligible for tax privileges after a holding period of 15 years from the date of the buyer's initial acquisition of majority interest in the partnership. Also, the current holding periods are extended from five to ten years, which are a legal requirement for application of tax exemptions pursuant to sections 5 and 6 of the German Real Estate Transfer Tax Act.
The draft bill contains wide-ranging transitional regulations, which have significant practical implications. These regulations are highly complex and must be carefully considered in each case. Specifically, the following provisions are being planned:
- The above-mentioned new regulations will generally apply to acquisitions made after 31 December 2019. In individual cases, application of the new regulations can be deferred to a later point in time.
- For non-taxable consolidations of shares or changes of shareholders (or partners) amounting to between 90 and 94.9%, the transitional regulations aim to ensure that an additional acquisition reaching the former threshold of 95% will still be taxable in future, irrespective of the threshold reduction to 90%. As a rule, an "additional acquisition" of this type will still be taxable if the share ownership threshold has reached 90% by 31 December 2019.
- The ten-or-15-year holding-period extensions in the draft bill, which are required for tax exemptions pursuant to sections 5 and 6 of the German Real Estate Transfer Tax Act, will not apply if the current period of five years has already expired by 1 January 2020.
The main content of the draft bill has already been publicised through press releases and other sources. Despite justified criticism from the real estate industry, the German government is expected to stay the course and submit the bill to the Bundesrat.
Under this bill, a RETT-privileged share deal will require the existing shareholder or partner to retain a minority shareholding of more than 10% for more than ten years, irrespective of the legal form of the property ownership vehicle.
If the draft bill's transitional regulations for taxing an additional acquisition breaching the former threshold of 95% are implemented without further changes, additional effort will be necessary to monitor and review these potential RETT-liable events. In our opinion, it would be more reasonable to limit the application of these regulations to a more manageable transitional period.
The other transitional regulations can be viewed positively since they carry a low risk of an adverse retroactive effect. However, minority-shareholding acquisitions (usually based on option rights) planned for after 31 December 2019 remain problematic. The transitional regulations will have to be considered in each individual case.
Businesses anticipating share deals or the exercise of option rights in coming years should monitor the legislative process and carefully consider the amendments in this bill before completing a transaction.