CMS - Focusing on Funds - Tougher Tax Rules for German Real Estate

This Focussing on Funds update looks at the continuing hot topic of how tax changes affect fund structures and deals. Following our previous look at the France and Luxembourg double tax treaty, the focus below is on German real estate. We also mention, as part of the general hot topic, UK changes for non-UK ownership of UK real estate and provide links to further information.

Tax changes for investment in German real estate

The proposed German tax changes affect the sale of companies owning German real estate directly or indirectly. They are likely to increase the tax cost of investing in German real estate. The changes are general in application and will potentially affect owners such as funds with investments in German real estate as well as vehicles which hold those interests. As explained below:

• it will be more difficult to prevent liability to German real estate transfer tax on the purchase of shares in companies and partnerships owning German real estate; and
• shareholders not resident in Germany will become liable to German tax on their gains on sale of shares in companies owning German real estate, even if the companies are not incorporated in Germany.

The UK also looks to extend tax on UK real estate

Germany is not alone in the news. The UK has been relatively unusual in not taxing non-residents on gains on UK commercial property. Following a consultation earlier this year, this will change in April 2019 when the UK will begin to tax non-UK residents on gains on UK property and on shares in UK-property rich entities. For further information on how these UK changes may affect investors, funds and other owners, click here.

GERMAN REAL ESTATE TRANSFER TAX ON SHARE DEALS

Proposed changes to German real estate transfer tax (“RETT”) will make it significantly harder to sell property companies or partnerships without triggering RETT.

Under current law, RETT is payable not only on sales of German real estate but also on direct or indirect sale of interests in real estate-owning partnerships or corporations. The rate varies between states, from 3.5% 6.5%. There is an exception for corporations if less than 95% is sold to one purchaser (or a joint group of purchasers) and for partnerships if less than 95% is sold and over 5% of the original partnership is retained by the seller for at least five years. In order to avoid liability to RETT, sellers often retain 5.1% of the partnership after sale of 94.9% and then sell the retained interest to the buyer after five years has expired. In order to make it more difficult to avoid RETT it is proposed, in broad terms, to:

• extend the stricter partnership RETT rules to sales of property owning companies;
• reduce to 90% the trigger for RETT on sale of partnership interests/shares in companies; and
• extend the five year period to 10 years.

As a result, RETT will be payable unless the seller retains over 10% for at least 10 years. It is not yet known when these changes will come into force but their implications should be taken into account on current transactions.

Read further for more details on this potential change in German tax law.

GERMAN TAX ON CAPITAL GAINS ON SALE OF REAL ESTATE COMPANIES

Germany also proposes to extend its taxing rights on sale of shares in certain companies directly or indirectly owning German real estate. If the proposed changes are implemented, Germany will be able to tax non-German residents on gains on sale of shares in foreign companies as well as shares in German companies.

Non-resident shareholders will be potentially liable to German tax on capital gains from the sale of shareholdings of 1% or more if over 50% of the value of the company at any time during the 365 days prior to the sale represents German real estate directly or indirectly. This new charge will apply not only to sale of companies which own property direct but also to sale of shares in holding companies and other companies which own shares in real estate companies directly or indirectly.

On the sale of shares in companies by other companies, there will be a reduced effective rate; typically 5% of the gain is subject to a corporate tax rate of 15.825%, but this reduced rate does not apply to sales of shares held as fixed assets by life and health insurance companies, nor to sales by banks and other financial institutions if they hold the shares as trading stock. Special rules also apply to sales by financial holding companies. For individuals the effective tax rate can be as high as 28.5%.

However, Germany’s right to tax non-German residents may, in some cases, be restricted by a double tax treaty with the shareholder’s country of residence. Germany’s treaty with the UK permits Germany’s taxing rights in this respect and the Germany/Luxembourg treaty has recently been amended to permit this.

To read more, click here to view the CMS Law-Now article.