German REITs Update. Contents. Real Estate Investment Trusts ( REITs ) Where are we now? Real Estate Investment Trusts ( REITs ) 1

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1 German REITs Update. Real Estate Investment Trusts ( REITs ) A REIT is a vehicle that invests in property and enjoys a measure of protection from corporate and trade tax in return for an obligation to distribute a significant amount of the vehicle s cash flows to shareholders. REITs have been an important part of the real estate markets in the United States since 1960 and in Australia since They have existed in Holland and Belgium since 1969 and 1995 respectively and, more recently, have been launched in the Far East in early 2000 and in France in The UK will introduce REITs in Broadly, the aim of a REIT is to provide returns to investors that mirror returns an investor would expect if it owned the property directly. This could be achieved with various models. Basically the REIT does not pay any profit taxes on its rental income or capital gains, but instead the tax burden is shifted to the shareholder/investor, who pays tax on the distribution it receives from the REIT. Further, the REIT should provide a means for investors to participate in these returns by acquiring shares in the REIT without having to raise the prohibitively high levels of capital required to acquire property directly. Listed REITs provide liquidity by enabling the shares in the REIT (rather than the asset) to be traded. Contents Real Estate Investment Trusts ( REITs ) 1 Where are we now? 1 German REIT Team 6 Where are we now? At the moment we still have no official German draft legislation (e.g. a Referentenentwurf ) on the G REIT from the Ministry of Finance. Nevertheless a first unofficial working draft of legislation implementing a G REIT, prepared by the Ministry of Finance, has become available and has been the subject of many reports in leading newspapers. The current unofficial time table for the implementation of the G REIT is 20. September 2006 : draft legislation to be tabled in cabinet 19. October 2006 : first reading in upper House (Bundestag) 29. November 2006: final consultation 15. December 2006: confirmation of lower House (Bundesrat) August 2006

2 After these steps, the G REIT legislation could enter into force on 1 January The 52 page working draft, dated 1 August 2006, very likely will be subject to many maybe significant - changes. Especially the figures are quite often in brackets or vary on different pages. However the basic parameters of the legislators thinking are instructive. The draft follows the concept of a REIT as a normal but tax exempt German stock corporation ( Aktiengesellschaft ) with ordinary dividends ( Dividendenmodell ). Other widely discussed and suggested models including partnerships, investment funds, new defined trusts ( Trennungsmodell ) or usufructs ( Nießbrauchsmodell ) are apparently not any longer on the agenda. The legislator wants to position the REIT as an additional and legally district alternative to the well established open ended real estate investment funds ( offene Immobilienfonds ). The current wording contains a separate REIT framework ( REIT Rahmengesetz ) and the draft includes the following key points: 1 Company Stock Corporation with legal and factual seat as well as unlimited tax liability in Germany. Not regulated by German supervisor ( Bafin ). Minimum stated capital 15 million. Single class of shares with voting rights. Designation REIT AG or REIT Aktiengesellschaft in company name. Establishment by creation of a stock company or by transformation in REIT AG pursuant to transformation act ( Umwandlungsgesetz ). Listing on a recognised EU/EEA stock exchange. Application for listing within 3 years after establishment of REIT AG required. Pre REITs are possible, but no private REITs. Qualification as Pre REIT upon registration in commercial register. The REIT must distribute at least 90/95 per cent (the draft is not entirely clear in this point) of the profits within 12 months after the end of the accounting period. Special reserve for investment purposes in cases of capital gains is possible. Income test: At least 75 per cent of the total profits must be profits from real estate. Asset test: At least 75 per cent of the total assets must be real estate. August 2006

3 2 Entry Charge and Exit Tax No entry charge or conversion tax on the fair market value of the real estate assets. Only 50 per cent of ordinary tax base as exit tax in case of selling real estate assets held longer than 10 year to G REITs (and open ended real estate funds). This is to motivate to realise hidden reserves in real estate assets. Only applicable until 2010 and not applicable if the tax payer will use the sold or contributed assets for his business, e.g. in sale and lease back structures. In this respect the draft contains different messages on different pages: It is likely that the 10 year holding period will be reduced to 5 years and sale and lease back structures will fall under this privileged tax rule. No privileges regarding Real Estate Transfer Tax ( Grunderwerbsteuer ). 3 Shareholder Structure No direct shareholding of 10 per cent or more. This rule is designed to avoid the application of reduced withholding tax rates for non German REIT investors according to many Double Taxation Treaties. Indirect holdings of more than 10 per cent are possible (but would generate no tax benefits). At least 15 per cent of the shareholding must be free float (participations of less than 3 per cent count as free float). It is still undecided how to monitor these rules in an efficient way. The draft suggests registered shares with restricted transferability ( vinkulierte Namensaktien ) and a simplified share register. 4 Debt Funding Restriction Leverage up to a maximum 60 per cent of all assets, as long as funding is arm s length and possible according to the articles of association ( Satzung ). This rule aims to achieve reasonable distributions for the shareholders and motivates equity injections in case of new investments. German REITs Update. 3

4 5 Harmful Activities Trading is not allowed: Trading means that gross purchase prices within five years exceed the average value per year within the same five year period by 50 per cent. Service activities have to be outsourced into separate and fully taxable subsidiaries. The value of these subsidiaries must not exceed 20 per cent of the companies assets. 6 Taxation and Sanctions at REIT Level Total exemption from corporate and trade tax ( Körperschaftsteuer und Gewerbesteuer ). Penalties for breaching the asset, income and distribution tests are possible as follows, subject to the assessment of the the fiscal authorities: (i) 1 to 3 per cent on assets breaching the 75% limit; (ii) 10 to 20 per cent on the gross profits exceeding the 75% limit; and (iii) 20 to 30 per cent on the amount by which the minimum distribution rule is breached. These penalties do not qualify as taxes. Loss of REIT status is possible in cases of persistent breach. Corporate law sanctions in case free float falls below 15 per cent include forced sale of shares upon resolution of shareholders meeting or repurchase of treasury shares. 7 Taxation at Shareholder Level Distributions taxable in the hands of the shareholder without any privileges, no half income method for private shareholders, no 95% tax exemption for dividends to corporations. REIT required to withhold tax of 25% (plus 5.5 per cent solidarity surcharge thereon) on distributions. However, some shareholders are entitled to receive distributions gross and some others enjoy reduced withholding tax rates. German resident shareholders are entitled to get credits or refunds for the withholding tax. For non German residents the German withholding tax is basically final, but reductions according to Double Taxation Treaties and depending on the shareholdings are possible. A reduction of withholding tax to zero according to the Parent Subsidiary Directive is not possible, because the German REIT is not designed as an entity with unlimited tax liability. Capital gains on share disposal fully taxable. August 2006

5 8 Topic REITs Topic REITs (e.g. hotels, shopping centres, warehouses) are possible, even with sale and lease back structures. REITs with flats and housing portfolios ( Wohnungs-REITs ) are possible, although this is still being heavily discussed in the government. 9 Important Open Points Time period for qualification as Pre REIT. Accounting according to German GAAP or solely under IFRS? This is relevant for nearly all necessary calculations of the legal conditions and hurdles. Details of Exit Tax. Rules to avoid owner occupied structures, that are unwanted according to the legislator. Rules for untaxed retained earnings of former tax exempt housing companies ( EK02 Issue ). Qualification of G REIT shares for regulated Insurance Companies as investors (share or real estate quota or new quota?) German REITs Update. 5

6 Amsterdam 22nd Floor, World Trade Centre Amsterdam Zuidplein XV Amsterdam Tel: (31 20) Fax: (31 20) Berlin Rankestraße Berlin Tel: (49-30) Fax: (49-30) Brussels Rue Brederode 13 B Brussels Tel: (32-2) Fax: (32-2) Köln Börsenplatz Köln Tel: (49-221) Fax: (49-221) Frankfurt am Main Mainzer Landstraße Frankfurt am Main Tel: (49-69) Fax: (49-69) German REIT Team For Real Estate Investments in Germany we have formed a dedicated team: capital market, corporate and tax lawyers with extensive experience in the structuring and handling of complex capital market transactions, in particular IPOs; real estate lawyers with expertise on large-scale portfolio acquisitions and tax-optimised financing; investment management experts with extensive funds know-how. We have been actively participating in the current German REIT debate and we are working closely with our clients to discuss opportunities for conversion and for the creation of new vehicles in Germany. We have developed solutions for various models and structural questions that will arise. For more information please contact: Dr. Florian Schultz Michael Steinbrecher Direct Dial: Direct Dial: florian.schultz@linklaters.com michael.steinbrecher@linklaters.com Dr. Herbert Harrer Christoph Vaupel Direct Dial: Direct Dial: herbert.harrer@linklaters.com christoph.vaupel@linklaters.com Alexander Vogt Direct Dial: alexander.vogt@linklaters.com London One Silk Street London EC2Y 8HQ Tel: (44-20) Fax: (44-20) Madrid Calle Zurbarán, 28 E Madrid Tel: (34) Fax: (34) München Prinzregentenplatz München Tel: (49-89) Fax: (49-89) New York 1345 Avenue of the Americas New York, NY Tel: (1) Fax: (1) Paris 25 rue de Marignan Paris Tel: (33) Fax: (33) This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts at Linklaters, or contact the editors. Linklaters. All Rights reserved 2006 Please refer to for important information on the regulatory position of the firm. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com 6