As the interest rates on financial investments considerably decreased in the aftermath of the European financial crises, real estate is widely seen to be a potential alternative. In this regard international investors in particular seem to focus on Germany. While according to recent figures in 2009 only 14 % of the investors in German real estate came from abroad, in 2015 already 68 % of the real estate investments were made by foreign investors. From a taxation perspective Germany offers considerable opportunities for inbound real estate investments. This guide provides some general information on major tax issues in such cases and a brief overview of some typical advantages and disadvantages of common investment scenarios. Please note that this guide cannot substitute professional advice taking into account the individual circumstances of the investor and the target at hand. I. Real Estate Investments: German Taxation Principles 1. Corporate Income Tax ("CIT") The rate of the German Corporate Income Tax (in German: Körperschaftsteuer ) currently amounts to 15.0%. An ancillary charge (the solidarity surcharge, Sol, in German: Solidaritätszuschlag ) of 5.5% of the CIT applies to all German income tax charges, leading to a combined income tax rate of only 15.825% applicable to inbound real estate investments by foreign corporations. However, in case of significant debt financing the effective tax burden might be higher as a consequence of the German thin capitalization regime. Foreign partnerships are not subject to German corporate income tax as long as they qualify as partnerships also from a German tax perspective. In this case, partnerships are supposed to be transparent for income tax purposes leading to direct income taxation of the partners holding the partnership interest. 2. Trade Tax ("TT") The rate of 15.825% mentioned above is only achieved if German Trade Tax (in German: Gewerbesteuer ) is avoided. TT is a local tax levied by the German municipality in which an enterprise has a permanent establishment. The municipalities are also entitled to fix the TT rate applicable in their territory (between approx. 7% and 19%). The TT assessment base is formed by the so called trading income of the relevant permanent establishment of the vehicle. The trading income consists of the income for CIT purposes after certain adjustments according to specific add-back and cut-back provisions of the German Trade Tax Act. For international investors there are different possibilities to avoid TT on real estate investments. As the case may be, investors could even make use of several of lines of defence against a TT burden on the investment: If the business activities of the company are strictly limited to the long-term use and management of own real estate, the so called extended trade tax exemption may allow for a carving out of the whole lease income of the TT assessment base. However,
investors must be aware of the fact that the requirements for this cut-back are interpreted incomparably strictly by the German tax authorities as well as the courts. In particular, de minimis thresholds are not accepted within this cut-back provision. Therefore, the tax structuring of the investment must, in particular, ensure that the entity does not rent any other assets (e.g. business fixtures, inventory etc.) to the tenants apart from the immovable property and does not render any other services to them beyond the mere lease of the immovable property owned by the entity. If such additional services are demanded by the tenants, there are in practice, nevertheless, structuring options in order to achieve this without losing the extended trade tax exemption. Another approach, especially of interest for foreign investors, is the avoidance of a German permanent establishment. For trade tax purposes, the mere ownership of a (even fully) rented building located in Germany does not in principle constitute a permanent establishment per se as it does not serve the landlord to conduct his business, but rather the business of the tenants. Yet, here again, there are different aspects which must be considered not only within the agreements, but also with regard to the practical implementation. For example, any kind of office or place where management decisions of the landlord are made should be outside of Germany. A German property or asset manager might be harmful from a trade tax perspective, too. In this regard the proper contract drafting as well as its due implementation and documentation is fundamental in order to avoid the foundation of a taxable permanent establishment. 3. Real Estate Transfer Tax ("RETT") While TT is an ongoing duty primarily aiming at the lease income in the letting phase, German Real Estate Transfer Tax (in German: Grunderwerbsteuer ) may be triggered upon the transfer of real estate (e.g. via asset deal) as well as upon the direct or indirect transfer of participations in real estate vehicles (share deal). Recently the German federal states have been entitled to determine the RETT rates applicable to real estate situated in their territory. Since then, a veritable race to the top can be observed. Currently, the tax rate ranges from 3.5% (e.g. Bavaria, Saxony) up to 6.5% (e.g. North Rhine-Westphalia, Schleswig-Holstein). Because of this development the management and reduction of RETT is one of the key issues when structuring investments in German real estate: As soon as a binding agreement on the transfer of German real estate has been concluded and notarized, RETT is triggered and may become payable even before the transaction is closed. According to standing market practice it is usually the purchaser who agrees to take over the RETT. The assessment base is formed by the consideration agreed upon between the parties. Hence, the constantly rising purchase prices of real estate at least in Germany's major cities are boosting the importance of RETT from a fiscal perspective. Besides the mere sale of immovable property the German Real Estate Transfer Tax Act also provides for numerous other ways of transfer subject to RETT, e.g. mergers, spin-offs, interim tradings etc. Broadly
speaking, RETT is in practice not avoidable if German real estate itself is transferred from one legal entity to another. RETT must also be taken into account in the event of a share deal as soon as there is German real estate anywhere in the corporate structure below the company whose shares are to be transferred. There are different rules to be considered: According to the so called "participation rule" the direct or indirect transfer of 95% or more of the interest in the assets of a partnership possessing German real estate to new partners within five years will trigger RETT upon the last relevant transfer. On the basis of the so called "concentration rule" RETT will also arise if 95% or more of the shares in a corporation or the interest in the assets of a partnership possessing German real estate are to be transferred at once or to one hand. This rule has recently been amended in order to address structures which at least economically lead to such a concentration as well. Generally speaking, these share deal provisions are highly complex because of their underlying and rather specific logic. Nevertheless, in contrast to asset deals investors should be aware of the fact that there are still some structuring options (e.g. club deal) allowing for a significant reduction or even complete avoidance of RETT when transferring shares in such companies. Against the background of constantly rising housing prices as well as RETT rates real estate share deals are becoming increasingly attractive for investors. 4. Value Added Tax ("VAT") Regarding German Value Added Tax (in German: Umsatzsteuer ) the structuring objective is rather to be seen in the avoidance of substantial tax downsides than in the achievement of an upside. As the economic impact of VAT on the returns of the investment may be considerable (current tax rate: 19%), VAT is regularly a major issue within the tax due diligence process as well as within the drafting of the necessary tax clauses in the lease agreements and in the transaction documents: In principle, the renting of German real estate is a VATable, but VAT-exempt supply of services. Due to this VAT exemption, the landlord on the one hand does not have to submit the rent under VAT. Yet, on the other hand he consequently is also not entitled to deduct input VAT on any supplies received with respect to the renting services. Such input VAT may achieve considerable amounts, e.g. when it comes to construction and maintenance costs. Therefore, under certain circumstances the landlord is allowed to opt for VAT regarding the renting. While the VAT on the rent may then be charged to the tenants (who themselves might deduct this input VAT within their VAT declarations), the landlord may deduct his input VAT burden. Yet, it must be taken into account that such an option for VAT depends on certain prerequisites to be taken care of on a case-by-case basis, e.g. when concluding the lease agreements or, as the case may be, when examining exiting lease agreements on the occasion of a tax due diligence. As soon as the conditions for the deduction of input VAT change during the renting phase, also the question of input VAT corrections has to be dealt with. As to the sale of German real estate via asset deal different scenarios have to be distinguished for VAT purposes: If for example the object is already let to tenants and
the purchaser continues these tenancies after the acquisition, the sale might have to be qualified as a so called transfer of a business or of a separable part of a business as a whole, which as a rule is not subject to VAT. However, depending on the individual circumstances of the case the sale might also be a VATable, but VAT-exempt delivery. Here again the question would be, whether the seller is able to opt for VAT in order to avoid any corrections of input VAT deducted in the past. For the purchaser such an option might lead to the so called reverse charge system meaning that he has to fulfill certain conditions in the future in order to avoid an input VAT burden on the purchase price. Because of the fact, that the distinction between business transfer and delivery is usually not that clear-cut, both possibilities have to be taken care of within the necessary tax clauses in the purchase agreement. If the real estate is sold via share deal, in practice the VAT treatment of the transaction is often not appropriately considered. Generally speaking, from the perspective of the purchaser it is recommended that the purchase price is gross and may, therefore, not be increased by any VAT amounts. Moreover, the seller should explicitly waive any potential VAT option right within the contract. 5. Further Potential Tax Issues As a regular tax on assets German Real Estate Tax ( RET, in German: Grundsteuer ) applies on all German real estate investments. RET is an annual local tax and the applicable tax rate differs between municipalities. As RET is usually borne by the tenants as additional costs, this tax is generally not of great importance with regard to the returns of the investment. Yet, it must be noted that under certain circumstances the purchaser of real estate may become liable for German tax obligations including RET relating to the possession phase of the seller. Such issues have to be addressed in the purchase agreement, e.g. via indemnity clause. II. Typical Advantages and Disadvantages of Common Investment Scenarios The tax structuring must encompass the whole lifecycle of the real estate investment including the acquisition, the letting, and the exit phase and has to be tailored to the specific and individual circumstances of the case: A direct-investment by the foreign investor may be advantageous as far as the letting phase is concerned. Although CIT and Sol will definitely be triggered (in case of a corporate investment leading to a combined tax rate of 15.825%), German TT could in principle be avoided, if the landlord does not have any permanent establishment in Germany. As a second line of defence, all possible steps should be taken in order to ensure that the preconditions for the extended trade tax exemption will be met. As a downside of this structure it has to be borne in mind that the acquisition of German real estate via asset deal inevitably triggers RETT which is usually borne by the buyer. The constantly rising RETT tax rates may therefore lead to significant additional costs in the acquisition phase. Moreover, the VAT treatment of the acquisition and the avoidance of a liability of the purchaser for any outstanding tax obligations of the seller (e.g. RET, TT)
have to be dealt with in the purchase agreement in a way to ensure that the transaction is tax-neutral for the buyer at least to this extent. Upon a later sale of the object Germany would be entitled to tax any capital gains and would submit these to CIT and Sol while TT might again be avoided, as the case may be. When setting up an indirect-investment through a German partnership held by the foreign investor care has to be taken as to not trigger RETT twice for an asset deal as well as for a share deal. On the other hand, this structure may even allow for a significant reduction of the RETT burden, when the acquisition of the interest in the partnership is extended over a certain period of time, i.e. that not all shares are acquired at once. As to the letting phase the utilization of a German partnership would be disadvantageous insofar as the defence line of not having a permanent establishment is lost. Hence, the avoidance of TT would even more depend on the extended trade tax exemption when using a German partnership as investment vehicle. The exit out of the German partnership would generally be treated like a sale of the property within the international taxation regime. An indirect-investment through a German corporate subsidiary of the foreign investor may particularly be of interest in the case of larger portfolios. Such a structure may allow for a completely RETT-free acquisition of the target if certain preconditions are met. Lease income would again be submitted to CIT and Sol while TT might be avoided by the use of the extended trade tax exemption. As far as both the foreign shareholder and the German subsidiary qualify as privileged entities in the sense of the EU parent-subsidiary directive German withholding tax might not be charged on dividends. Depending on the applicable double taxation treaty any capital gains resulting out of a sale of the shareholding in the German corporation might yet be taxable in Germany. In a nutshell, inbound real estate investments should be structured carefully in advance in order to profit from significant tax advantages offered by the German tax regime. With regard to the transaction documents as well as the lease agreements tax risks for the investor should be minimized by the use of appropriate tax clauses tailored to the particularities of the case. To discuss your requirements please contact the International Office on +44 (0) 1245 449266 or email us directly. Kreston International Kreston International Limited is a global network of independent accounting firms with the reputation for providing trusted compliance and advisory services to entrepreneurial business in the SME and mid-market sectors. Currently ranked as the 13th largest accounting network in the world, Kreston has a presence in over 100 countries, providing a resource of over 20,000 professional and
support staff. Our members are accustomed to working together to deliver cohesive international solutions to ensure clients receive the highest quality of expertise available in their respective countries. Beyond assurance, quality and experience, clients will enjoy the unique synergy that stems from the trusted relationships that Kreston members have created globally and which support the consistent delivery of exceptional international service. This information is provided for guidance only and is not a substitute for professional advice. Neither Kreston International Limited nor its member firms accept any liability for any loss arising as a result of actions taken or not taken based on the information contained in this document. The information in this document was prepared as at 31 May 2016