Real estate investors with their corporate seat and management outside of Germany may be subject to German taxation on capital gains from share deals. Non-resident individuals (investing directly or through partnerships or funds) will primarily be affected.
According to a German draft tax bill, the sale of shares by foreign-based shareholders of foreign-based companies primarily holding real estate in Germany will trigger a new capital gains exit tax as of 1 January 2019. This change may signal a need for alternative exit strategies.
In classic No-PE structures (i.e. a structure avoiding a permanent establishment in Germany), foreign-based companies investing in German real estate are subject to German corporate income tax (at a rate of 15.8%) with respect to the company’s rental income and sale proceeds in case of asset sales of German real estate. Neither rental income nor capital gains are subject to German trade tax (generally ranging from 7-17%) if neither a company’s corporate seat nor permanent establishment is situated in Germany.
Share deal exits from No-PE structures are currently not taxable in Germany, i.e., capital gains from share deals with the target being a foreign-based real estate company (for example a Luxembourg S.à.r.l with non-German based shareholders) are not subject to German corporate income or trade tax. The draft bill aims to change that from January, 1, 2019.
Extended Taxation of Capital Gains-
Although neither the real estate company nor its shareholders are tax-based in Germany in No-PE structures, the legislature intends to tax capital gains from respective share deals. The draft bill con-cerns all shareholders of foreign-based companies, the share value of which directly or indirectly consists of at least 50% of German real estate.
The tax rate applying to those share deal gains depends on the shareholders’ legal form. Corporations face a tax rate of 15.8% (including solidarity surcharge), though in most cases they will benefit from the participation exemption regime. Capital gains of individuals, including shareholders of a tax transparent fund, are taxed at an effective income tax rate of approximately 25-30% — the new rules will affect them most severely.
Irrespective whether and to what extent the sale proceeds are thereby subject to German corporate tax, all shareholders of foreign real estate companies are obliged to file tax returns in Germany. In fact, shareholders may face criminal prosecution and fines in case of non-compliance. Notably, even minority shareholding of less than 1% of a company’s share capital leads to respective tax filing obligations.
The legislature’s motive to extend the taxation of real estate companies derives from a certain taxa-tion right in a number of double tax treaties. This allows German tax authorities to tax the proceeds from a sale of shares in case of foreign-based companies if they own property located in Germany. However, a domestic tax provision to exercise this right is lacking to date. Should the draft bill pass the legislative procedure, this gap will be closed from 1 January 2019.
In order to prevent the ratio of German real estate the target company holds dropping below 50% shortly before the shareholders’ exit, the envisaged tax provision will apply if, at any point during the year before the exit, the property objects in Germany constituted more than half of the company’s assets (review period). However, German tax authorities can use this anti-abuse rule only if the respective double tax treaties grant an equally comprehensive taxation right to the German Federal Republic. To date, none of Germany’s tax treaties contains such a clause.
The following aspects are now crucial for No-PE investments:
- Alternative investment structures – or an alternative exit structure in case of existing No-PE structures – may mitigate the effects of the new rules.
- Investors should carefully examine not only a potential tax liability, but also the potential obligation of foreign-based investors to file tax returns in Germany to avoid criminal prosecution.
- Investors should consider that combined asset and share sales can possibly result in a double taxation if the (already taxed) proceeds stemming from asset deals are not repatriated before the sale of shares is subject to capital gains tax.
- Shareholders of investment vehicles partly investing in German real estate and partly in other assets (including non-German assets) may find the need to prove that less than 50% of the company’s assets consist of German real estate a challenge. Predictably, minority shareholders with limited access to the necessary information will experience difficulties in this regard. This need should be addressed in purchase and shareholder agreements.
- January, 1, 2019 is not only the date on which the draft likely will come into force, but also the reference date for the calculation of the sale proceeds resulting from a subsequent exit. To be able to state the correct tax base, the individual real estate objects should be revalued with regard to this date if respective tax obligations are to be expected.