The German real estate market is still buoyant, attracting a significant number of foreign investors. Recently, it has been possible to observe realizing profits and streamlining portfolios. More and more foreign investors are structuring the acquisition of shares in foreign companies owning German real estate (share deal), sometimes via interposed German companies, rather than by direct acquisition of real estate (asset deal). Till now, it has been possible to avoid German taxes on the sale of shares in such foreign companies, in contrast to the more direct sale of German real estate involving an asset deal.
Expanded taxation of capital gains related to German real estate expected
The expansion of capital gains taxation derived from the (indirect) sale of German real estate has been a source of discussion for a long time. Looking to the future, German legislation is likely to amend domestic tax law as follows:
- Introducing of capital gains tax from the sale of shares in foreign corporations owning German real estate
- Amending of the determination of taxable capital gains for foreign companies selling German real estate directly
- Tightening German RETT on the sale of shares in companies owning German real estate
New capital gains tax from the sale of shares in foreign corporations owning German real estate
Capital gains derived by an individual or incorporated foreign shareholder from the sale of shares in a foreign (or domestic) corporation are expected to be subject to limited income tax liability in Germany. From what we here, this will be the case if, at any time during the 365 days preceding the sale, these shares derived more than 50 per cent of their value directly or indirectly from real estate situated in Germany but only if the seller owned the shares at that time.
However, the new capital gains tax also seems to apply to situations in which the real estate company had already sold its real estate before the sale of its shares. Germany would thus tax not only the profits from the sale of the real estate, but also for the shares in the former real estate company for a further year.
The new capital gains tax will affect share deals taking place after December 31, 2018. More importantly, the new capital gains tax will be limited to the portion of the fair market value that to be added only after December 31, 2018. To avoid disputes with the German tax authorities on the valuation of the business and the valuation of German real estate close to the end of 2018, the investor could consider selling some shares to a third party in 2018 to document the fair market value at that time.
Tax treaty implications for new capital gains tax
The new domestic capital gains tax is in line with Germany’s latest bilateral tax treaties corresponding to the OECD Model Tax Convention (OECD MTC) including Art. 13(4). In other words, Germany has a taxing right for such capital gains under its tax treaties.
All the same, the 365 days rule was only included in the 2017 update of the OECD MTC. Thus, it has not (yet) been integrated into German tax treaties. Therefore, if a tax treaty applies, the shares in the foreign company must derive more than 50% of their value from German real estate at the time of sale, irrespective of the composition of their value before that time. From a tax planning perspective, the shares’ value could be adjusted (e.g. by granting shareholder loans) before the time of their sale in order to fall below the 50% when they are sold. Nevertheless, it is expected that Germany will amend approximately one-fifth of its tax treaties accordingly by implementing the Multilateral Instrument in the near future.
What about domestic tax exemption for foreign companies selling shares in such foreign companies?
That said, if the foreign seller is not an individual but a corporation, the capital gains from the sale of company shares are tax exempt for corporate income tax purposes under German domestic law. This view has also been taken by the German tax authorities and German tax courts.
Tax authorities in Germany normally consider the capital gains from the sale of company shares only as, in fact, partially tax exempt (95%) for corporate income tax purposes. This partial tax exemption applies within Germany.
For all that, interpreting the wording of German domestic tax law, the Federal Tax Court concluded that capital gains are fully tax exempt (100%), unless the foreign selling company has a permanent establishment in Germany, to which the shares are allocated. Nevertheless, it is still uncertain whether the German tax authorities will generally apply this decision for all other cases, i.e. 100% tax exemption, or will limit its application to the case decided.
In any case, foreign selling companies will have to file German tax returns for the sale of shares in foreign companies owning German real estate, even if zero capital gains are to be declared. However, administrative fines will presumably not apply for late filings by foreign sellers if the capital gains are fully tax exempt.
Computation of taxable capital gains for foreign business investors selling German real estate
If a foreign business investor sells German real estate directly, the realized capital gains are still subject to limited income tax liability. However, as the standard procedure for computing these capital gains is not explicitly covered in the Tax Code, the general rules and principles for the computation of business profits and losses are applied. This will remain the case in the future. Nonetheless, it will now be explicitly stipulated that capital gains are the difference between the purchase price and the historical acquisition costs, minus amortization and all other expenses (e.g. financing costs) that are not directly economically connected with other income, even if they have been incurred before the sale (i.e. at a time without limited income tax liability).
Moreover, capital gains will now include changes in the value of other assets or debts that are related to the German real estate. The legislature has leveraged real estate investments in mind, in which the creditor waives a loan. The income realized at the level of the debtor will now be part of the capital gains.
German real estate transfer tax (RETT) – current situation
The transfer of German real estate usually triggers real estate transfer tax (RETT) of 3.5% to 6.5% of the purchase price or the fair market asset value. The actual tax rate depends on the German region where the real estate is located.
However, there are some opportunities to avoid the German RETT by structuring the acquisition of shares in companies owning German real estate (share deal) if it is below a 95% threshold, rather than by acquiring real estate directly (asset deal). To put it simply, a tax-free share deal requires that the investor (or related investors) directly or indirectly combines less than 95% of the shares in the real estate company. Partnerships owning German real estate may not have transferred the remaining 5% or more in the previous five years. The indirect acquisition of companies owning German real estate is more complicated.
If the 95% threshold is exceeded, German RETT is triggered on the total fair market value of the German real estate affected. In practice, this threshold can be unintentionally triggered by foreign MNEs during divestments, international group reorganizations or post-M&A integration, even several times. To avoid this risk, the shareholding of a group company owning German real estate and leasing it to other affiliated companies has sometimes structured the ultimate foreign parent company owning more than 5% of the German real estate company (RETT blocker structure).
Tightening German RETT on share deals involving German real estate
The public has perceived such type of share deals as harmful, although a share deal is not fully comparable with an asset deal in terms of a higher risk when acquiring a legal entity instead of a single asset. The new German government addressed this issue by incorporating it into its coalition agreement including future tax-policy goals and the measures to achieve them, including the tightening of the German RETT for direct and indirect transfers of shares in companies owning German real estate.
It now appears that the Finance Ministers of the Federal States have agreed to tighten the German real estate transfer tax (RETT) in direct and indirect transfers of shares in companies owning German real estate. Most importantly, the decisive 95% threshold will be reduced to 90%. Moreover, a new RETT-triggering event for (indirect) share deals within MNEs will be introduced. In the case of a partnership owning German real estate, the relevant period of 5 years will be extended to 10 years.
Next, the legislature will draft a respective bill.
Impact on foreign MNEs owning German real estate
The expected tax developments in Germany show that sooner or later the German tax burden for foreign investments in German real estate will increase. Foreign MNEs with a German RETT blocker structure in place have to carefully monitor developments in the months ahead.