Real estate investment: issues in Germany

Taxing times

17 June 2015

Jürgen Bauderer outlines some of the key issues for those investing in German real estate

Germany is often viewed by international investors as the most stable real estate market in Europe. In addition, continuously low interest rates result in attractive financing conditions that make up for constantly high multipliers across Europe. Before embarking, foreign investors should in particular be aware of the following tax aspects and particularities.

Real estate transfer tax

Real estate transfer tax (RETT) is imposed not only on the direct acquisition of real estate (i.e. in asset deals), but also on certain share deals. While the detailed rules can be somewhat complex, as a general principle RETT is triggered if 95% or more of the shares in a company that, directly or indirectly, owns German real estate are transferred within 5 years or are, without any time limitation, assembled in the hands of one or a group of acquirers. In general, in case of asset deals RETT is levied based on the consideration paid, and in share deals based on the so-called special tax value of the real estate (in practice, usually amounting to 70% of the fair market value).

The applicable RETT rates depend on the state where the real estate is located. Currently, rates in Germany vary between 3.5% (e.g. Bavaria and Saxony) up to 6.5% (e.g. Schleswig-Holstein, Nord Rhine Westphalia and Saarland). Further increases may be decided by the states over the forthcoming years. In case of a share deal, RETT may only be avoided by not exceeding the thresholds of less than 95%. Depending on the specific facts, this may be achieved by the seller retaining a 5.1% stake in the structure.

Trade tax

In addition to corporate income tax (CIT) at an effective rate of 15.825%, real estate investments may also be subject to trade tax (TT), provided a permanent establishment is maintained in Germany. TT generally is levied based on the CIT base, adjusted by certain add-backs and deductions. Depending on the municipality, the applicable rate generally varies from 7% to 17.15%, potentially causing a substantial overall tax leakage.

To avoid this, German-bound real estate investments are often structured by using a foreign corporation (e.g. a Luxembourg SARL) as the acquisition vehicle. However, in such scenarios, care must be exercised to avoid a German permanent establishment. In particular, it has to be documented that the property company maintains its effective place of management outside Germany (e.g. by regularly held board meetings abroad) and that substantial management decisions are not delegated to German service providers such as property managers. German property managers should also not be authorised to legally represent the property company (e.g. in concluding lease agreements).

Earning stripping rules

For efficiency reasons, foreign investors aim at ensuring that interest payments on internal and external debt are tax deductible. Under German tax law, interest expenses are generally tax deductible provided the respective debt is effectively connected to German (taxable) income and interest is charged at market rates. However, the German earning stripping rules impose a ceiling on the deductibility of net interest expenses (i.e. interest expenses less interest earnings) of up to 30% of earnings before interest deduction, taxes, depreciation and amortization. This rule applies to interest on loans from both related and unrelated parties. Exemptions to the rules include a de minimis threshold of €3m (i.e. net interest expenses of less than €3m pa are generally deductible irrespective of the 30% ceiling).

Regulated fund vehicle

In practice, institutional investors such as pension funds, sovereign wealth funds, or insurance companies may prefer or are for regulatory reasons only allowed to invest in or via regulated investment fund vehicles, such as a German domestic asset pool (Sondervermögen). A fund of this type does not have a legal personality and is not incorporated, but is established in contractual form (i.e. contractual-type funds) between the investors and the investment fund’s management company. Due to the lack of legal personality, assets belonging to the fund are legally owned by the management company, which holds them in trust and for the account of the fund and the investors.

A domestic asset pool provides several tax advantages, e.g. a complete tax exemption (CIT and TT) at fund level – provided certain criteria are met – but taxation with 15.825% at foreign investor level, a non-application of earning stripping rules at fund level and a RETT neutral transfer of fund units.

Jürgen Bauderer is Partner, Real Estate Tax at Ernst & Young

Further information

This feature is taken from the RICS Property journal (May/June 2015)