Domestic and foreign investors rate the German real estate market as extremely attractive, in particular due to low interest rates and market security. This is also true today, although there has been a slight increase in interest rates over the past six months. Over the past few years, a steady increase in investment volume has been observed. While just ten years ago (in 2009) the real estate investment market hit rock bottom with a transaction volume of around 13.4 billion Euro, there have been positive changes, especially from 2013 onwards. The transaction volumes increased annually by about 6-8 billion Euro. By 2015, a new peak was reached with a transaction volume of 79 billion Euro. Even though the transaction volume is now decreasing slightly (2016 in the amount of 65.7 billion and 2017 in the amount 72.8 billion Euro) the German real estate market is in high demand. A sustained high level is to be expected for 2018 also. This applies in particular to foreign investors.
A successful real estate investment depends on the right framework conditions. In particular, the choice of the investment model is of central importance concerning tax law. Depending on the investment model the tax burden for the investor can be significantly reduced. For tax optimisation, the foreign investor can choose between a direct investment or, a structurally more sophisticated, indirect investment via a capital company or a partnership. The following overview (Part 1) focuses on German income tax. It deals with income tax, corporate tax, real estate transfer tax and trade tax issues. Part 2 of the overview will illuminate the principles of value added tax.
Direct investment as an individual
When private investors (as an individual) invest directly into real estate by buying real estate objects and directly acquiring real estate property, we speak of a so-called direct investment.
The extent to which a direct investment in Germany must be taxed depends in particular on the respective investment activities of the private investor. In that regard, a distinction must be made between a commercial investor and an asset managing investor. The distinction is based on the overall picture of the conditions and generally accepted standards. With commercial activity, the exploitation of substantial assets via reallocation takes centre stage. With asset management on the other hand, the utilisation of assets regarding the beneficial use of substance that must be maintained is typical. As a rule, an investor acts in a commercial way if the purchase and sale of estate and buildings correspond to the general image of a “real estate agent”. When applying the principle of the so-called three property limit, the sale of more than three objects within a five-year period is regarded as commercial activity. If an investor does not generate this commercial picture, he will be, in general, only an asset manager. This is the “usual case” for foreign investors in the private sector.
Experience has shown that foreign private investors act with the intention of earning income. Even if the intention to earn income has to be assessed on a case-by-case basis, established case-law of the German Federal Fiscal Court (BFH) irrefutably assumes an intention to earn income when long-term apartment letting or leasing is present.
For the taxation of foreign private investors in their country of residence, it is crucial whether they have concluded a so-called double taxation agreement (DTC) with Germany. According to Article 13 (1) of the OECD Model Tax Convention, profits resulting from the sale and, pursuant to Article 6 (1) of the OECD Model Tax Convention, rental income and leases are taxed in the country of residence (this means in Germany). In accordance with German negotiation practice, such income is no longer taxed in the country of residence. Pursuant to Article 23 A (3) of the OECD Model Tax Convention, however, the country of residence normally reserves the right to take into account the exempted income when setting the tax rate (so-called progression clause). But there are also other countries (typically from the Anglo-Saxon legal area) that choose the imputation method (Article 23 B OECD Model Tax Convention). Then the German tax is charged onto the tax of the home country.
Amount and type of German tax
For private investors, only the income tax is relevant. In contrast, foreign private investors are not subject to trade tax, as long as the real estate investment does not reach a level that leads to commercialisation (see above) and there is no permanent establishment in Germany. Rented or leased property does not count as a permanent establishment regarding the German tax system or the OECD Model Tax Convention. For a domestic permanent establishment there must be “a sufficient degree of stability and a structure that, from a human and technical point of view, enables an autonomous performance of the service in question”. Generally, because of this, the mere letting/leasing of property does not constitute a permanent establishment in Germany.
However, pursuant to Section 1 (1) no. 1, 2 GrEStG (German Real Estate Transfer Tax Act) the purchase of real estate is subject to real estate transfer tax varying from 3.5% to 6.5% depending on the federal state. A so-called property tax is also added, which will be neglected here.
Income from ongoing revenues
Income resulting from letting and leasing immovable property relates particularly to land and buildings in accordance with Section 21 (1) sentence 1, no. 1 EStG (German Income Tax Act). The foreign private investor is therefore subject to limited income in Germany in accordance with Section 49 (1) no. 6 EStG. Pursuant to Section 50 (1) sentence 2 with Section 32a (1) EStG he has to tax his income under the progressive income tax rate. He regularly has no advantages from the joint assessment with the spouse.
According to this, in the year 2018 incomes of up 9,000 Euro remain tax-free. Subsequently, the marginal tax rate increases. An income of up to 54,949 Euro is taxed at a rate of 14 % to 42%. An income of 54,950 Euro up to 260,532 Euro is taxed at a fixed rate of 42%. An income of 260.533,00 Euro upwards falls under the so-called “wealth tax” of 45%.
A solidarity surcharge of currently 5.5% of each yet to be determined income tax is added. As a result, the aforementioned income tax rates can increase up to 47.475%.
Income from the sale of real estate
In principle, the income tax for the sale of real estate is only due in the event that the sale takes place within the so-called speculative period. According to Section 49 (1) no. 8 letter a) with Section 23 (1) no. 1 EStG this takes effect if there are no more than ten years between the acquisition and the sale of the property (with the respective conclusion of the contract of sale).
The assessment basis for the income tax is the capital gain. In order to determine the capital gain the selling price must be reduced by the acquisition or production costs, as well as the advertising costs, and increased by the deduction for wear and tear. If the investor trades commercially the trade tax will also be due. In this case, however, according to Section 35 EStG, the income tax is reduced by a compounded deduction of trade tax, insofar as it is proportionate to the business income contained in the taxable income.
If the investor resells the property within ten years, the income tax arises according to the progressive income tax rate (see above). After the expiration of the ten-year limit the foreign investor benefits from the same exemption under Section 23 (1) no. 1 EStG for private sale transactions, which also applies to persons with unlimited tax liability.
The indirect investment as an institutional investor
Institutional investors represent the majority of foreign investors on the German real estate investment market. While in the above section the natural persons “themselves” buy the property, the following covers the legal situation when natural persons integrate themselves into a company form. The property is bought by a company in a so-called indirect investment. The property will become a company asset. The company is the investment vehicle. Here, a distinction is made between an investment via a foreign corporation and an investment by a German asset management partnership (typically a GmbH & Co. KG). There are also investments through foreign partnerships.
Indirect investment through a foreign property corporation
In this structural variant, the foreign investor invests via a foreign corporation. This may typically be a corporation residing in the EU area, for example a Luxembourgish S.à.r.l. In any case, the foreign company’s type must correspond to a German corporation. Generally, the investor constructs this foreign corporation as a sole shareholder. Often, for the purpose of the perfect exit flexibility, a separate foreign corporation is established for each property (one property company). In turn, the corporation acquires the German property (so-called asset deal). If a (one) property company already has a property within its assets, there is also the option of acquiring (all) shares of this already existing company (so-called share deal) and thus allowing the property to be included indirectly into its assets. This also produces topics regarding the deduction of financing interests.
Income from ongoing revenues (letting and leasing)
According to Section 49 (1) no. 2 letter f) double letter aa) EStG with Section 2 no. 1 KStG (German Corporation Tax Act), the foreign property corporation with its current letting and leasing income is subject to limited corporation tax in Germany.
However, in the absence of a permanent establishment on domestic territory (see above) there will be no domestic business enterprise on a regular basis so that the income will not be subject to trade tax (Section 2 (1) GewStG – German Trade Tax Act).
Therefore, only the corporation tax rate pursuant to Section 23 (1) KStG plus a solidarity surcharge amounting to a total of 15.825% will be applied regularly.
In the case of forwarding profits via the foreign corporation to the shareholders (here distribution to the foreign investor as a natural person), due to a lack of a domestic connection, no capital gains tax applies. In addition, depending on the legal situation in the country of residence, there may be a corporation tax.
Income from property sale or sale of corporation shares
Hereafter, it will be distinguished between the aforementioned sale options of the asset deal and the share deal. In the context of the asset deal, the foreign corporation with its sale profit is always subject to German corporation tax to the amount of 15.825% (Section 49 (1) no. 2 letter f) double letter aa) EStG, Section 8 KStG).
Within the framework of the share deal, the so-called “exit” takes place via the sale of the investment in the (foreign) corporation and, in the absence of a domestic connection point according to the current German legal situation, is tax-exempt – for a German GmbH as holding company of the property, if applicable due to the relevant DTT. However, pursuant to Section 1 (2a) sentence 3 et seq. GrEStG, the real estate transfer tax needs to be payed if at least 95% of the company’s shares are directly and/or indirectly transferred to new shareholders (“fiction of change of ownership”). If the corresponding 95% limit is not reached, the real estate transfer tax can be avoided.
Indirect investment via a (German) property-GmbH & Co. KG
The foreign institutional investor participates in the domestic partnership (GmbH & Co. KG) by holding the limited partner’s shares as a limited partner through an intermediary foreign capital company. The so-called “holding company” abroad has neither a seat nor management in Germany. The general partner is a German GmbH, that is generally not involved with the assets. The shares of the general partner-GmbH are usually held by the holding company or the investor standing behind it. According to Section 2 (1) sentence 3 GewStG, a foreign holding corporation does not have to pay trade tax if it has no permanent establishment in Germany.
Income from ongoing revenues (letting and leasing)
The property-GmbH & Co. KG is not subject to corporation tax or income tax, as it is tax-transparent as a partnership and thus is not a taxable entity. Instead, the revenues of the property-GmbH & Co. KG are directly attributed to the shareholders, in this case the foreign investor or the foreign holding company, as they alone hold an interest in the KG (see Section 39 (2) no. 2 AO (German Tax Code), Section 23 (1) sentence 4 EStG). Thus, current revenue – on the level of the foreign holding company – is subject to corporation tax to the amount of 15.825%, including solidarity surcharge.
On the other hand, rental revenue is generally not subject to trade tax, at least insofar as the requirements of Section 9 no. 1 sentences 2 et seq. GewStG (so-called extended property reduction) are met. Here, the fulfilment of the conditions, such as that no business operations are destroyed and otherwise no harmful commercial activities are undertaken, is of central importance. Often a foreign corporation & Co. KG is established because of the basic trade tax liability of the GmbH & Co. KG.
Income from property sale or sale of the holding
For the investor, there are various possibilities to bring about an “exit”. On the one hand, he can sell the shares in the foreign holding company. This is tax-exempt according to German law.
In addition, it is possible to sell shares in the property-GmbH & Co KG. Due to the transparency of the partnership, the tax consequences correspond to those regarding the sale of the property. Within the aforementioned ten-year limit, the profit in this case is subject to corporation tax including solidarity surcharge in the amount of 15.825%, whereby this tax will also be due on the level of the holding company (see Section 8 KStG, Section 49 (1) no. 2 letter f) with Section 23 (1) no. 1 EStG).
If the company purely acts as an asset manager the trade tax is cancelled. If the company is commercially active, which is generally to be assessed according to the aforementioned three property limit, trade tax is applicable. If the company acts as a “pure real estate company” the trade income can be reduced according to Section 9 no. 1 sentence 2 GewStG by the part attributable to administrating and using the property, the so-called “expanded reduction”. This way, the income can actually be free of trade tax.
To date, another option is to hold the real estate via a foreign property corporation, for example a Dutch BV or a Maltese Limited. With pure letting there is no permanent establishment in Germany and therefore no trade tax (Section 7 sentence 2 GewStG). This works similarly with a BV & Co KG. The taxation occurs abroad. However, case law increasingly assumes the existence of a permanent establishment, for example when using facility management or, more recently, when operating wind turbines.
The sale of a foreign property corporation is also tax-exempt if the investment is sold by way of a share deal. (Change from 01.01.2019)*
It should be noted, however, that the discussion draft by the BMF (German Federal Ministry of Finance) of the Annual Tax Act 2019 stipulates that from 2019 onwards, tax liability for non-resident taxpayers in Germany (subject to the DTTs, but going in this direction) also applies to the profits from selling shares in foreign corporations, when they have more domestic real estate than anything else for one day of the year. The valuation of the assets of the foreign corporation is likely to be based on the average value of the shares. If this were to be implemented, the design of an indirect real estate investment in Germany via a foreign corporation would become less attractive. Here we will have to wait for the final legal regulation.
The acquisition of shares in a property-owning partnership, like the sale of shares, is not subject to real estate transfer tax due to a lack of changing legal ownership. However, pursuant to Section 1 (2) letter a) GrEStG, the real estate transfer tax becomes due if the status of shareholders changes directly or indirectly within five years in such a way that at least 95% of the shares are transferred to new shareholders. For a long period of time it was possible to avoid the 95% limit and thus the real estate transfer tax through the interposition of other companies (so-called “RETT blocker structure”). Following the introduction of Section 1 (3) letter a) GrEStG, indirect holdings must now also be considered for the 95% limit. In the case of indirect participation, taxability is only triggered by the acquisition of the last share. The process that leads to the acquisition of this share is indeed the tax-triggering moment. However, subject of the tax is not the acquisition of shares as such, but the thus caused attribution of at least 95% of shares in one hand. With the acquisition of shares, the person in whose hands the shares are combined is treated as if they had acquired the real estate from the company, whose shares merge in that person’s hand. The consolidation of shares may also be achieved through acquiring the shares in the estate owning company partly directly and partly indirectly. This was again confirmed by the German Federal Fiscal Court (BFH) in 2017. In the case of an interposed partnership that participates directly or indirectly in an estate owning company, according to Section 1 (3) no. 1 and 2 GrEStG, as share – also in the case of an interposed corporation – the participation in the share capital and not the legal ownership or substantive view of the total assets is decisive.
Although the legislator and the tax authorities are steadily restricting the scope of the RETT blocker structures, there is still room for improvement, which is of particular importance due to the increasing tax rates on real estate. However, the new federal government intends to lower the 95% limit. At the finance ministers’ conference of the federal states in June 2018, it was decided that (in the future) the limit for real estate transfer tax exemption should be 90% instead of 95% for a “share deal”. If partnerships wait ten years and only then, in a second step, acquire the remaining ten percent of the shares in a property, no real estate transfer tax will be charged. So far, the limit here was five years.
The aforementioned statements have made it clear that one cannot simply speak of a “correct” tax solution for real estate investment by foreigners. The investor must deal with the individual advantages and disadvantages of each structure and weigh up accordingly. Therefore, a structural decision on tax optimisation cannot be made adhering to general principles, but only on a case-by-case basis. There are still detailed topics such as interest deduction, loss carry-forwards and more, which were not discussed here.
This post will be continued.
Changes in 2019!
49 paragraph 1 number 2 letter a EStG governs the basic case of limited income tax liability in the presence of a domestic permanent establishment. In this case, the scope of taxation is based on the principles applicable to commercial entrepreneurs. Profit is therefore the difference according to § 4 paragraph 1 S. 1 EStG, which refers to the business assets of the permanent establishment according to the general principles.
According to the newly inserted § 49 para. 1 no. 2 letter e double entry. cc EStG, limited profits are also subject to profits from the sale of shares within the meaning of § 17 EStG, the value of which is based on more than 50% of domestic immovable assets at any time during the 365 days prior to the sale. This formulation is based on Art. 13 (4) OECD-MA 2017.
The legislature has thus oriented itself on the new OECD view and not on what is currently actually agreed in the DTT. However, this makes sense in this case, as the wording of Article 13 (4) OECD MA 2014 at least allows the interpretation that meets the 50% criterion on any day of the last 365 days prior to the divestiture have to be. More generous views in favour of the source state would continue to lead to non-taxation in Germany in the future, as there is no national tax liability.
The change in § 49 EStG is logically reproduced in the reverse case in § 34 EStG. According to this, foreign income is also that arising from the sale of shares in accordance with § 17 EStG, if the unit value at any time during the 365 days prior to the sale is based more than 50% on immovable property located in a foreign state. The wording of the provision (“in a foreign state”) allows both the interpretation that the immovable property must be located in a particular state as a whole, and that the assets must be located in any foreign state.
Germans highest Financial court, the BFH, has decided with judgment of the 7.12.2016 that the controllability in accordance with § 49 paragraph 1 number 2 letter f EStG on the domestic listed there sources of income and activities relates and limited. The limited tax liability is therefore subject only to the income from the letting and leasing as well as the sale of domestic immovable property. Therefore, in the dispute, the creditor-sided waiver of the repayment of a loan did not result in domestic income of the borrower within the meaning of § 49 paragraph 1 number 2 letter f sentence 2 EStG aF, even if the property previously financed by this loan was used to generate income taxable under this provision.
Von Urs Breitsprecher, Experte für Gesellschaftsrecht, M&A und Tax. Urs ist ein Mitglied von IR Global, dem weltweit am schnellsten wachsenden globalen professionellen Service-Unternehmens-Netzwerk
Ursprünglich veröffentlicht in Steuerliche Behandlung eines ausländischen Investments in deutsche Immobilien (Teil 1)