Taxation of capital gains resulting from the sale of shares in real estate companies
There is a recent recommendation of the Financial Committee of the Upper House of the Parliament (Finanzausschuss des Bundesrates) on the draft law regarding the transformation changes of the EU Mutual Assistance Directive and further measures against base erosion and profit shifting (Gesetz zur Umsetzung der Änderungen der EU-Amtshilferichtlinie und von weiteren Maßnahmen gegen Gewinnverkürzungen und –verlagerungen, Drucksache 406/16) which would considerably change the tax situation for foreign investors regarding their investments in companies investing in real estate property located in Germany. The Upper House of the Parliament should decide on the proposal on 23 September 2016 and then the Lower House of the Parliament will decide before the end of this year.
I. Current situation
Under current German tax law, a capital gain resulting from the sale of shares in a corporation only triggers a German income taxation for the foreign shareholder, if
- the real estate holding corporation has its seat or place of management in Germany and the shareholder holds at least 1% in such cooperation (section 49 para 1 No. 2 lit 2 ITC); and
- the double tax treaty between Germany and state of residence of the shareholder attributes the taxation right for such capital gain to Germany. This generally only applies in cases in which the applicable treaty contains a so-called real estate company clause according to which Germany as the situs state of the real estate is entitled to tax a capital gain from the sale of the shares provided that more than 50%/75% of the value of the corporation consists of German located real estate (e.g. treaty with Luxembourg, the Netherlands, UK or Poland).
This means for example that according to current tax law, shares in a Luxembourg S.a.r.l. which holds exclusively real estate located in Germany can be sold by a foreign shareholder (not being subject to German unlimited tax liability) without triggering a German income taxation on the capital gain even though the treaty with Luxembourg contains a real estate company clause in its article 13 para 2 . This is because Germany cannot exercise the taxation right attributed to it by the treaty because the sale of the shares is (according to current domestic tax law) not subject to limited tax liability in Germany.
II. Suggested change
This shall be changed according to the recommendation of the Financial Committee. According to the proposal, Germany intends to exercise the taxation right attributed to it by a treaty with regard to capital gains from the sale of shares in a foreign real estate corporation.
Section 49 para 1 no. 5 sentence 1 ITC shall be expanded and, henceforth, provide for a limited tax liability for income according to Section 20 para 2 sentence 1 no. 1 ITC, i.e. for capital gains resulting from the sale of shares in a corporation provided that more than 50% of the value of the corporation’s assets directly or indirectly consist of immovable property located in Germany. In other words, capital gains resulting from the sale of shares in corporation should be subject to a limited tax liability in Germany, if more than 50% of the corporation’s assets consists directly or indirectly of German real estate irrespective of whether this corporation has its seat or place of management in Germany. Therefore, in the future also the sale of shares in foreign real estate companies, e.g. Luxembourg S.a.r.l. or Dutch BV, would trigger a German income tax liability.
In this respect it should be noted, that the limited tax liability should be triggered irrespective of a participation threshold in the real estate corporation. Furthermore, due to the use of the words “directly or indirectly” in the proposed wording also the sale of holding companies which hold shares in real estate holding corporation should be covered by the suggested new law.
According to the reasoning of the law, the tax should be levied by applying a withholding tax. However, neither the draft legislation of the federal government nor the recommendation of the Financial Committee includes any wording regarding the withholding tax mechanism. In our view it should from a practical point of view be difficult to implement such withholding tax mechanism, i.e. it is unclear how the purchaser of the shares in a foreign real estate corporation can be obliged to withhold German withholding tax. The German tax authority will regularly only gain knowledge of the sale of the shares after the sale has taken place so that an withholding obligation of the seller at least according to the current wording of section 50a para 7 ITC should be excluded.
III. Consequences and prospect
In a not atypical constellation where a Cayman company holds 100% of the shares in a Luxembourg holding S.a.r.l. which holds 100% of the shares in a Luxembourg real estate S.a.r.l. which ultimately invests in German located real estate, the sale of either the shares in the Luxembourg holding S.a.r.l. or of the shares in the Luxembourg real estate S.a.r.l. should – according to the wording of the proposed law – trigger a German capital gains taxation.
If the seller of the shares in the real estate corporation is itself a corporation, basically only 5% of the capital gain would be subject to German taxation with corporate income tax and solidarity surcharge according to section 8b para 2, 3 CITC (there is currently a court case with the federal tax court pending as to whether such 5% taxation is allowed with respect to a foreign investor). German trade tax should not be applied due to the lack of a German permanent establishment such structures. If the seller is an individual, 60% of the capital gain would be subject to taxation according to the so-called partial income privilege with progressive tax rate of up to 45% plus solidarity surcharge.
The partial tax exemption according to section 8b para 2, 3 CITC or the partial income privilege are however not granted if the seller is a financial enterprise which acquired the shares with the intention to achieve a short-term proprietary trading profit. This can be the case with respect to private equity funds since holding companies are generally to be regarded as financial enterprise as.
Even though this draft legislation is currently only a recommendation of the Financial Committee, it cannot be excluded that it will be implemented, especially because in all recently negotiated German treaties a real estate company clause has been included which – under current law – does not apply in the relevant cases. As mentioned above, the Upper House of the Parliament will presumably on 23 September 2016 decide whether the new rule described above shall be included in the further legislation procedure. In case of an implementation of the rule further technical details need to be clarified in the new law. Depending on the further development on the legislative procedure, existing structures should be reviewed and a restructuring may be considered to improve the tax situation.
Any questions? Please contact: Dr. Michaela Engel or Dr. Matthias Geurts
Practice Group: Tax & Private Clients