Country - Germany
Taxes
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A. AVAILABLE INVESTMENT STRUCTURES
Which legal structures are available for an investment in real estate in Germany?
Investors wishing to invest in German real estate have various options. Chiefly these are either a direct acquisition of real estate or an indirect investment through the purchase of shares or a holding in a corporate vehicle or partnership that owns or exploits the real estate.
Since 1 January 2007 the relevant corporate vehicle may also be established by way of a Real Estate Investment Trust (REIT).
An acquisition can be effected via a direct acquisition from abroad, a direct acquisition from abroad through a local permanent establishment or an indirect acquisition through a local company.
German REIT
A German REIT can only be established in the form of a publicly listed stock corporation with a minimum registered share capital of EUR 15,000,000. The maximum direct shareholding by any one person or entity is limited to 10% of the shares, and at least by any one person or entity of 15% on the date of admission and at least 25% of shares must be held in free float. A share is held in free float if the shareholder holds less than 3% of the voting rights in the REIT.
At least 75% of the assets of a REIT must consist of real estate (an existing residential building cannot be part of the assets of a REIT) and 75% of the REIT's gross yield must result from letting, leasing or selling immovable assets.
REITs are exempted from corporate and trade tax as long as at least 90% of the REIT's profits are distributed. The distributions are fully taxable at shareholder level (i.e. are neither subject to tax preferences, i.e. known as the "half-income system" for dividends, nor to the German participation exemption). In principle the REIT must apply a withholding tax of 25% (plus 5.5% solidarity surcharge). At present such withholding taxes are credited against assessed income tax and/or refunded if applicable.
As of 1 January 2009 the taxation of private income from capital investment will be radically overhauled by the Business Tax Reform Act 2008. As of that date, income will in principle be subject to a final withholding tax of 25% (plus a 5.5% solidarity surcharge). It is still to be determined whether the legislator will leave this rule unchanged with respect to distributions by a REIT.
B. TRANSFER TAXES, NOTARY FEES AND OTHER ACQUISITION COSTS
How is the purchase of a real estate asset taxed?
The following indirect taxes apply to real estate asset acquisitions:
- Real estate transfer tax (Grunderwerbsteuer).
- Value added tax (where the seller opts out of the VAT exemption).
Real estate transfer tax
Real estate transfer tax applies to the direct purchase of a real estate asset at a rate of 3.5% (4.5% for Berlin). Real estate transfer tax also applies to a transfer of ownership in real estate by operation of law, for example in the case of a merger, or to the grant or transfer of heritable building rights (Erbbaurechte). Real estate transfer tax is also payable on the direct or indirect acquisition of at least 95% of the share capital of a corporation or of 95% of the capital interests in a partnership owning real estate. This rule also applies if the shares/or holdings are transferred within the same group of companies.
Value added tax
Transactions subject to real estate transfer tax are generally exempt from VAT. If real estate is to be used for activities subject to VAT, the seller can opt for the sale not to be exempt from VAT. This is only for a sale of real estate to an entrepreneur for the purposes of his business.
The sale of a business or a division of a business is not subject to VAT. If a business owns only one building, then the sale of the building is regarded as the sale of that business or of one of its divisions. In such cases the buyer assumes all the rights and liabilities of the seller under VAT legislation.
Do any specific rules for transfer taxes apply if the asset is a shopping centre or another asset used for retail activities?
No.
How is the purchase of shares in an SPV holding real estate taxed?
Where at least 95% of the shares or capital interests in the SPV are purchased, the purchase is subject to real estate transfer tax at a rate of 3.5% of the purchase price (4.5% in Berlin).
Who normally pays the transfer taxes, the buyer or the seller?
Although both parties are liable for real estate transfer tax it is normally paid by the buyer.
Are notary fees determined by law or should they be negotiated?
Notary fees are governed by statutory law and are not negotiable.
Are there any other costs related to the purchase of real estate assets or SPVs?
Other costs include the fees of professional advisors.
Court fees are payable for registration of a change of ownership in the land register (Grundbuch). These are governed by statute.
C. TAXATION OF OPERATING INCOME
How is income generated from the letting of real estate taxed in Germany?
(a) Direct investment through a permanent establishment
Corporate investors
If the foreign investor is a corporate entity with a permanent establishment in Germany, profits generated through the permanent establishment, including income from the letting of real estate located in Germany, are subject to corporate income tax at a rate of 25% plus 5.5% solidarity surcharge resulting in an effective tax rate of 26.375%. As of 1 January 2008 due to the Business Tax Reform Act 2008 the corporate tax rate will be lowered to 15% (plus 5.5% solidarity surcharge so that the effective corporate income tax rate will amount to 15.885%).
Currently trade tax (of between 13% and 20% on trade earnings), real estate tax and amortisation are deductible.
From 2008 onwards the effective trade tax rates will be lowered to between 7% and 17.15%, but the basis on which trade tax is levied will be broadened. Additionally trade tax will no longer be a deductible item in the calculation of taxable income.
Amortisation only applies to buildings, including the cost of acquisition and related expenses (such as notary fees, legal fees, expert's fees, etc), but not to land itself. Deductions can be claimed for interest or royalties paid by a branch to its head office, or to another branch of the same company, provided that these payments are made on an arm's-length basis and that the branch has sufficient equity to meet the requirements of the "safe haven test" (a debt to equity ratio of 1.5 to 1).
With regard to the deductibility of interest payments the Business Tax Reform Act 2008 establishes the "Interest Cap Rule". This rule is already in force and must be applied by companies whose business year begins on or after 25 May 2007 and not ending prior to 1 January 2008. Under the Interest Cap Rule all interest expenses will generally be fully deductible as business expenses in an amount equal to the interest income of the "Business Unit" (Betrieb). For interest expenses in excess of interest income ("Net Interest Income")–regardless of where the debt derives from–exceeding EUR 1,000,000 the deductibility of interest paid on debt will be limited to 30% of EBITDA (earnings before interest, taxes, depreciation and amortisation). Several exemption rules apply however.
With regard to trade tax, inter alia, 25% of all interest on debt payments (as far as interest payments have already been deducted) and 6.25% of the expenditure on temporary usage of rights (especially licences and concessions) will have to be added back to the taxable income.
Income from lettings is, in principle, exempt from VAT, but the investor may opt to waive the VAT exemption. This is likely to be exercised, for example, if input VAT has been paid on the cost of maintenance or repairs and the investor would like to recover this.
Individual investors
If the foreign investor is an individual generating income through a permanent establishment in Germany, including income from the letting of real estate located in Germany, this is subject to income tax at the individual tax rate of the investor. The income tax rate for individuals ranges, for EU nationals from 15% to 42% and for non-EU nationals from 25% to 42%, with an additional solidarity surcharge of 5.5% on the income tax. As of 1 January 2007 an additional tax bracket of 45% applies to taxable income in excess of EUR 250,000 for individuals and EUR 500,000 for married couples. For allowable deductions, see the section above on corporate foreign investors.
Income generated through a permanent establishment in Germany is further subject to trade tax at a rate of between 13% and 20%. At present trade tax is deductible from the amount of income subject to income tax.
(b) Direct investment without a permanent establishment
Corporate investors
If the foreign investor is a corporate entity generating income from letting real estate in Germany, this German income is subject to limited corporate income tax at a rate of 25% (plus 5.5% solidarity surcharge). Therefore, the rate of corporate income tax is effectively 26.375% of the income generated in Germany: from 1 January 2008 onwards the rate will be 15% plus 5.5% solidarity surcharge thereon). Real estate tax and amortisation are deductible.
Individual investors
If the foreign investor is an individual generating income through letting real estate in Germany, this income is subject to limited taxation. The income tax rate is determined by the amount of the income of the investor in Germany.
(c) Indirect investment through a corporate entity (a non-transparent entity)
All business profits generated worldwide by a German corporate entity are subject to 25% corporate income tax (plus 5.5% solidarity surcharge), resulting in an effective tax rate of 26.375% (15.885% as of 1 January 2008).
Business profits are also subject to trade tax at a rate of between 13% and 20%. This tax liability is deductible from the business profits which are subject to corporate income tax.
Real estate tax and amortisation are deductible. The annual amortisation rate for buildings varies between 2% and 4% of the acquisition or construction costs.
(d) Indirect investment through a partnership (a transparent entity)
Income derived from letting real estate in Germany is taxed as for corporate entities, depending on whether the partners in the partnership have a permanent establishment which holds the partnership interests or are deemed to have a permanent establishment due to the partnership's activities in Germany. If this is the case then see section (a) above. If there is no permanent establishment then see section (b) above.
How can income generated by investment be transferred to a foreign investor?
(a) Direct investment through a permanent establishment
Once income has been subject to the relevant income tax regime, no further taxation applies on its transfer to a foreign investor.
(b) Direct investment without a permanent establishment
Once income has been subject to the relevant income tax regime, no further taxation applies on its transfer to a foreign investor.
(c) Indirect investment through a corporate entity
Dividend distributions to shareholders
Profits are subject to corporate income tax at an effective rate of 26.375% (15.885% as of 1 January 2008).
Once profits have been subject to corporate tax they can be distributed to the shareholders with no additional tax burden on the distributing entity.
As a general rule, dividends paid by German companies are subject to a 20% withholding tax.
Under the EU Parent-Subsidiary Directive, no withholding tax is payable on dividends paid by a German company to another EU company, where the latter has held 20% of the shares in the former for an uninterrupted period of 12 months preceding the date of the distribution of dividends. Notwithstanding this, according to the German Income Tax Act dividend distributing corporations are obliged to withhold withholding tax of 20% even if the conditions of the EU Parent - Subsidiary Directive are met. The shareholder has a claim for the refund of the withholding tax but only if the requirements of the "substance test" are fulfilled. A shareholder entitled to the benefits under the EU Parent–Subsidiary Directive may provide an exemption certificate to the individual paying company. In such a case no withholding tax on dividends will be applied.
Dividends paid by a German company to a German resident individual are subject to a withholding tax of 20% which will be credited against the individual income tax within the tax assessment of the individual. From 2009 onwards the withholding tax rate will be 25%.
Taxation at the level of the shareholder
Resident shareholders
- Corporate shareholders
If the shares in the company owning the real estate are held by another company as fixed assets rather than as trading stock, 95% of the dividends received are exempt from corporation tax.
- Individual shareholders
50% of the amount of dividends received is tax exempt but by the same token only half of any related expenses are tax deductible (this is known as the "Half-income System"). Due to the Business Tax Reform Act, from 2009 onwards the amount of dividends will be fully taxable at a rate of 25% plus 5.5% solidarity surcharge. Income-related expenses are only deductible as a lump sum amount. A shareholder with a lower individual income tax rate than 25% can opt for tax assessment of this income together with the rest of his income. If the shares are business assets of the individual the dividends are 40% tax exempt and related expenses are 60% tax deductible.
Non-resident shareholders
According to nearly all German Double Taxation Treaties, dividends are taxable in both countries (i.e. the country in which the shareholder is resident and Germany as the country in which the dividends originate). Please note that the right of Germany to levy tax in these cases is limited (mostly to a maximum of 15%).
(d) Indirect investment through a partnership
If a foreign investor has invested through a German partnership, which is treated as transparent for income tax purposes, the business profits will already have been taxed at partner level and therefore the partners will not be taxed again.
Are there local taxes on the possession of real estate assets?
Municipalities levy a real estate tax on local property, calculated on the basis of its estimated value. Tax rates vary from 1.05% to 1.855% per annum. The value is calculated by multiplying the predicted net rental earnings by certain factors determined by, for example, the type of building, its age, use, etc.
D. DEPRECIATION
What are the basic rules for the depreciation of real estate assets?
Most tangible and intangible assets of a taxpayer are depreciable (land and shares in a corporation are exceptions). The basis for depreciation generally is the original acquisition cost. The depreciation rate is determined according to the average economic life time of an asset.
In general, the depreciation rate is 3% for non-residential buildings and 2% for residential buildings. Special regimes also apply to refurbished buildings in urban redevelopment areas (Sanierungsgebiet) and to expenses relating to the refurbishment and renovation of architectural monuments (Baudenkmale): 9% p.a. for the first eight years, and 7% p.a. for the next four years. Higher depreciation rates apply if the taxpayer can prove that the economic life time of the building is shorter than that implied by the applicable depreciation rate. Equipment and machinery are also depreciated over their economic life time.
Can land be depreciated?
No. Since land is considered to have a continuous economic life time, no depreciation is allowed. However, if the land has been permanently reduced in value, a one-off write-down to a fair market value is possible.
Can a participation in an SPV holding real estate be depreciated?
No. A participation can, however, be subject to a one-off capital loss, provided that its value has reduced permanently. These capital losses, however, are not tax deductible where the German participation exemption applies.
E. VAT
Is the purchase of real estate assets subject to VAT?
In general, the acquisition of real estate is VAT exempt. However, if both parties to the transaction are businesses, and the buyer uses the property for carrying out business activities subject to VAT, the seller can opt out of the VAT exemption. In this case VAT applies at present at a rate of 19%. The VAT due on a real estate sale is subject to the reverse charge rule, i.e. the amount due as VAT must be withheld by the buyer and paid to the tax authority. This rule does not normally result in an actual payment being made because of the rules allowing VAT to be recovered.
How can VAT paid on the purchase price be recovered?
The buyer is entitled to recover any VAT paid if the building is used for activities on which VAT is levied.
VAT paid on a real estate transaction can be reviewed for a period of 10 years. If the VAT status of the building changes during this period (for example from a building where VAT-taxable activity is carried out to a building used for VAT exempt activities), an adjustment will be made of the VAT initially reclaimed on the acquisition or construction of the building. The amount due is calculated as x/10 where x is the number of years of the 10-year period that had not yet expired at the date the status changed.
VAT incurred on the acquisition of real estate is immediately deductible in full if the real estate is used 100% for VAT-taxable activities.
VAT can be recovered by offsetting the VAT incurred (which includes VAT paid on behalf of a seller by a buyer under the reverse charge rule) against the VAT received from other transactions in the VAT return period.
F. LEVERAGE AND THIN CAPITALISATION RULES
If interest payments are to be tax deductible, is it necessary for the financing to be taken out simultaneously with the purchase of the asset?
No. However, the investor must prove that the interest paid is directly related to the real estate and is therefore a tax deductible expense. Please note that with the Business Tax Reform Act 2008 the new Interest Cap Rule is applicable. In general this limits the full deductibility of all interest expenses if they exceed the interest income by more than EUR 1,000,000.
Are there any rules which limit the deductibility of interest for third party (bank) financing?
At present interest on loans for the acquisition of real estate is, in principle, fully deductible, irrespective of the source of the loan. Under the Business Tax Reform Act 2008 the deductibility of interest payments is now governed by the new Interest Cap Rule.
Additionally the source of the debt may be important in relation to the deductibility of interest if the lender is related to the borrower and is located in a country regarded as a tax haven. Specific legislation covers loans made to a German company by companies established abroad under a tax regime which is significantly more advantageous than that in Germany.
Interest paid to such lenders is only tax deductible if the taxpayer provides evidence that the payments meet the following conditions:
- they serve a genuine economic purpose;
- they do not exceed an arm's-length rate of interest and
- the beneficial owner makes a full disclosure of payments under the loan agreement.
If these requirements are not met, interest payments may not be deductible.
Are there thin capitalisation rules in Germany and if so, how do they work?
In general, German thin capitalisation rules apply to loans provided by major shareholders, related parties or third parties entitled to certain forms of recourse against the major shareholders or related parties. Interest deductions exceeding a minimum of EUR 250,000 per annum for loans granted by major shareholders, or lenders with similar status, are limited in several ways. Interest payments on the portion of the loan exceeding a debt to equity ratio of 1.5 to 1 are not deductible. If the borrower can prove that a loan could have been taken out on exactly the same terms and conditions with an independent third party, these limitations do not apply.
If the interest due on a shareholder loan depends on the economic performance of the borrower, the interest is non-deductible.
Shareholders who directly or indirectly hold shares of more than 25% of the borrower's share capital are defined as major shareholders. Related parties are considered to be entities which are controlled by a major shareholder, which control a major shareholder or which are controlled by the same entity as a major shareholder.
Loans granted by third parties are subject to the thin capitalisation rules if the payment claims of major shareholders or related parties are subject to a security right in favour of the third party. If, however, the borrower can prove that the third party loan is not part of a back-to-back finance structure, such a loan is not subject to thin capitalisation rules.
The debt to equity ratio is determined for each shareholder separately. The share in the equity of each shareholder is determined by reference to the capital contribution of the respective shareholder. Differing voting rights are disregarded.
In terms of the thin capitalisation rules, equity consists of the following elements: (a) share capital; (b) capital reserves; (c) retained earnings; (d) annual profit, less the following: (a) unpaid capital contributions; (b) losses carried forward; (c) current losses, all as of the end of the preceding financial year.
These rules also apply when the borrower is a partnership in which a corporation owns a capital interest which exceeds 25% of the partnership's capital, provided that the lender is a major shareholder in the corporation or a related party.
Please note that the thin capitalisation rules as described above will be fully replaced by the interest cap rule. The interest cap rule is already in force and applies to companies with a business year beginning on or after 25 May 2007 and not ending prior to 1 January 2008.
The interest cap rule applies to all types of debt financing. In contrast to the current thin capitalisation rules the interest cap rule also applies to interest expenses on bank loans and other third party debt non-recourse. Interest expenses are defined as consideration paid for debt, which reduces the relevant profit.
Interest expenses up to the amount of the interest income are entirely deductible. Interest expenses exceeding the interest income (net interest expense) by more than EUR 1,000,000 may be deducted only up to 30% of the taxable profit plus interest plus regular depreciation and amortisation (EBITDA) in the same year. Interest which is non-deductible under the interest cap rule may be carried forward to subsequent years. The interest carried forward can be utilised if and to the extent that the net interest expense in subsequent years does not exceed the threshold of 30% of the EBITDA.
As mentioned above several exemption rules exist. These are as follows:
Non-Group companies
The term "group" for the purpose of the interest cap rule is broadly defined. A business belongs to a group if it is or could be consolidated with one or more further businesses or its finance and business policy could be jointly determined.
For non-Group companies the interest cap rule is not applicable, provided that interest expenses on loans granted or secured by major shareholders (i.e. those who directly or indirectly hold more than 25% of the company's share capital) or entities related to major shareholders do not exceed 10% of the "negativer Zinssaldo" (net interest expenses = interest income – interest expenses giving a negative result) of the respective Business Unit.
Group companies
For group companies the interest cap rule is not applicable if the respective group company proves that its equity to balance sheet total ratio the ("Equity Ratio") at least equals that ratio showing the consolidated annual accounts for the group (group - escape clause). An equity ratio of the Group company falling short of the equity ratio of the group by no more than 1% from the Equity Ratio of the Group is harmless.
For the comparison of the equity ratios of the group company and the group itself generally the figures deriving from IFRS-accounting have to be employed. If there is no such IFRS-accounting system the figures from annual accounts prepared in accordance with the commercial law of one of the member states of the European Union may be used, provided that no such IFRS-annual account was required to be prepared.
Counter exemption
The exemption of the group escape clause, however, does not apply in the case of "harmful shareholder loans". With regard to group companies one prerequisite for a harmful shareholder loan is–that interest expenses on loans granted or secured by major shareholders or entities related to shareholders exceed 10% of the net interest expenses. Please note that in this respect harmful shareholder loans are only loans which were granted by major shareholders from outside the group, i.e. those who hold more than 25% but less than 50% plus one share in any company belonging to the same group. Note also that a harmful shareholder loan in one of the group companies is sufficient to "infect" the whole group with a harmful shareholder loan financing.
Additionally, if a taxpayer wants to rely on the group-escape clause, he must provide evidence that there is no such harmful shareholder loan in any part of the group.
Does Germany apply any withholding taxes on interest paid to foreign financing banks or to foreign shareholders?
No withholding tax applies on interest if the borrower is not a bank or if the borrower uses a bank as payment agent. Additionally, no withholding tax applies if the recipient of the interest payment is a bank. Most German double taxation treaties do not provide for withholding taxes on interest.
G. TAXATION OF CAPITAL GAINS
How are capital gains deriving from the sale of real estate assets taxed in Germany?
(a) Real estate assets held by foreign investors directly without a permanent establishment in Germany
If the foreign investor is a non-resident company selling real estate located in Germany, any income is subject to corporate income tax at a rate of 25% (plus 5.5% solidarity surcharge) leading to an effective tax rate of 26.375% (15.885% as of 1 January 2008). The income is also subject to trade tax, which is a deductible expense for corporate tax purposes, although, under most German Double Taxation Treaties, trade tax is not normally payable.
Please note that as of 1 January 2008 trade tax will be non–deductible.
If the investor is a non-resident individual selling real estate located in Germany, this income is only subject to tax in Germany if the real estate was held for less than 10 years. The tax rate will be determined according to the overall income of the taxpayer in that tax year. If the real estate was held for 10 or more years the income deriving from it is not taxable in Germany.
(b) Real estate assets held by foreign investors through a permanent establishment in Germany
If the foreign investor is a non-resident corporation with a permanent establishment in Germany, through which it sells real estate located in Germany, any income generated is subject to corporate income tax at a rate of 25% (plus 5.5% solidarity surcharge) which leads to an effective tax rate of 26.375% (15.885% as of 1 January 2008). The income is also subject to trade tax, which is a deductible expense for corporate tax purposes but deductible only until 31 December 2007).
If the foreign investor is a non-resident individual with a permanent establishment in Germany, through which it sells real estate located in Germany, any income generated (including capital gains) is subject to income tax. Trade tax is also payable on the capital gains.
How are capital gains deriving from the sale of shares/interests in a corporate entity taxed in Germany?
If a non-resident seller sells his shares in a German (real estate owning) company, according to most German Double Taxation Treaties, the proceeds of the sale are not subject to taxation in Germany.
Are there any rules regarding participation exemptions in Germany?
The German Corporate Income Tax Act provides for a participation exemption, which is applicable to both domestic and foreign shareholdings. Generally all profits from holding shares (for example, dividends or capital gains realised on the sale of a participation) are exempt from corporate income taxation. Please note that 5% of the relevant profit amount is deemed to consist of non-deductible business expenses. This amount must be added to the taxable income of a corporation. To benefit from the participation exemption, only for trade tax purposes (only a minimum participation of 10% increasing to 15% as of 1 January 2008 is required).
As mentioned above under the EU Parent-Subsidiary Directive, no withholding tax is payable on dividends distributed by a German company to another EU company, where the latter has held 20% of the shares in the former for an uninterrupted period of 12 months preceding the date of the distribution of dividends. Under German anti-treaty shopping rules a foreign corporation will only be entitled to the benefits under the EU Parent-Subsidiary Directive and benefits under Double Taxation Treaties with respect to withholding taxes on dividends if it meets the requirements of this substance test.
The requirements are as follows:
- this must be an economic or other significant reason for the interposition of the foreign company;
- more than 10% of its gross revenues result from the company's own economic activities (in this respect simple asset management is not regarded as an economic activity); and
- the company must have sufficient resources and infrastructure of its own to pursue its business in the market.
If the substance test is met and the minimum 20% shareholding in the subsidiary/ies has lasted for a minimum period of 12 months the parent company can apply for a notice of exemption for the respective capital gains.
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