The sale of German real estate by companies or natural persons based outside Germany was recently made more difficult by the fact that the German tax authorities have obliged buyers to withhold and pay a lump sum of up to 25% of the purchase price for the account of the seller to secure the income tax incurred on the purchase price. The legal basis (found in Section 50a(7) of the Income Tax Act) has existed in more or less the same form for decades, but has only recently been used intensively by the German tax authorities. Such a tax deduction can in particular lead to the transaction failing if the purchase price is insufficient to cover both the seller's financing to be repaid in the course of the transaction and the lump-sum tax deduction. Even if the purchase price is sufficient, special contractual provisions are recommended in order to rule out any adverse effects on the transaction.
The seller's tax authority can order the buyer to withhold tax pursuant to Section 50a(7) if the profit from the sale constitutes income of the seller (tax debtor) subject to limited taxation and this income is not already otherwise subject to tax deduction. The requirements are often met if the seller is a natural person or legal entity based outside Germany and achieves income subject to limited taxation by selling a property located in Germany. The lump-sum tax deduction is 25% of the purchase price (for natural persons) or 15% of the purchase price (for corporations, partnerships or estates). It can also be adjusted by the tax authority in line with the tax which is expected to be owed.
The ordering of tax to be deducted to secure the tax claim must be appropriate. Appropriateness usually already exists if the seller has no other significant assets in Germany apart from the real estate being sold, so that any tax debt would possibly have to be enforced abroad. This is probably the case for many companies based outside Germany which have been incorporated only in order to purchase the real estate in question.
The tax deduction assessment notice from the tax authority is addressed directly to the buyer. The buyer is obliged on the basis of the assessment notice to withhold the tax deduction which has been determined and to pay this to the tax authority. If the buyer does not comply with this obligation, the buyer is personally liable for withholding and paying the tax. This has the following consequences for the transaction:
- The buyer should be prepared to pay the tax deduction only if this payment is offset against the purchase price owed to the seller. It should therefore be agreed in the purchase agreement that the buyer is entitled and obliged to make the payment to the tax authority only, subject to this being offset against the purchase price.
- Additional provisions are required if the seller has already assigned the claim to the purchase price (eg, to the financing bank) and this is disclosed to the buyer. The buyer runs the risk that the payment of the tax deduction to the tax authority will not satisfy the assignee and that the assignee could still demand the entire purchase price. It must therefore be ensured contractually that the buyer is obliged only to pay the purchase price if the payment of the tax deduction also has the effect of satisfaction with respect to the purchase price. Various possible structures for this are conceivable, including an additional requirement for the purchase price becoming due only if the competent tax authority has not issued any order pursuant to Section 50a(7) or an obligation of the seller to obtain a corresponding declaration of consent from the assignee.
- The situation is critical if the purchase price is insufficient to pay the financing to be repaid by the seller and the tax deduction. The seller often needs the purchase price paid by the buyer to redeem the property from encumbrances. The buyer would therefore still have to pay the purchase price and in addition pay the tax deduction in order to purchase the property free of encumbrances. The buyer will not normally be willing to do this. Various contractual provisions to secure the buyer should be considered – for example, an obligation of the seller to redeem the property from encumbrances by other means if necessary (eg, interim financing) or a due date provision stating that the purchase price does not become due or ceases to be due if any tax deduction in accordance with Section 50a(7) together with any encumbrance to be redeemed in connection with the financing exceeds the purchase price. These provisions could be supplemented with a right of rescission of the buyer if the transaction should fail due to the fact that the seller cannot redeem the property from encumbrances due to the tax deduction.
- It is also recommended that sellers based outside Germany have the documents and evidence required to determine their actual tax debt available and if necessary proactively send these to the competent tax authority immediately after concluding the agreement. This ensures that the tax authority can determine the actual tax debt and does not therefore establish an unnecessarily high lump-sum tax deduction. To the same end, the seller could be granted a contractual period within which the seller is permitted to procure a revocation or reduction of any tax assessment notice issued by the tax authority in accordance with Section 50a(7). This could be in the interest of both parties in order to prevent the transaction failing.
The tax authorities have for some time been making relatively consistent use of the tax deduction possibility in accordance with Section 50a(7). This can have a considerable effect on a transaction, even leading to its failure. Foreign investors who want to sell their German real estate and buyers who want to purchase real estate from foreign investors should therefore keep this issue in mind and take it into account when structuring their agreements.
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