German Real Estate Transfer Tax (RETT) is an important cost factor in mergers and acquisitions, real estate transactions in Germany and intra-group restructurings. Despite the German legislature’s widely advertised intentions to enable RETT-neutral intra-group restructurings, recent developments have increased the scope of the tax’s application. Based on the wide range of transactions that trigger RETT and the steady increase of the applicable tax rates in recent years, the application of exemption rules and anti-abuse provisions in the RETT is among the key structuring considerations for many transactions.
What Kinds of Transactions Trigger RETT?
German RETT is triggered by the following transactions in particular:
- Transfer of ownership in German real estate to another legal entity, e.g., by way of a sale. The rule also applies to transfer of real estate in corporate restructurings, such as mergers, spin-offs, split-ups or contributions of assets.
- Transfer of at least 95 percent of the interests of a real estate holding partnership to new partners within a period of five years (New Partner Rule).
- Acquisition of at least 95 percent of the shares or interests of a real estate holding corporation or partnership by one acquirer or a group of related acquirers (not necessarily in one transaction) (Unification Rule).
The New Partner Rule and the Unification Rule refer to direct and indirect changes in the holding structure of a German or foreign entity that holds German real estate. Therefore, a multinational’s engagement in an M&A transaction or a corporate restructuring could also trigger German RETT, even if various intermediary holding levels are interposed, since all indirect changes to the shareholding structure must be taken into account.
Which Tax Rate Applies?
The RETT rate depends on the German federal state in which the real estate is located. Since the federal states have been able to determine the rates, rates have been on the rise and now vary between 3.5 percent (Bavaria and Saxonia) and 6.5 percent (North Rhine-Westphalia, Saarland and Schleswig-Holstein). In light of the precarious financial situation in which many federal states find themselves, a further increase in tax rates is to be expected.
The tax base is generally the purchase price of the real estate or, where no such purchase price exists, the specially determined real estate value, which in most cases is slightly below the market value.
When a RETT rate increase is imminent, notaries observe a marked increase in purchase notarizations, as parties aim to trigger RETT at the old rate by signing the purchase agreement prior to the change in law. The old rate remains applicable if the purchase agreement as a whole is subject to conditions precedent (e.g., the approval of the tenants regarding amended lease agreements), provided the conditions are outside of the discretion of the parties. A condition precedent has the benefit that RETT only arises once the condition is fulfilled. Otherwise, the signing of the agreement triggers RETT, and the purchaser might have to fund its payment shortly after the signing, before the acquisition financing is available.
What Exemptions Are Available for Intra-Group Restructurings?
Certain transfers of real estate from a partnership to its partners, and vice versa, are tax exempt provided the applicable five-year holding periods are observed. Prior to December 31, 2009, no other exemption was available for intra-group restructurings, meaning that any direct or indirect transfer of real estate or real estate holding companies between related companies was subject to RETT. As a result, the RETT burden was considered one of the main obstacles to corporate restructurings. Another hindrance to group restructurings was the forfeiture of tax losses as a consequence of a share transfer, even where transferor and transferee were members of the same group of companies.
On December 31, 2009, the so-called intra-group restructuring exemption clause was introduced (together with group restructuring relief and the hidden reserves exemption rules for the preservation of tax losses) in order to facilitate economically reasonable restructurings. Although the exemption rule has been amended three times since its implementation, it still has limited relevance in practice, partly because the German tax authorities have published binding administrative guidelines that limit the scope of the exemption rule even further.
The exemption rule for intra-group restructurings is only applicable to mergers, spin-offs, split-ups or contributions of assets under German restructuring law or comparable rules of a Member State of the European Union or the European Economic Area. Restructurings under U.S. law are not within the ambit of the exemption. The exemption rule further requires that the entities involved in the restructuring be part of the same group. A group only exists if there is a controlling entity that holds at least 95 percent of the shares in all controlled entities involved for a period of five years before the restructuring and five years after the restructuring. Even a holding structure that has been in place for considerable time might not be eligible for the exemption rule, however, because the German tax authorities also require that the controlling entity conduct an active business, i.e., be more than a mere holding entity.
What Structuring Scenarios Are Available, and Which Anti-Abuse Provisions Should Be Taken into Account?
Based on the New Partner Rule and the Unification Rule applicable to real estate holding entities, certain structuring scenarios allow for the sale of all or almost all of the shares or partnership interests without triggering RETT. The common denominator of such scenarios is that they require the participation of a party unrelated to the purchaser, which may be undesirable for a number of reasons.
RETT is not triggered if one person or group of related persons purchases less than 95 percent of the shares. Two joint venture partners may therefore purchase a real estate holding entity that is a corporation; each may acquire 50 percent of the shares without any RETT (provided the joint venture partners are not considered to be related persons for RETT purposes). However, such involvement of an unrelated person is rare in a group restructuring.
In the past, it was common to find so-called RETT-blocker structures that at least economically minimized third-party participation. If an acquirer directly purchased 94 percent of the shares of a real estate corporation and also acquired 94 percent of interest in the partnership that held the remaining 6 percent of the shares of the real estate corporation, the acquirer economically held more than 99 percent of the shares in the corporation (94 percent + 94 percent x 6 percent). This did not trigger RETT under the Unification Rule because, based on the formal understanding of the concept of partnership interests, the shares indirectly held through the partnership were not taken into account for the calculation of the 95 percent threshold of the Unification Rule.
The so-called Anti-RETT-Blocker Rule, applicable since June 7, 2013, introduced a substance-over-form approach for calculating the 95 percent threshold. Under this anti-abuse rule, RETT becomes due if a person or entity directly or indirectly acquires an economic participation of at least 95 percent in a real estate holding partnership or corporation. All direct or indirect shareholdings of a person or entity in a real estate entity are now taken into account, including any and all indirect minority shareholdings.
As a result, RETT-blocker structures with an economic 99 percent participation are now effectively prevented. Under the new rules, the involvement of a “real” minority shareholder will be the price for not triggering RETT, which may make blocker structures less attractive to both investors and financing institutions.
What Developments Are to Be Expected?
RETT rates are expected to increase to meet the federal states’ funding needs. The German legislature is currently planning to amend the RETT Act in order to broaden the scope of the application of the New Partner Rule. It will most likely be several years until the fiscal courts decide whether the German tax authorities’ narrow interpretation of the applicability of the intra-group restructuring exemption clause is legitimate. Taking all these factors into account, diligent RETT planning and structuring will become even more important in the future.