Secondary tax base for German real estate transfer tax unconstitutional – Share deals could possibly be subject to increased real estate transfer tax burden retroactively

In a recently published decision dated 23 June 2015, the German Constitutional Court held the so-called "secondary tax base" used in the calculation of real estate transfer tax ("RETT") to be unconstitutional. Parliament therefore needs to establish a new rule for the taxation of share deals involving companies holding real estate for the time from January 2009 by mid 2016.

Taxation of a transfer of more than 95 % of shares in a company holding real estate

Under German tax law, not only an asset deal involving German real estate, but also the sale of shares in a company holding German real estate will trigger RETT. As the company itself has more assets than just the real estate, the consideration for the real estate, and thus the tax base for RETT, cannot – in contrast to an asset deal – be determined on the basis of the purchase agreement. Up to now, RETT was determined using the so-called secondary tax base. In the case of undeveloped real estate, the publicly available land value was used; in the case of buildings, a simplified income approach (vereinfachtes Ertragswertverfahren) was used, which was based on the actual or customary annual rental income (see Sec. 8 Para. 2 German RETT Act and Sec. 138 et seq. German Valuation Act).

Evaluation of real estate unconstitutional in the case of share deals

The tax base calculated under the rules just described, however, only reflect on average 50 – 70 % of the market value of the real estate according to the German Constitutional Court, leading to a higher RETT burden for a purchaser in the case of an asset deal, compared to the RETT burden in the case of a share deal. The Court held that this violates the principle of equality. Parliament now needs to find a new tax base for RETT closer to the market value. One possibility would be to require independent evaluations of real estate in order to determine the RETT base.

Retroactive effect on transactions from 2009 onward possible, as there is no final and binding assessment

The court has – in deviation from its usual handling of similar cases (e.g. of inheritance tax) – not instituted any grandfathering rules, but has instead laid out a long-term retroactive effect for share deals back to 2009. Recent transactions will be affected in instances where the time limit for challenging the tax assessment notices has not yet lapsed or the assessment notice has been challenged already. Older transactions will be affected in cases where the tax assessment notice contains a statement that the tax assessment is not final, subject to Sec. 138 et seq. of the German Valuation Act being constitutional. We  recommend reviewing transactions in the period from 2009 up to the present from a tax point of view. In some cases, it may be recommendable to retract any challenge to the tax assessment notice in order for this notice to become final, and therefore possibly avoid a retroactive increase of the RETT burden.