Structuring the investment
Real estate transactions can be structured either as a direct purchase (or 'asset deal'), where the property is directly transferred from one individual (or company) to another individual (or company) or as a share deal, where the shares of the target company owning the real property are transferred to the purchaser without directly transferring the ownership of the property from one entity to another (after the completion of the share deal, the target company will remain the owner of the property).
The asset deal is a very common transaction form among private individuals who are selling their (residential) real estate, although from a tax perceptive it is not very advantageous for the purchase because of the transfer taxes (i.e., 7 per cent of the property value for direct transfers of properties; office and commercial properties located in the city of Luxembourg are taxed at 10 per cent of the property value). Moreover, the capital gains realised by the seller will normally be taxed upon transfer of the property.
For the above reasons, the vast majority of large real estate transactions are structured through a share deal, whereby the purchaser acquires the shares of the target company owning the real estate asset. Because the registered owner of the property (namely the target company) will remain unchanged, no transfer tax will be due. At the moment of the share sale, the then-realised capital gains (difference between the book value of the property and the sales price) will not be taxed as the property is not considered to have changed hands in the eyes of the tax authorities. This tax burden will be transferred to the new shareholder of the target company, as the taxable gain is only realised when the property is ultimately sold in an asset deal. Thus, the selling price is usually diminished by a provision for latent capital gains.
Because of the corporate veil and the flexible legal framework, the private limited liability company and the public limited liability company are the most commonly used special purpose vehicles (SPVs) for the holding of real estate. The private limited liability company would require a minimum share capital of €12,000, whereas the minimum share capital of a public limited liability company is set at €30,000.
As a general principle, any capital gain realised upon the transfer of an asset should be subject to corporate income taxes at a rate of 26.01 per cent (including municipal tax) for companies having their registered office in the city of Luxembourg. If the tax returns of the company demonstrate that there have been losses, these losses may be offset against any capital gains realised by the company that will ultimately lead to a decrease of the taxable base for the company.
By structuring the deal through tax-transparent entities (e.g., partnerships), the municipal tax (6.75 per cent for the city of Luxembourg) may be saved, depending on the place of residency of the ultimate shareholders. Whether or not it is worth structuring the transaction through a tax-transparent structure has to be assessed on an individual basis, taking into account the individual exit strategy of the investor.
In addition, investment fund regimes are becoming increasingly popular within real estate investors in Luxembourg. Because of the high setup costs and ongoing expenses, the setup of such a fund structure is only worth considering for large volume real estate portfolios.
The specialised investment fund (SIF), a collective investment structure governed by the Luxembourg Law of 13 February 2007 and reserved to well-informed investors, is an investment structure that can be structured in a very tax efficient way to the extent that realised capital gains may be totally tax-exempt (if certain criteria are met).
Under Luxembourg law, there are no restrictions on ownership or occupation of real estate by foreign investors. A lot of large real estate complexes in Luxembourg are ultimately held by foreign (institutional) investors, often acting through a Luxembourg SPV.
As to the Luxembourg security package with regards to financing transaction, there are generally no restrictions applicable to foreign investors. Moreover, the Luxembourg legal framework in the matter of collateralisation is generally regarded by business professionals and practitioners as one of the most valuable systems within the EU.
Because of its combination of a number of different features, namely the contractual flexibility allowing tailor-made structuring, a non-formalistic approach, full protection against insolvency risk, an efficient and safe enforcement process and investor friendly case law, the Luxembourg law of 5 August 2005 on financial collateral arrangements is very popular amongst local and foreign investors who are looking to secure their real estate deals.
By transposing into national law the European directive of 6 June 2002 (Directive 2002/47/EC), the Luxembourg legislator decidedly exceeded the guidelines of the directive by providing a protection regime that is very attractive to (foreign) holders of collateral, whether under the form of pledges, transfer of title for security purposes, repos or netting arrangements.