A draft bill for the German Annual Tax Act 2018, published by lawmakers in late June, proposes to levy taxes on the sale of real estate companies owned by foreign-based taxpayers.
Content of the new regulation
The new right to levy taxes on the sale of property companies shall chiefly affect non-resident taxpayers. These may be people or companies, which do not reside or do not have a registered office or management in Germany. This new regulation has no impact on purely domestic cases, which are already subject to an unrestricted right to levy taxes.
This new regulation provides for income subject to restricted taxation (see Section 49 of the Income Tax Act) to be expanded in the following way:
- The sale of public limited company shares is regarded as income earned from commercial activity if the seller directly or indirectly held at least 1% of the company's share capital in the last five years, if more than 50% of the company's share value was based either directly or indirectly on immovable domestic assets at any time during 365 days prior to the sale, and, if the shares were allocated to the seller at this time.
- Profit from the sale of public limited company shares is regarded as income from capital investments when more than 50% of its share value was based either directly or indirectly on immovable domestic assets at any time during 365 days prior to the sale, and the shares were allocated to the seller at this time.
If passed, the new regulations are to become applicable after 31 December 2018.
Profit from the sale of shares in property companies in cross-border cases is usually taxable in the country where the property is located. To date, Germany has had no explicit right to levy taxes on such profits under national law. This situation shall now being changed.
Inter-governmental agreements (double tax treaties)
Cross-border taxation conflicts are regulated by double tax treaties (DTT). According to the OECD Model Tax Convention – and also according to Germany's negotiating basis for double tax treaties -, profit from the sale of shares in property companies is taxable in the country where the immovable assets are located. The Model Tax Convention of the UN contains a similar provision.
A property company shall typically exist if more than 50% of its value is directly or indirectly based on immovable assets. This rule – with some variations – occurs more frequently in German double taxation treaties, such as treaties with France, Great Britain, Luxembourg, the Netherlands and Spain.
The background to this property clause is that – in accordance with international consensus – profit from the sale of property is basically taxable in the country where the property is located, whereas profit from the sale of shares is taxable in the country where the shareholder resides.
If a company principally or solely holds property, the sale of the respective shares shall be treated in the same way as the direct sale of property using a property clause. Ultimately, this requirement prevents a person or company from circumventing the generally recognised cross-border distribution of taxation by simply installing a company as intermediary.
German tax law
In the case of non-resident taxpayers who directly hold public limited company shares outside of Germany, the sale of shares is only taxed if the company's registered office or management is located in Germany, and the seller has directly or indirectly held at least 1% of the company's share capital in the last five years.
The property clause, which is sometimes included in double taxation treaties, is currently only relevant for shares in a property company that is subject to unrestricted taxation (i.e. a company with a registered office or management in Germany). The sale of shares in public limited companies without a registered office and management in Germany does not fall into this category even if the company has property in Germany. This also applies if the minority holding of 1% is not reached. The German right to levy tax is not justified in these cases. Cross-border taxation rights using double taxation treaties are not applicable in such cases because there is no right under German law to levy tax.
Consequences of the new regulation
Attuned to the prevailing international consensus, Germany wishes to introduce a taxation right to levy taxes comprehensively on the sale of property companies.
This newly proposed provision is modelled on a similar provision in the 2017 OECD Model Convention on Tax.
Recognition of the sale of foreign property companies
The new regulation is particularly important in the sale of shares in property companies by non-resident taxpayers with both a registered office and its management located abroad. This configuration enables such a tax to be levied in Germany for the first time.
In other words, purely foreign transactions (i.e. the sale of a foreign share by a non-resident taxpayer) are to be subject to German taxation if a German property company is affected. This is designed to allow taxation similar to the way the direct sale of German property is taxed.
Foreign property companies and property holding companies will mainly be affected by this. It must also be noted that an indirect holding in German property may already be sufficient justification to be taxed.
Recognition of the sale of small holdings
In the future, the sale of small holdings in property companies (i.e. holdings of less than 1%) will also be subject to taxation.
Review period of 365 days
In order for the above-mentioned profits to be taxed, at least 50% of the value of the shares must be directly or indirectly based on domestic immovable assets. This precondition will be deemed satisfied if this was the case at any time during the 365 days prior to the sale, and if the shares were allocated under civil law and/or allocated economically to the seller. Both conditions must be satisfied cumulatively.
The 365-day review period is to avoid situations where the distribution of assets at the company is changed shortly before the sale of shares to prevent the 50% limit from being reached.
As a rule, the 50% limit is to be determined by comparing the market value of the affected (domestic) property with the market value of all the assets owned by the company (without taking into account debts or other liabilities). In cases where the shares sold could possibly exceed the 50% limit due to an indirect holding, the real property quota is to be determined on the basis of the total assets of a company based on a consolidated view.
Taxation of new profit in accordance with general principles
If Germany establishes this (new) right to levy tax in the cases mentioned above, profit from the sale of property will be subject to taxation according to general principles.
In the event of a sale by an individual, the "partial income procedure" would apply to a holding of at least 1% (i.e. only 60% of the profit from the sale would be subject to taxation). If a very small holding (less than 1%) is sold, in principle capital gains tax of 25% would be applied. In the event of a sale by a legal entity, 95% of the profit would generally be tax-exempt. If the selling legal entity has no permanent establishment and no permanent representative in Germany, the profit could even be 100% exempt from tax according to latest case law of the German Federal Fiscal Court.
It should be noted that cases such as a hidden contribution to a corporation are also considered the equivalent of a sale of shares.
Applicable to sales from 2019
If passed, the new provisions will be applicable to profit from the sale of shares sold after 31 December 2018. However, this will only cover profits based on a change in market value occurring after 31 December 2018. In other words, only hidden reserves created after 31 December 2018 are to be subject to tax. In light of this, an interim valuation will be necessary on 31 December 2018 in each individual case in order to separate the existing reserves from any new ones.
Conclusion: Reviewing old structures and monitoring current transactions
It remains to be seen whether and how the proposed new regulation will be implemented. If the bill does become law, structures set up in the past would have to be reviewed, particularly German property portfolios held by foreign property companies. Future changes to these structures will have to be reviewed to determine any tax implications in Germany. With regard to the 365-day review period, it would be advisable to take the precaution of careful documentation.