Recent developments in German real estate transfer tax (RETT) law

German state finance ministers propose cutting share deal privileges

End of June 2018 the finance ministers of the 16 German federal states discussed possible reforms of the German Real Estate Transfer Tax Law (Grunderwerbssteuergesetz or GrEStG in its German acronym), which will have implications for structuring of real estate acquisitions in Germany.

The German Real Estate Transfer Tax Law treats real estate acquisitions differently depending on whether the acquisition is done directly via an asset deal or indirectly by acquiring shares or interest in a company or partnership – share deal. Where real estate is acquire in an asset deal, real estate transfer tax is unavoidably triggered. Acquisitions via share deal, however, may be structured so as to avoid paying real estate transfer tax. With real estate transfer tax being charged at rates between 3.5 and 6.5 percent of the property value depending on the location of the property, being able to structure a transaction without triggering real estate transfer tax poses a significant commercial benefit.

According to the information released to date, the finance ministers propose to – among other changes – limiting the privileges of share deal real estate acquisitions. In particular, we understand the finance ministers suggested to

• apply the change of ownership rule to companies;
• extend the holding period; and
• reduce thresholds for tax free transactions.

This brief overview discusses the proposed amendments and the impact they may have on past and future transactions.

Change of ownership rule

Under the German Real Estate Transfer Tax Law in its current form real estate transfer tax is triggered if, in a property holding partnership – direct or indirect – ownership of at least 95 percent of the partnership interest changes within a period of five years. This provision – the so-called change of ownership rule – does under the current real estate transfer tax regime not apply to property holding companies.

For property holding companies, a sale of the entire share capital in a company does not trigger real estate transfer tax, provided non of the new shareholders – directly or indirectly – increase his shareholding in the company to 95 percent or more. The finance ministers now proposed to extend the application of the change of ownership rule to companies.

Holding period

The five year period during which transfer of interest in a property partnership may trigger real estate transfer tax – the holding period – allows real estate transactions involving property holding partnerships to be structured in a real estate transfer tax efficient way. An investor may acquiring the partnership interest in the holding vehicle in two steps. In the first transaction the investor would acquire 94.9 percent of the partnership interest.

The remain 5.1 percent could either be acquired by a minority shareholder, who must not be related to the majority shareholder through beneficial ownership, or remain with the original owner. In a second transaction after the expiration of the holding period the majority investor would acquire the remaining 5.1 percent of the partnership interest. The second acquisition can be secured by a call option included either in the sale and purchase agreement of the first transaction or a separate agreement or undertaking.

Under the current real estate transfer tax regime the waiting period after which the second acquisition can be made is five years. Should the proposal of the finance ministers to extend the holding period to ten years be implemented, the waiting period would be doubled.

Threshold

The purpose of the German Real Estate Transfer Tax Law is to tax the transfer of ownership of real property. Consequently, real estate transfer tax attaches where 100 percent of a property holding company is acquired. However, to avoid circumvention of the real estate transfer tax the law includes a threshold that allows for the taxation of transactions in which less than 100 percent of the shares in a property holding vehicle are transferred.

Currently this threshold is 95 percent. Thus, where an investor – directly or indirectly – acquires 95 percent or more of the shares in a property holding company, real estate transfer tax calculated on the full value of the property acquired is charged. Thus, the investor is treated as if he had acquired 100 percent of the property.

The finance ministers now proposed to reduce the threshold from 95 to 90 percent. If this proposal would become law real estate transfer tax would be triggered upon the – direct or indirect – acquisition of 90 percent or more of the share in a property holding company. In order for a real estate transaction to be structured in a real estate transfer tax optimized manner, the shares in a holding company would have to be acquired by at least two shareholders non of which may hold 90 percent or more of the shares in the property company. Furthermore, as under the current real estate transfer tax regime, where shareholders that are related through beneficial ownership collectively acquire 90 percent or more of the company’s shares real estate transfer tax would be triggered.

Progress of implementation

As of now, the finance ministers only announced above outlined key points of their proposal for amending the German Real Estate Transfer Tax Law. Further details of the proposed amendment as well as the time line for its implementation are still outstanding. Thus, it remains unclear how long it will take for a first draft of the law amending the German Real Estate Transfer Tax Law to be published and to what extent the finance ministers’ proposals will ultimately become law.

Still, we consider it likely that the ministers’ proposals will be transferred into law quickly and comprehensively. There is a strong political will to implement the proposed reform as the privileged treatment of share deal real estate transactions in respect to real estate transfers tax is perceived as unfair. Therefore, and since the law may have implications for existing holding structures, investors in German real estate will have to review their holding structure and prepare for coming changes in the law.

Retroactive application

Pursuant to a principle of German tax law tax legislation may not be amended in a manner that would have undue retroactive disadvantages for tax payers – a principle that has been reaffirmed by the German Federal Constitutional Court in multiple decisions. Still, not every negative retroactive effect of a German tax law amendment is considered an undue retroactive disadvantage of tax payers under this principle. German law distinguishes between amendments with true retroactive effect, which, if their effect is negative for tax payers, are generally not permissible, and those with pseudo retroactive effect, which are generally permissible, regardless of whether their effect for taxpayers is negative or not.

An amendment of a tax law is considered to have a pseudo retroactive effect if the change in the alters the tax burden for an event that was initiated prior to, but completed after the amendment becomes effective. Pseudo retroactive effects most frequently occur where laws governing taxes that are charged on a continuous basis – such as personal or corporate income tax – are amended towards the end of the relevant tax assessment period. While the legitimacy of each amendment of a tax legislation has to be assessed on a case-by-case basis, amendments during a fiscal year are – in principle – permissible as the taxpayers’ liability arises only at the end of the fiscal period and the German legislator may – as a matter of principle – amend legislation at any point during the then current assessment period, which may impact the tax liability for the whole assessment period.

An amendment is considered to have a true retroactive effect, if the change in law alters a tax liability that has arisen prior to the relevant amendment. Since German real estate transfer tax is triggered upon the obligation to transfer ownership of a real property arising – thus, upon the parties concluding the sale and purchase agreement and not upon ownership actually being transferred – the tax liability is assessed pursuant to the laws applicable at the date the obligation to transfer real property is created. Therefore, where real estate transfer tax legislation is amended, such an amendment is deemed to have true retroactive effect.

Amendments with negative true retroactive effect are permissible only under specific conditions. True negative retroactive effects are permissible where the underlying amendment of law is made:

• due to the law amended having been found to be unconstitutional in its pre-amendment form;
• to clarify ambiguity in the law;
• to satisfy a compelling public interest; and
• to clarify an existing uncertainty from the taxpayer’s perspective as to whether an existing tax law continuous to apply or not.

While the first three conditions are not fulfilled with respect to the proposed amendment of the German Real Estate Transfer Tax Law, statements made by the legislator may create uncertainty form the taxpayer’s perspective as to the continued application of a tax law. At this stage the proposal for amendment of the German Real Estate Transfer Tax Law made by the finance ministers are still too vague to create uncertainty as to the continued application of the law. Therefore, a retroactive application of the proposed amendment should only be permissible as of the date on which a draft legislation providing for the amendment has been submitted to parliament.

Outlook

The finance ministers of the German federal states requested the federal and state finance ministries to start drafting a law that would implement the changes to the real estate transfer tax regime they proposed. With parliament’s summer break coming up, we do not expect the first draft of the law to be available before September 2018. Furthermore, until a final draft of the amendment is agreed and published some more time will go by. Thus, investors will have to wait and see to which extend the proposed amendments of the German real estate transfer tax regime proposed by the financial ministers will be implemented.

Still, since some changes will likely come within a reasonable time frame investors should be prepared to on short notice review existing structures in order to ensure that these structures will be optimal for the amendments to come.