Here is a summary of the key rules included in the draft act and their application to current and future share transactions:
1. Extension of “change of ownership rule” to corporate property entities
Currently, changes of ownership in property holding partnerships and corporate entities are treated differently for RETT purposes. If, in a partnership, ownership of at least 95% of the partnership interest directly or indirectly changes within a period of five years (the “cooling period”), RETT will be triggered (the so-called “change of ownership rule”). Whereas, for corporate entities, a sale of the entire share capital in a company does not trigger RETT, provided each new shareholder owns less than 95% of the shares in the company. The current RETT rate is between 3.5% and 6.5% depending on the location of the underlying property.
The draft act now proposes that the application of the change of ownership rule will be extended to corporate entities, i.e., that a cooling period will also apply to share transfers in such companies. Therefore, if shares of 95% (or the respective lower future threshold – see below) or more in a property holding corporate entity (e.g., a German GmbH or a Luxembourg S.à r.l.) are transferred to new shareholders within the cooling period, RETT will be triggered, irrespective if such shares are transferred to one or several new shareholders.
The draft act does not include an exemption for share transfers in listed property companies or in property companies being part of listed industrial groups. Therefore, such groups owning German properties may struggle to analyze any future RETT implications of their share trades at stock exchanges, as according to German securities law, share trades need not be reported by investors if they do not trigger respective thresholds (e.g., share trades below 3% of the share capital). The lack of such an exemption has been criticized by several authors in the tax literature and industry representatives during the preparations of the draft act, but has not yet been addressed.
2. Reduction of “equalization threshold” from 95% to 90%
The underlying intention of German RETT law is to tax the acquisition of real estate — irrespective of whether the real estate is acquired directly (i.e., via an asset deal) or indirectly (i.e., via a share deal). For this purpose, the German legislator previously introduced the “equalization threshold”, i.e., a share ownership threshold in a property holding company, the transfer of which is treated as if the investor for RETT purposes had acquired the underlying real estate. This threshold is currently 95%. Therefore, if an investor acquires 95% or more of the shares in a property holding company, RETT is triggered on the full tax value of the real estate.
The draft act proposes to reduce the equalization threshold from 95% to 90%. Therefore, in the future RETT will be triggered if at least 90% of the partnership interests in a property holding partnership or shares in a respective corporate entity are transferred within the cooling period.
3. Extension of the cooling period from five to 10 years
Currently, the cooling period – which is only applicable to the transfer of ownership in property holding partnerships - is five years. In the past, an investor was able to acquire properties owned by a partnership in a RETT-efficient manner by acquiring the partnership interest in two steps: first, the investor acquired 94% of the partnership interests (which would translate to 89% according to the new rules). Following the expiry of the cooling period, the investor then acquired the remaining 6% (e.g., by exercising a call option already agreed in the acquisition of the first tranche).
According to the draft act, this cooling period will be extended to 10 years.
As set out above, the new ten-year cooling period will apply in the future to both share deals in property holding partnerships and in respective corporate entities. Therefore, to achieve RETT-efficient share transactions in the future, the seller of a property holding entity will need to retain a share of at least 11% (instead of 6%) for 10 years (instead of five years). This constraint will make future property-related share deals more complex and costly for investors.
4. Effective date
In general, the new RETT rules will apply to all share transactions that close (i.e., legal ownership in the shares is transferred to the acquirer) after December 31, 2019.
However, the draft act includes a transition period for currently ongoing transactions. If the (unconditioned) SPA was signed before the draft act is officially introduced into the legislative process (i.e., by presenting it to the German Parliament) and the transaction is closed within one year of that date, the new RETT rules on share transactions will not apply to that transaction. In this case, RETT would only apply if triggered based on the current RETT law. However, this would only apply if the SPA was signed no earlier than one year before the draft act is introduced, as set out above.
5. Relevance for transactions under current cooling periods and for changes in existing structure
The new RETT rules will affect current share transactions and changes of ownership in existing structure as follows:
- Current cooling periods for the transfer of interest in property holding partnerships (five-year period) that have not expired by January 1, 2020, will be extended to the new period of 10 years. For example, if an investor acquired 94% of interest in a partnership in February 2017, the cooling period for the acquisition of the remaining 6% will be extended until February 2027.
- If the current cooling period has expired before January 1, 2020, the current period will not be extended. For example, if an investor acquired 94% of interest in a property holding partnership in December 2014, the current five-year cooling period will expire in December 2019 and will not be extended.
- Besides the new RETT rules, the current RETT law on share transactions, i.e., the current change of ownership rule regarding property holding partnerships, and the current equalization threshold regarding property holding entities remain applicable (partly for an interim period) for transfers of partnership interests or shares that will close after December 31, 2019, in cases where the share ratio of the respective shareholder on January 1, 2020, is at least 90%, but still below the current threshold of 95%. This will in particular hinder existing investors stepping up their share in a property holding company without triggering RETT.
Ongoing transactions, as well as future changes in the ownership of existing structures, should therefore be analyzed carefully based on the potential applicable RETT rules, before transactions are executed.
6. Reporting requirements
Based on the current RETT rules, RETT taxpayers are required to notify RETT relevant transactions (e.g., the signing of a respective SPA) to the German tax authorities within the relevant time periods (two weeks or one month).
As the change of ownership rule under the new law will be extended to share transactions in property holding corporate entities, the target entity itself – like, currently, a property holding partnership - will be the respective tax payer if the share transaction triggered RETT, and will have to notify the German tax authorities accordingly.
Failure to notify may be treated as a tax compliance offence. Furthermore, potential RETT reductions for the unwinding of transactions, retransfers of shares or changes of the purchase price, may be denied if the notification was not made properly
Until 5 June 2019 the Federal Ministry of Finance will collect comments from industry associations. Following that the (amended) draft act must be approved by the German Government, which will then introduce the Government draft act into the official legislative process by presenting it to the German Parliament. It is currently intended to conclude the legislative process by the end of 2019.
Although the draft act is mainly based on the key terms agreed by the German state finance ministers, it may still be subject to changes during the legislative process. We recommend to keep a close eye on the act as it proceeds through the legislative process, in particular in case you recently executed or intend to execute share deals involving German property.
Client Alert 2019-124