Cayman Islands: German Funds - Using Offshore Real Estate To Invest In UK Real Estate

Last Updated: 19 September 2008

Recent changes to the German Investment Act (the "Act") have made it easier for German investment funds to incorporate offshore companies for use when acquiring UK or other real estate.

Ogier have recently completed several transactions for German fund clients acquiring UK real estate, have developed know how and precedents for use by German funds and with offices in offshore jurisdictions including Jersey, Guernsey, Cayman and BVI should be ideally placed to meet the particular needs of a client. In the past, for a German fund to be able to set up an offshore company, regulatory approval was required from the German Federal Financial Supervisory Authority (Bundesenstalt für Finanzdianstleistungsanfsicht, BaFin). This approval process took up to 3 months or longer. One of the recent changes to the Act is to abolish the requirement for prior regulatory approval to be obtained.

This has permitted offshore companies to be used where previously transaction timetables could not afford to wait three months for a regulatory approval.

The Act also now allows greater flexibility for real estate funds. Previously funds were not allowed to invest in real estate companies that held participations in other real estate companies. This restriction has now been removed, although an indirect participation must be a 100% holding.

Setting up Offshore Companies

Offshore companies can be incorporated quickly (within a day) and the company laws of offshore jurisdictions tend to be very flexible which is advantageous to the shareholder. For example, dividends can be paid out of capital as well as profits, subject to a solvency test being met.

Offshore Taxation

In general, offshore jurisdictions are tax neutral. Therefore, there will be no taxes to pay in the jurisdiction where the offshore company is incorporated. For example, there is no withholding tax, stamp duty on the transfer of shares or any income, corporate or capital gains tax.

However, in respect of UK real estate the rental income will be subject to UK income tax but the company, provided the property has been acquired for investment purposes (and not for development and onward sale), should not incur any capital gains tax on a sale.

Detailed tax advice should always be taken in the UK and Germany to ensure the appropriate structure is set up as there are other taxation matters which need to be addressed in both jurisdictions.

Management and Control

There are no rules under most company laws in offshore jurisdictions governing where directors must be resident although it is important when structuring the company to ensure that its management and control is not undertaken in the UK or in Germany. Therefore, all directors should only participate in board meetings outside Germany and the UK. Typically, the company will have offshore resident directors appointed to manage the company and the administrator, who will act as secretary and operate the company's bank accounts etc., will also be resident offshore.

Exiting the Investment

Investors around the world are familiar with Jersey, Guernsey, BVI and Cayman companies (which are all based upon English company law principles) and generally have no objection to owning them. Therefore, it is almost always the case that a sale of the company can be effected when selling the asset rather than the asset itself having to be sold. This is convenient and means that the fund in not left with a shell company to wind up once the asset is sold. It also means that the purchaser will avoid paying stamp duty on its acquisition of the asset and may enable the fund to benefit from this saving when the purchase price is agreed since it is common to see the saving split between the two parties.

Permanent Establishment

Although the company will not have its own exclusive office space at the offices of the administrator in the offshore jurisdiction, it is possible to manage the company to ensure that meetings are held offshore and the administration is conducted offshore. Provided that this is carried out in practice and little or no administrative or management actions or decisions are undertaken in the UK or Germany, the company should not be deemed to have a permanent establishment in Germany or be managed and controlled in the UK.

Other Requirements under the Act

The Act also imposes other requirements on the fund and the company. For example, that certain restrictions must be contained in the constitutional documents of the company relating to the number and type of assets the company may hold.

Those restrictions required between the company and the shareholder not suitable for inclusion in the constitutional documents are included in an investment agreement between the fund and the company which further regulates how the company will be operated. This may include reserving certain rights in favour of or on behalf of any custodian.

Debt Finance

Pursuant to the Act no fund can be more than 50% leveraged with third party debt finance. However, it is possible for a shareholder to loan the company up to 80% of the property value. It is consequently possible to negotiate a favourably light security package with the bank which is lending to the fund and / or the company in respect of the property acquisition.

Limited Liability

Under the Act it is also a requirement that the liability of a shareholder is limited to the amount paid up on the shares that have been issued to it. Once the shares of a company have been issued and are credited as fully paid there is no further liability on the shareholder to contribute to the company.

Auditors, Accounts and Currency

As a general guideline, a company may adopt whatever generally accepted accounting principles it wishes. The company may also produce its accounts in pounds Sterling, Euros or such other currency as it wishes. Typically, there is also no requirement that the auditor actually be in the jurisdiction of incorporation and, subject to other qualification requirements, it ought to be possible for the fund's auditor to be appointed as auditor to the company.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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