Keywords: real estate, German Real Estate Transfer Tax Act, construction contracts, ground rent, Power of Representation, land charge,
The Federal Fiscal Court ("BFH") Decides on an Indirect Change of Partners Pursuant to Section 1 Para 2a of the German Real Estate Transfer Tax Act ("GrEStG") Through a Different Attribution of the Interest
By Cornelia Wiendl
In its ruling of July 9, 2014 (II R 49/12), the BFH decided on an indirect change in partners pursuant to Sec 1 Para 2a GrEStG through a different attribution of the interest. In accordance with the wording of Sec 1 Para 2a GrEStG, a prerequisite for the taxation of such procedures where partners change directly or indirectly within five years is that at least 95 percent of the interest must be transferred to new partners. While the conditions for acceptance of a direct change in the partners of a land-owning partnership have largely been resolved without problem, indirect changes of the same create major practical and doctrinal issues.
Since the adoption of the identical decree by the upper tax authorities of the Federal States on February 25, 2010 (Federal Tax Gazette –BStBl. I 2010, 245), the tax authorities have interpreted this differently depending on the legal form. According to their view, it depends on whether the company involved in the land-holding partnership is a partnership ("Personengesellschaft") or a limited liability company ("Kapitalgesellschaft"). This was contradicted by the BFH in its ruling of April 24, 2013 (II R 17/10): It first stated that the condition of " indirect transfer of interest" in Sec 1 Para 2a GrEStG could not in any way be interpreted specific to the legal form. It also ruled that a change in the equity structure would make the participating company a "fictitious new partner" only in those cases where the partner's status has changed completely, directly or indirectly, through the application of an economic approach, in the relevant five-year period. The BFH clarifies this economic approach in the judgment handed down now.
A (contribution: EUR 450,000) and B (contribution: EUR 2,050,000) held interest in the applicant, a GmbH & Co. KG, as the sole limited partners. A-GmbH, a German limited liability company, was general partner without its own equity interest.
A sold its total limited partnership interest by agreement of October 16, 2000 and B the majority of its limited partnership interest, with the exception of a remaining partnership interest of 5.6 percent. With the same agreement, A and B sold their interests in A-GmbH to X. Because of an option right that was granted and that was valid until December 31, 2006, X had the right to require transfer of B's remaining partnership interest at a fixed purchase price at any time. By agreement of November 19, 2001, B received a loan from X in the exact amount of the fixed purchase price. The fixed term of the loan was to expire on December 31, 2006; the loan was paid directly in the discounted amount. By further agreements of November 19 and 20, 2001, B transferred profit-sharing rights for her remaining partnership interest to X and granted an irrevocable power of attorney with regard to her remaining partnership interest, limited up to and including December 31, 2006. All rights could thereby be exercised and declarations submitted to third parties. There was an exemption from the restrictions of Section 181 of the Civil Code. These restrictions prohibit a representative – unless the latter has been exempted from the restrictions of the rule as in this instance – from performing a legal transaction on behalf of the entity he represents with himself for his own account or as representative of a third party.
Content And Subject Of The Decision
With its current decision of July 9, 2014, the BFH ties in with the principles developed in its decision of April 24, 2013 (II R 17/10). Within the meaning of an economic approach, based on the civil-law obligations of an entity that is a direct partner in the land-owning partnership, it could also be assumed that this participant's interest is attributable to a third party. This third party is thus a "fictitious new partner" within the meaning of Sec 1 Para 2a GrEStG. In that regard, the attribution of the interest is treated equally as the acquisition of the interest under civil law by a new legal entity. By way of justification, the BFH – considering the peculiarities of real estate transfer tax – draws on the principles of Sec 39 Para 2 No 1 of the Tax Code ("AO"), in accordance with which an asset is under certain conditions for tax purposes not attributable to the owner but to the so-called beneficial owner.
On the whole, the BFH relies on an overall view of each individual case, but it establishes certain criteria according to which it must be assessed whether in an agreement of a purchase option or – as in the case at issue – a "double option" that includes the purchaser's right to purchase and the seller's right to offer on the basis of fixed conditions, beneficial ownership of the buyer must be assumed in each case: If the purchaser has already acquired a legally protected position that is aimed at the acquisition of the right and it can no longer be taken away from him against his will, and if the essential rights associated with the interest as well as the risk of depreciation and the chance of an appreciation has been transferred to him, beneficial ownership would exist.
Impact On Day-To-Day Business
In practise, in order to avoid taxation under Sec 1 Para 2a GrEStG, it is customary that a previously participating partner remains in the company with a "dwarf interest" and only transfers this interest at the end of the five-year period. In order to avoid economic reclassification, in structuring this equity interest of the former partner, the criteria developed by the BFH should in future be followed and economic erosion that is too pronounced should be avoided. Since the conditions for the adoption of an economic reclassification must, however, be met cumulatively, some room for tax planning within the scope of normal structuring – aside from that which is provided for in the case under discussion – is given, which needs to be exploited.
In addition, the judgment should not affect the interpretation and application of the criteria of Sec 1 Para 3a GrEStG ("Anti-RETT-Blocker Legislation"). This refers to the financial circumstances for the occurrence of Real Estate Transfer Tax liability. Here, the legislature has clearly and definitively defined how an indirect holding of an economic interest of at least 95 percent is to be determined. It results from the sum of the direct and indirect interests in the capital or assets of the company and shall for indirect investments be assessed by multiplying the percentages in the capital or assets of the company. In the absence of loopholes in the regulations, which the BFH attempted to close in its judgment of April 24, 2013 (II R 17/10) in Sec 1 Para 2a GrEStG through interpretation from an economic point of view, the principles of Section 1 Para 2a GrEStG referred to in the judgment therefore do not apply to the Anti-RETT-Blocker Legislation.
Overall, however, it remains to be seen what the real consequences are that will arise in practice. In this regard, it is of particular importance whether the tax authorities – such as in view of the judgment of April 24, 2013 (II R 17/10) – prevent application of the judgment beyond the individual case by adopting a non-application decree. There were efforts undertaken by the German Bundesrat (opinion on the government draft law to adapt the Tax Code to the Customs Code of the Union and amending other tax regulations, "Customs Code Amendment Act", BR-Drs. 432/14) to normalise the current practice of fiscal administration by statute, and to retroactively make clear that an economic perspective in relation to the interpretation of Sec 1 Para 2a GrEStG had not been intended. This proposal was not yet adopted by the German Bundestag, so that the further development has to be awaited.
Contract Design for Construction Contracts – VOB/B Agreement – "Hot or Not?"
By Anja Giesen
VOB/B ("German construction contract procedures part B: The general contractual conditions relating to the execution of construction work") is a body of rules designed specifically for construction contracts, which is currently available in the version of 2012 (proclamation on July 31, 2009, BAnz (Federal Gazette) no. 155 of October 15, 2009, amended by a proclamation on June 26, 2012 in the Official Section, reference citation BAnz AT July 13, 2012 B3). The parties, however, must explicitly agree if the rules of the VOB/B shall apply. When concluding a construction contract, clients and contractors face the question whether or not the VOB/B should be agreed upon and whether the VOB/B should be agreed as a whole or merely individual clauses thereof. With the following article we would like to illustrate several advantages and disadvantages of agreeing to the VOB/B in construction projects.
Strictly speaking, the VOB/B was established in order to provide a consistent standard for construction contracts. Therefore, one advantage of including terms of the VOB/B is that it constitutes a body of rules that is conclusive and tailored to the specialties of a construction contract and provides the parties with an existing basic concept. The VOB/B is subject to the law governing general terms and conditions pursuant to Secs 305 et seq. of the German Civil Code (BGB). The rules apply neither automatically nor supplementally in the event of an omission in a contract, if the validity of the VOB/B has not been explicitly agreed. Particularly in light of the fact that the VOB/B contains rules which deviate from the statutory regulations governing works and services contracts (Secs 631 et seq. German Civil Code), it must be effectively included in the contract pursuant to Sec 305 Para 2) German Civil Code, and the included clauses must bear up to scrutiny against the laws governing general terms and conditions.
Including the VOB/B in full in a contract
One way to conclude a construction contract is to simply negotiate material parameters such as the object of the construction contract (performance) and price separately, and to otherwise agree that all provisions of the VOB/B shall become part of the contract. In this case it is sufficient to include an explicit reference to the VOB/B in the contract, if the parties to the contract are professional actors in the real estate industry – or, as the Federal Court of Justice (BGH) put it, "experienced" persons (cf. e.g. BGH ruling of October 20, 1988, ref. no. VII ZR 302/1997). Alternatively, the VOB/B may be included as an addendum. In this manner one arrives at a conclusive contractual concept that is inherently consistent, which considers the interests of the parties involved in the construction. A further advantage is the legal certainty in agreeing the VOB/B in full, as case law and literature now provide extensive explanations and interpretations of the various provisions, at least if and insofar as it does not pertain to the provisions amended in the latest version.
Depending on the individual requirements of the construction project, however, the body of rules is not necessarily conclusive, leaving a certain scope of application open in individual cases.
An example of a penalty (Sec 11 VOB/B)
In parts, the VOB/B contains provisions that only take effect under certain conditions. For instance, the applicability of Sec 11 VOB/B requires that a penalty was agreed in the first place, and merely substantiates an agreement made by the parties as the case may be. If the parties have agreed to a penalty of 0.3 percent of the total price for each week that the contractor is delayed with completion of construction, then this provision will be substantiated by Sec 11 Para 3 to the effect that if there is a delay of eight working days, a penalty of 0.4 percent will be levied, namely 0.3 percent for the full week and 1/6 for every working day of the subsequent week (2 x 0.05 percent). This substantiation by the VOB/B is an advantage if the parties have not substantiated the provision themselves, in that it avoids a dispute over the amount. A conceivable alternative provision could be to impose a penalty of 0.3 percent for each week begun (for eight working days: 0.6 percent, as the second week has already begun) or 0.3 percent per each full week (in the case of eight working days, merely 0.3 percent for the first week begun). This can constitute a significant difference, depending on a project's size. However, if desired by the parties, then a specific agreement is recommended over a blanket assumption of the VOB/B.
Agreeing the VOB/B "for the remainder"
Taking into account the specifications of a particular construction project, the parties may wish to conclude such or similar specific agreements deviating from the stipulations in the VOB/B. Therefore, quite often the parties do not agree upon the VOB/B as a whole, but rather refer to the VOB/B supplementally "for the remainder", meaning for any case no individual or specific clauses have been agreed. In this case the basic rule of Sec 305b of the German Civil Code applies, namely that individual agreements take precedence over general terms and conditions. If the parties did not agree a scope of applicability, this "gap" is then closed by a provision of the VOB/B. However, if there are agreements between the parties that contradict the provisions of the VOB/B, then the VOB/B provision does not apply and instead the specific agreement has priority. The advantage is the greater flexibility. A disadvantage, however, lies in the risk of a disequilibrium between the parties to the contract if this breaks the balanced overall concept of the VOB/B, which may result in individual clauses becoming ineffective and then failing to withstand scrutiny when compared against Secs 307 et seq. of the German Civil Code.
Agreeing individual clauses of the VOB/B
The idea behind this creation of the VOB/B was not that each party might choose individual provisions that appear convenient at the time. This may likewise result in a breach of the concept. Nonetheless, there are complex construction contracts in which parties wish to extensively and individually govern rights, obligations and legal consequences.
If the goal is to agree individual clauses of the VOB/B, it is essential that the respective clause is effectively included in the contract (such as by referencing the VOB/B provision concerned or simply repeating its wording) and that it individually withstands scrutiny against the laws governing general terms and conditions. Particularly when parties are unable to reach an agreement in certain situations, individual clauses of the VOB/B are resorted to and then included separately in the contract. Again, the contract needs to be drafted very carefully. One may dispute whether the VOB/B can be deemed balanced or advantageous for the contractor or client. However, cherry-picking individual provisions will almost certainly lead to an imbalance and invalidity of clauses. In the above agreement of a penalty for example, this might be invalid if the amount of the lump sum compensation agreed is inappropriate.
The inclusion of an individual clause may be particularly problematic if the provision concerned is not included in the agreement verbatim, but rather in a modified version. This may have the disadvantage that it is not possible, when designing the contract, to reliably assess in advance the risk of invalidity of a modified provision under the law governing general terms and conditions. Moreover, a modified clause may be more likely to give rise to disputes between the parties over the parties' intention behind including the clause, if the reasons for modification are not clear and available for interpretation. If deviations are desired, then it is always recommended to explicitly include the individual clauses in the contract and to discuss them, and to negotiate the respective concepts separately in order to minimise the risk of an infringement of the laws governing general terms and conditions.
The example of the change of plan concept
Depending on a construction project's individuality, and particularly in the field of plant construction, it may be in the parties' interests to negotiate an individual contract. For instance, this is true for right of say, right to participate and right to cooperate as well as the option to change the scope of works. Changes to the scope of works or plans are typical means by which a client maintains flexibility.
Pursuant to Sec 1 Para 3 (changes to the construction plan) and Sec 1 Para 4 (additional performances that become necessary in order to execute the performance agreed under the contract as well as other performances with the client's consent), a client may request changes for a corresponding fee. Pursuant to Sec 2 Para 5 VOB/B, a new price must be agreed that accounts for additional or reduced costs if changes to the construction plan or other client orders resulted in changes to the basis of the price of a performance stipulated in the contract. Agreeing such a price adjustment may take up valuable time.
Therefore, depending on the construction project, it may be appropriate to agree upon a deviating concept for adjustment that could include fixed options which predefine performance packages and remuneration, and grants the client the right to unilaterally exercise those options (possibly up until a certain point in time). Depending on the amount of work involved, a conceivable version is to assign a number of different prices to an option, depending on the point in time when the client exercises the option). This provides a considerable advantage over the VOB/B provisions regarding both parties' planning and cost certainty, but has the disadvantage that it is not very flexible. In order to grant more leeway to the parties and the client in particular, there are also far more complex concepts in which, for example, the contractor is bound to a particular cost model and is required to disclose calculations for client-requested changes, enabling the client to decide whether or not to commission the change depending on the offer. Changes proposed by a contractor may also be admissible if the contractor possesses the required expertise.
Whether it is advantageous or disadvantageous for both parties or even just one party to agree a construction contract under the VOB/B – as it is often the case – depends on the scope, individuality and circumstances of a project.
One advantage of applying the VOB/B as a whole or individual clauses thereof is that the risk of a clause infringing the laws governing general terms and conditions and therefore being rendered invalid tends to be small, as these clauses have been used and reviewed a lot. Also, existing case law and literature involving the VOB/B provides for extensive interpretations and provisions governing interpretations. This equips the parties with legal certainty.
However, the examples given illustrate that agreeing on the VOB/B as a whole is not exclusively advantageous. In parts, individually agreed concepts that deviate from it may serve the parties' interests better. A decision must often fall somewhere between legal certainty and planning certainty regarding costs and deadlines on the one hand, and maximum flexibility in executing a construction project on the other. Individually agreed clauses do however increase the risk of invalidity under the laws governing general terms and conditions if they lead to the contract's disequilibrium or an inappropriate disadvantage for a party in individual cases. Depending on the construction project's complexity, it is necessary to weigh up the advantages and disadvantages.
Originally published December 18, 2014
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