UK: European Tax Bulletin For Real Estate Funds

Last Updated: 23 August 2010
Article by Deloitte Tax Group

Most Read Contributor in UK, August 2017

UK: Effective tax rate – pan-European real estate funds

A common theme for maturing pan-European estate funds is a steady increase in the effective tax rate as the fund matures due to, for example, the utilisation of brought forward tax losses, utilisation of capital allowances/write down in the tax depreciation basis of underlying assets.

As such, a recent area of focus for many funds is consideration of methods of minimising local country taxes payable whilst also achieving certain commercial objectives (e.g. rationalisation of entities, improved flexibility to repatriate cash and creation of accounting efficiencies).

As a consequence of recent legislative and practice changes there are a number of opportunities for pan-European real estate funds to achieve the above. These primarily focus on increasing the amount of shareholder interest that can be accrued and deducted for tax purposes at the local asset owning company level. Legislative changes include:

  • the German earnings stripping rules and more specifically the exemption from these rules if the annual net interest expense of the relevant German asset owning company is less than a specified threshold amount of €3 million per annum;
  • refinancing of real estate in Italy and securing the finance by way of a mortgage over the property to fall within an exemption to the Italian 30% EBITDA limitation which applies to the deduction of interest. However, consideration should be given to the interpretation of the above exclusion issued by the Italian Association of Companies on 18 November 2009;
  • introduction of wholly owned local REITs, for example in France, Poland and Czech Republic; and
  • re-investment reserve planning in the Netherlands to achieve a step up for thin capitalisation and tax depreciation purposes.

In addition savings can be made through accelerating the use of local tax losses by either rationalisation of entities and/or tax groupings.

UK: Capital gains tax changes

As widely anticipated, the Emergency Budget on 22 June 2010 increased the rate of UK capital gains tax for disposals made after Budget day.

A new 28% rate of capital gains tax (CGT) will apply to higher rate and certain other taxpayers. Individuals will continue to pay CGT at 18% where their total taxable income and gains are within the basic rate band (£37,400 for 2010/11). The new 28% rate applies to gains above this limit. Non-UK domiciled individuals who claim the remittance basis will pay CGT at a flat rate of 28%, regardless of the level of their taxable income and gains.

The Budget also announced an increase in the lifetime limit on gains qualifying for Entrepreneurs' Relief to £5 million. Where Entrepreneurs' Relief applies, gains up to the lifetime limit are taxed at a rate of 10%. This can result in a potential tax saving of up to £900,000 per person.

Shares or securities in a trading company can qualify for Entrepreneurs' Relief where the following conditions have been met for at least 12 months prior to disposal:

  • the holder is an employee/officer of the company/group; and
  • they hold a minimum of 5% of the ordinary share capital and voting rights in the company.

In addition, disposals of a business carried on in partnership may also qualify. The relief may be relevant to management teams of portfolio companies, where those companies are regarded as trading. Where the 5% minimum holding criteria are not met, planning opportunities exist to fall within the relief.

Fund executives may also be able to claim relief on disposals of interests in the fund management business where this is carried on through a limited company or limited liability partnership.

The relief is unlikely to apply to promote arrangements, however, the longstanding model for the taxation of promote arrangements remains unchanged by the Budget announcements.

UK: HMRC release draft guidance of examples in which they will not challenge residency

HMRC have released draft guidance on company residence, which sets out examples of cases where they won't seek to investigate that a company is UK resident for corporate tax purposes.

HMRC make the following assumptions:

  • the company is wholly owned by a UK headed group or a UK headed sub-group with a non-UK resident ultimate parent;
  • the company is incorporated outside of the UK in a territory where it is considered to be resident for tax purposes by virtue of its incorporation there;
  • the country of incorporation and residence has a double taxation agreement with the UK which contains a residence tie-breaker;
  • the company is genuinely established in its territory of residence;
  • the company does not (except in the particular circumstances of examples 6 to 8) have investment business as its main business; and
  • the central management and control of the business of the company is at least in part exercised at meetings of its board of directors.

HMRC provide the following examples of cases in which they would not seek to review the tax residence of the company:

Example 1

A company includes as a member of its board of directors a UK resident, all other members being resident in its territory of residence and elsewhere outside of the UK. The company's board of directors meets only outside of the UK.

Example 2

A company has more than one UK based director on its board, but the majority of board members are based outside of the UK in its territory of residence or elsewhere. The board meets only outside of the UK.

Example 3

The minority UK based attendance in example 2 becomes a majority on an isolated occasion due to the unforeseen unavailability of one or more of the overseas based directors.

Example 4

The UK based directors in examples 1 and 2 do not travel to attend board meetings in person but habitually participate by electronic link from the UK.

Example 5

The board of directors in examples 1 and 2 hold the majority of its meetings in any one accounting period outside of the UK but a small minority – no more than one or two – of the meetings are habitually held in the UK.

Example 6

A company has as its main business the holding of majority shareholdings in operating companies resident in its own territory of residence or region (which does not include the UK). Its board of directors meets both in its territory of incorporation and in the territories of incorporation of its subsidiaries. It includes on its board a minority of one or more UK based directors.

Example 7

The UK based directors in example 6 habitually participate in meetings by way of electronic link from the UK.

Example 8

The situation is the same as in examples 6 or 7 except that while the board holds the majority of its meetings in any one accounting period outside of the UK, a small minority of the meetings (no more than one or two) are habitually held in the UK.

HMRC also give a single example of a case in which they would seek to review the residence status:

Example 9

The majority of directors habitually perform a significant part of their duties in the UK, merely leaving the UK to attend board meetings.

The draft guidance also covers the key factors in determining the location of individual directors. HMRC state that the location is the place from which an individual exercises central management and control that is the relevant factor for locating the residence of a company rather than the territory in which their personal tax liabilities arise.

Spain: VAT – Change of rates

The main VAT rate has increased from 16% to 18%, and the reduced VAT rate has increased from 7% to 8% from 1 July following changes included in the 2010 Spanish Budget Act.

Invoices for ongoing services, payments in advance and other complex payments arrangements will need to be reviewed carefully in order to ensure the correct VAT treatment is applied.

Spain: Corporate Income Tax – Transfer pricing

Since 19 February 2009, Spanish taxpayers are subject to transfer pricing documentation requirements in order to substantiate the arm´s length nature of related parties transactions. This requirement is based on the European Union's Code of Conduct relating to Transfer Pricing Documentation for Associated Enterprises.

A recent Royal Decree, dated 9 July 2010, exempts intragroup transactions from this requirement provided the transaction value does not exceed €250,000 during the tax period.

The following transactions are not covered by this exemption and will not be taken into consideration for the €250,000 threshold:

  • transactions performed with individuals or entities resident in tax havens;
  • transactions performed in the course of business activities with individuals subject to certain special tax regimes (estimación objetiva) and holding 25% or more of the shares (either directly or indirectly) of the company;
  • transfers of business, shares, or participations in the capital of any type of non listed entities in any official stock exchange market; and
  • transfers of real estate, or of any assets defined as intangibles for accounting purposes.

 

Additionally, the Royal Decree includes two new exemptions:

  • transactions performed between entities in Economic Interest Groups (EIGs), Temporary Group of Companies (Unión Temporal de Empresas or UTEs), or in the same Tax Consolidation Group as entities in EIG or UTEs; and
  • transactions between financial entities included in certain specific control protection systems approved by the Spanish Central Bank, under certain conditions.

It is however compulsory to report all transactions performed with the same related individual or entity exceeding €100,000 during the tax period in the CIT return even if these transactions fall within a documentation requirement exemption.

Netherlands: New UK-Netherlands double tax treaty

Subject to parliamentary approval in both states, it is likely that the new treaty will enter into force on 1 January 2011 in the Netherlands, and in the UK on 1 April 2011 for Corporation Tax purposes and 6 April 2011 for Income Tax purposes.

Dividends from investment vehicles

The new treaty provides for an exemption of withholding tax on dividends when the recipient of dividends holds 10% or more of the voting power in the distributing company. In order to ensure that tax is levied on dividend distributions by UK REITs and Dutch Fiscal Investment institutions (fiscale beleggingsinstelling), both of which generally do not pay corporate income tax, the exemption does not apply to these types of investment vehicles if the dividends directly or indirectly derive from real estate. The treaty provides that dividend distributions by such entities are subject to 15% withholding tax.

Alienation of shares in a 'real estate company'

In contrast to the current treaty, capital gains that are realized on the sale of shares in a 'real estate company' may be taxable in the country in which the real estate is situated.

A company qualifies as a 'real estate company' when 75% of the value of its shares directly or indirectly derives from real estate. In particular, when a UK resident alienates shares in a Dutch 'real estate company', the Netherlands Tax Authorities are entitled to tax the gain.

Based on current tax law, the Netherlands will tax the gain, broadly if the UK shareholder holds at least 5% of the shares in the Dutch 'real estate company' and those shares do not belong to the assets of an 'enterprise'.

This tax treaty provision does not apply to real estate of a company which is used for its business or that of its shareholders. Furthermore, the treaty provides for an exemption when:

  • the alienator owned less than 50% of the shares or other comparable interests prior to the first alienation; or
  • the gains are derived in the course of a corporate reorganization, amalgamation, division or similar transaction; or
  • the alienator is a pension scheme, provided the gains do not derive from any business carried on by the pension scheme. Under domestic law, the UK will continue to exempt Dutch shareholders from taxation on capital gains realized on sale of shares in a UK company.

Germany: Federal Fiscal Court confirms residence country taxation of interest income from rental profits in cross-border situations

In a decision published on 28 April 2010, the German Federal Fiscal Court confirmed the view taken by several lower courts that the interest income of a partnership deemed to be trading and renting out property in the U.S must be allocated to its partners and is subject to tax in the country where the partners are resident.

In this case, the cash surplus resulting from the leasing activities was invested and generated interest income. Applying the interest article in the Germany-U.S. double tax treaty, the court held that, from a treaty perspective, the interest income does not fall within the scope of the business profits article (owing to the fictitious "deemed trading" nature of the partnership's activities), or the real estate article as the income arises from the use of capital, not real property.

The court also held that in the case of double taxation, a credit for any foreign tax paid is possible only if there is a binding decision of the tax authorities that the mutual agreement procedure would not resolve the issue.

Although this case involved a German outbound situation, the decision should also apply to inbound situations. In situations where foreign investors hold German real estate for rental purposes through a foreign entity (e.g. Netherlands B.V. or Luxembourg Sarl) or through a partnership deemed to be trading by virtue of law, interest income earned in connection with the real estate should, in principle, be subject to tax outside Germany (at the level of the foreign entity or at the level of the partners in the partnership, respectively).

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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