This bulletin aims to highlight key tax issues which may be of importance to real estate funds and investors.

Denmark: Corporation tax rate reduction proposed in tandem with restriction on interest deductions
A draft bill was published by the Danish Minister of Taxation on 1 February 2007, proposing some significant changes to Danish corporate income tax, interest deductibility, tax depreciation and dividend payments. The main items of the proposed draft bill are:

a) The bill proposes to reduce the statutory corporate income tax rate from 28% to 22%, with effect from fiscal years commencing 1 January 2007. Further talks after the publication of the draft bill seem to suggest that the corporate income tax rate may be reduced only to 24% or 26%; and

b) The bill also includes a proposed restriction on interest deductions which will apply to both inter-company debt and third party debt. The rules contained within the bill provide that:

  • Only 55% of net interest expenses in excess of DKK 10m (approx.EUR 1.35m) will be permitted as a deduction in computing taxable income. This results in a deduction at an effective rate of 12.1% (22% of 55%) for expenditure which exceeds the DKK 10m threshold;
  • Net financing expenses will not be deductible to the extent they exceed a cap, calculated at a standard rate of return (presently 6.5%), on the tax base of the company’s assets (less certain financial assets). Interest expenses that are restricted as a result of the cap will not be eligible for carry forward or carry back for set-off in fiscal years where the cap does not apply; and
  • To the extent that they do not exceed DKK 10 million, net financing expenses should always be tax deductible. The proposed changes on interest deduction have encountered fierce opposition within government and industry representatives and there are now talks to replace the suggested rules by a stricter thin capitalisation regime (in principle, 2:1 debt/equity ratio) combined with some further restrictions on the amount of taxable income which could be sheltered by deduction of interest expenses.

It is envisaged that Danish property owning companies or Danish permanent establishments of foreign companies owning Danish properties will be negatively affected by the bill as they tend to be primarily debt financed and are normally structured in order to rely intensively on interest deductions. It is still unclear when the proposed changes will be implemented and become effective from.

Germany: Taxation changes expected to impact private equity houses
It is expected that the German authorities will propose taxation changes which will impact the availability of tax relief for interest payments. It is anticipated that, in order to obtain a deduction, it will be necessary to demonstrate that the debt/equity ratio at a German entity level does not exceed that which arises at a consolidated level. As such, a practical concern has arisen, that the German tax authorities will require consolidated accounts for tax filing purposes, thus significantly increasing the administrative burden as currently such accounts are often not produced by private equity houses at fund level or Luxembourg intermediate levels.

The preliminary draft states that in cases where consolidated accounts under IFRS are not produced, equivalent accounts under German GAAP or US GAAP would be sufficient, as audited for German tax purposes.

Germany: Preliminary draft of German tax reform plans for 2008
German tax reform plans for 2008 were released earlier this month and contain a number of proposals that, if enacted, will significantly affect businesses. It is expected that most of the changes would become effective from 1 January 2008. According to the current draft, the 2008 tax reform will include the following:

a) The combined effective tax rate for corporations would be reduced to 29.8% (although the trade tax element of the combined rate is variable depending on the location of the company). In addition, trade tax will no longer be treated as a deductible business expense for corporate income tax purposes; and

b) The transfer pricing rules will be amended, via proposed modifications to both the AO (General Tax Code) and the AStG (Foreign Tax Code):

  • Amendments to the AO include a tightening of the transfer pricing documentation requirements. In addition, the proposal allows the tax authorities to estimate a taxpayer’s income in certain cases, even if the taxpayer has produced documentation to support a filing position; and
  • Amendments to the AStG include provisions such that the terms "transfer prices" and "arm’s length" would be defined according to international standards. In addition, the proposal would also give rise to a priority of the ‘comparable uncontrolled price’ ("CUP") method over other transfer pricing methods.

Germany: Proposed changes to the German Investment Act (GIA)
The German Federal Ministry of Finance has recently published a preliminary draft version of the proposed amendments to the German Investment Act (GIA).

One of the main changes proposed is in respect of non-German funds qualifying as "investment funds" as defined in the GIA. Under the proposed rules, non-German funds will only be treated as "investment funds" if they offer a redemption right to their investors.

In case a foreign fund does not qualify as an "investment fund" under GIA, its tax treatment would be as follows:

  • Foreign closed-ended funds would no longer be subject to the German Investment Tax Act and would therefore not be subject to its reporting requirements; and
  • German investors would be taxed under the normal German tax rules. No lump sum taxation would therefore apply.

Poland: Tax free step-up in real estate base cost still available
Further to the information provided in the November Bulletin, due to the existence of transitional provisions, it is still possible to achieve a tax free step-up in the base cost of Polish real estate. The transitional provisions provide that taxpayers who carried out business activities in 2006, and applied an extended tax year (ending in 2007), may benefit from tax provisions in force in 2006. Provided the above applies, companies are still able to improve their tax position in Poland by increasing the tax base cost available for depreciation under the tax-free step up regime.

Hungary: Minimum tax abolished
The Hungarian Constitutional Court abolished the minimum tax on 27 February 2007. The minimum tax previously affected structures in which a Hungarian company received tax-free income. As a result of the abolition of the tax, Hungary has become a more attractive holding location as Hungarian holding companies can now receive tax-free income without attracting a charge under the minimum tax regime.

Romania: Real estate transfer taxes abolished with effect from 2007
Commencing 2007, stamp duty which was previously payable upon the transfer of real estate will no longer be charged. Notary fees, amounting to approximately 0.5% of the transfer value will still be levied.

Spain: Transfer tax anti avoidance measures announced
Amendments to article 108 of the Stock Market Act 1988 affect the application of transfer tax. Previously transfer tax applied only to the sale of shares in companies which own real estate representing more than 50% of the company’s total assets. Now the rules have been extended such that the transfer of shares in companies with shares in another company owning Spanish real estate, which exceeds 50% of the company’s assets, will also attract transfer tax.

The repercussions of the extension of the rules remain unclear; it appears that the Spanish tax authorities are seeking to clamp down on the use of foreign entities as a vehicle for the avoidance of transfer tax.

United Kingdom: Authorised Investment Funds on a similar "level playing field" to UK REITs
Following Government discussion on the taxation of Authorised Investment Funds (AIFs) which invest in property, it was announced on 21 March that the new regime effective for UK Real Estate Investment Trusts (UK REITs) from 1/1/07 is to be adapted to Property AIFs established as Open-Ended Investment Companies (OEICs), although Authorised Unit Trusts (AUTs) will not be eligible because of perceived double tax treaty complications. Existing Property AUTs will, however, be able to convert to OEICs and access the new regime.

Broadly, there will be no corporation tax cost in the AIF itself under the new regime. The point of taxation on income moves from the Property AIF to the investor, with the result that investors face broadly the same tax treatment had they owned real property or UK REIT shares directly.

Access to any new Property AIF will be available only to AIFs whose investment portfolio comprises predominantly real property or shares in UK REITs. Subject to further discussions with the industry, the property holding requirement will be similar to that of UK-REITs, (i.e. 75% of income and assets). AIFs meeting the property holding requirement would be able to elect into the new regime but it would not be mandatory.

The key features of Property AIFs announced on Budget Day are:

  • No entry or conversion charge for any new Property AIF.
  • Complex streaming of income: Ring-fencing of income into three separate pools: Property Income; Other Taxable Income (primarily interest and non-UK dividends); and UK Dividend income. The Other Taxable Income pool will operate in a similar way to a bond fund.
  • Withholding Tax (WHT) on distributions: Each of the distributions out of the above pools would be subject to UK tax rules applicable to that form of income in the hands of the recipient. Distributions of Property Income and Other Taxable Income would be subject to WHT at 22% (for now) and 20% respectively. This WHT would be available for credit or, for certain investors, repayment.
  • Requirement to be ‘widely held’: As for UK REITs the Government propose to introduce a 10% corporate ownership test which will take account of the openended structure of AIFs and their crosssection of institutional investors. Also they propose to introduce a diversity of ownership test to avoid closely-held Property AIFs. Developing these rules will be subject to further discussion with the industry working party.

The UK tax authorities will consult on the details during 2007 and resolution of the above issues is not expected much before the end of the year.

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.