UK: European Tax Bulletin For Real Estate Funds

Last Updated: 20 February 2008
Article by Deloitte Real Estate Group

Most Read Contributor in UK, August 2017

European Union: Possible Changes To VAT Treatment Of Property Fund Management

There has been much discussion about the VAT treatment of various types of "fund management" fees following the ECJ decision in AIC. The debate on the VAT treatment of these services looks set to continue and the situation looks to be further complicated by EC Commission proposals to alter the VAT exemption for management of investment funds and that "investment funds" will mean undertakings for collective investment in "exempted financial instruments" but will now also include investments in real estate – which would have the effect of widening the current UK exemption.

This means that the EC Commission is proposing to apply VAT exemption to the management of collective investments in real estate. Such VAT exemption already exists in some EU Member States (for example Luxembourg and the Netherlands) but not in the UK where many property fund managers are located. The proposals are aimed at simplifying and updating the VAT rules for exemption that apply to the financial services sector but it is still not clear how these rules would apply cross-border.

These proposals would generally benefit property funds investing in property that gives rise to no VAT deduction, for example residential or property that has not been "opted to tax" or for funds investing in indirect property investments. However, it may increase costs for funds or fund managers advising funds that invest directly in property which gives rise to a VAT deduction as the fund manager would no longer be able to recover VAT on its costs. Where the risk of the possible futures changes would lie may depend upon the contractual position.

One further complicating factor is the EC Commission's proposal that EU Member States would be forced to allow taxpayers to "opt to tax" certain financial services but that they would be allowed to define the scope of such an option to tax. However, since this represents a risk to the revenue it is unlikely that this will be agreed in its current form.

Obviously these are only proposals at the moment and it is likely that the overall proposals will change before they are introduced. Furthermore, it is likely that it will take some time before the proposals will be in a form that the Member States can agree to. Deloitte is involved in the consultation process with HM Treasury and we would welcome your views on the current proposals to feed into the consultation process.

France: Guidance On Thin Capitalisation Rules Published

French tax authorities published (on 31 December 2007) guidelines on the thin capitalisation rules that were enacted on 1 January 2007. The 2007 rules introduced an arm's length test for related party financing arrangements. Interest paid to related parties is fully deductible only if the interest rate is at arm's length. An interest rate will be deemed to be at arm's length if it does not exceed the average annual floating rate applied by banks to two-year loans granted to businesses. If the interest exceeds that rate, the taxpayer must demonstrate that the rate complies with the arm's length principle.

Even if the interest rate is acceptable, however, an interest deduction still may be disallowed if the interest exceeds certain limits. Interest paid to related parties will not be fully deductible if it simultaneously exceeds all of the following thresholds:

  1. a related party debt/equity ratio of 1.5:1;
  2. 25% of adjusted current profits (i.e pretax operating and financial profits, increased by items such as intra-group interest and depreciation) for the year; and
  3. interest income received from related parties (if the company uses the funds to finance other affiliated companies).

Interest is deductible up to the amount corresponding to the highest of the above ratio/thresholds, with the possibility to carry forward the non-deductible amount within certain limits (reduced by 5% each year as from the second year), unless the company can demonstrate that its own total debt/equity ratio does not exceed the worldwide group's third party debt/equity ratio.

If these cumulative tests are met simultaneously, the interest deduction is limited, although any excess interest may be carried forward.

It is also worth noting that the French tax authorities intend to apply the thin capitalisation rules to a French branch of a foreign company, even though this probably conflicts with the terms of the existing law.

Finally, the guidelines resolve the issue regarding partnerships held by corporate taxpayers. The thin capitalisation rules do apply to partnerships which could result in double taxation when a partnership is funded by a corporate taxpayer. In such a case, the guidelines provide that the partner is allowed to refrain from charging interest to the partnership.

Germany: Draft Guidance On New Interest Deduction Limitation Rule Now Available

According to a first unofficial draft of the German tax authorities' guidance on the new interest deduction limitation rule, the following issues are expected to be addressed in detail in the final guidance:

  • definition of interest income and expense;
  • treatment of the factoring of receivables;
  • treatment of interest expense and interest income resulting from the discounting of receivables; and
  • treatment of public and private partnerships for purposes of the interest deduction limitation rule.

The unofficial draft suggests that the tax authorities will not accept partnership-based planning ideas in which taxable profits of the partnership may effectively be used twice in determining the 30% of EBITDA interest limitation. The draft guidance also includes the tax authorities' view on when shareholder recourse for third party financing can jeopardise the use of the escape clause/group clause exemption from the general interest deduction limitation rules. The tax authorities rely on a very broad interpretation as included in the 1994 thin capitalisation rules. Specifically, the definition of "recourse" will not be limited to back-to-back secured financing structures.

A number of practical questions and technical detail, specifically with regard to the escape clause/group clause test, are not (yet) addressed in the guidance, so substantial uncertainty is likely to remain if the draft is not amended. The same applies to the definition of a "group" for purposes of the interest deduction limitation rule and the escape clause/group clause, as the guidance fails to address important practical questions (e.g. the top tier group entity in private equity cases).

Italy: Treasury Clarifies Rules On Deduction Of Interest On Mortgages Over Leased Properties

As a response to different questions raised by taxpayers on the practical application of the earnings stripping rules recently introduced in Italy, the local Government amended the final version of the Italian 2008 Budget Law for 2008 to determine that interest paid on financing provided to a real estate owning company and secured by a mortgage over the property will not be included in the calculation of the 30% EBITDA limitation which applies to the deduction of interest by Italian resident companies from 1 January 2008. This benefit will only apply provided that the real estate over which the mortgage is granted is leased.

This news has been received with great enthusiasm by the property market, in particular as, under the current version of the law, this tax treatment generally applies to interest payable on any debt secured by a mortgage over a leased real estate, even if the debt is provided by a related party company. The Italian Government have also announced that they will issue a more detailed set of regulations applicable to the property market later in the year.

Portugal: Relaxation Of Rules To Benefit From EC Parent-Subsidiary Directive

The final version of the Portuguese Budget Law for 2008, published in the Official Gazette on 31 December 2007, has relaxed the requirements for Portuguese resident company to benefit from the EC Parent- Subsidiary Directive. Under the new rules, dividends paid by a Portuguese resident company to a shareholder resident in another EU Member State are now exempt from withholding tax if:

  • the EU parent company holds at least 10% of the share capital (previously 15%) of the Portuguese subsidiary or the acquisition value of the shareholding is at least EUR 20 million; and
  • the shares have been held for an uninterrupted period of one year (previously two years).

The new regime also covers profits distributed to a permanent establishment of an EU parent company situated in another EU Member State.

The Budget Law measures are effective as from 1 January 2008 and aims to grant the same tax treatment to dividends paid by Portuguese subsidiaries to their Portuguese and EU parent companies. As such, EU companies that meet the above criteria and which have been subject to withholding tax on dividend income arising from their Portuguese affiliates should consider the possibility of requesting a refund of the Portuguese tax unduly borne under the previous dividend taxation regime.

Spain: Amortisation Of Financial Goodwill

The Spanish Government has recently contested the EU Commission's determination that the amortisation of financial goodwill qualifies as state aid under the EU Treaty.

In accordance with Article 12(5) of the Spanish Corporate Income Tax Act, the difference between the acquisition price of shares in a non-resident company and the net book value at the date of acquisition should be assigned to the different assets of the non-resident entities in accordance with consolidation accounting rules. The amount not assigned to the assets will be tax deductible at a maximum annual rate of 5%, provided that certain criteria are met.

It is the Spanish Government's view that this amortisation does not meet any of the conditions to qualify as state aid under Article 87 of the EU Treaty. The Spanish Government argues that in such case, the EU Commission should consider the existing Spanish tax rules alongside several other tax schemes in force within the EU. The Spanish Government also claims that the Commission's procedure against Spain is contrary to the European Law general principles of "legal certainty" and "legitimate expectations". Spain's appeal is now to be analysed by the Commission and further developments will be reported in this Bulletin.

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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