Norway: The Norwegian Real Estate Market From A Legal Perspective

Originally published in Euromoney Real Estate Finance Review in September 2006.

The purchase and sale of all real estate, including both residential houses and business properties, is regulated by the Norwegian Alienation Act. Contracts are relatively short compared with what you will normally find in e.g. UK or USA, as the provisions and principles of the Alienation Act will be adopted to fill in on matters where the contract itself is silent.

Under the Alienation Act, the seller will also be liable for substantial hidden defects even if the property is sold "as is". Normally, the parties in a commercial real estate deal will deviate from the Act on this point, as the seller will normally restrict his liability for hidden defects to situations where information given by the seller has been incorrect or incomplete.

The parties will also deviate from the Alienation Act’s time given to make claims (five years). In a standard commercial transaction this time will be limited to two years, and sometimes even less.

The most significant legal change in the Norwegian commercial property market over the last two years, is the tendency to sell shares in a single purpose property owning company rather than the property it self. The reason for this is undoubtedly the tax reform implemented during the years 2004 to 2006. As from 2004, a corporate shareholder has been entitled to sell shares in a limited liability company free of tax. As from 2006, the same applies to a corporate owner of parts in a general- or limited partnership. Losses will, on the other hand, not be deductible. Tax will not be triggered until an ultimate private owner receives the gain, for example by way of dividend distributions.

It is our experience that as much as approx. 75 percent of commercial real estate deals are now structured as sales of shares or parts. This percentage seems to increase as the trend is not only driven by the tax advantages but also by the dramatic disadvantages of selling the property directly if the difference between the tax base of the property and the market price is substantial, as often will be the case where the seller has historically acquired the shares and has therefore not been granted a step up in the tax base for the property.

The purchase of a company provides for a more detailed and comprehensive contract than the direct purchase of real property. To protect the buyer from unknown corporate obligations, the seller will have to be prepared to provide a set of warranties in addition to the regulation pertaining to the property it self.

The Alienation Act does not apply directly where shares or parts are sold, but the parties will normally agree that the Act’s principles shall apply to the standard of the property, but with the market’s standard exemptions (cf. above).

Under the Norwegian Companies Act, one is, as a main rule, not allowed to mortgage a property as security for a loan taken to fund the share purchase. The same applies to the acquisition of parts in a limited liability partnership. The Act does, however, provide an exemption clause for the Ministry of Trade and Industry. During last year, the Ministry started to grant exemptions in transactions where all shares in a real estate company were sold, provided that the company owned little more than the property and had few other creditors than those the mortgage is supposed to be established in favour of. Guidelines for the dispensation practise have recently been published in an official circular of the Ministry.

Legal framework pertaining to leases

Lease contracts are regulated by the Landlord and Tenant Act. The Act regulates both lease of residential- and commercial property. The Act is regarded as rather "tenant friendly", and professional parties will normally agree on rather extensive deviations from the Act. Contracts are often based on an accepted market standard between professionals. The trend in business leases is that more of what has traditionally been the responsibility of the landlord, such as outdoor maintenance and replacement of installations (such as elevators, ventilating systems etc), has been taken on by the tenant. We also see examples where the building’s insurance and property tax are covered by the tenant, and where the tenant cannot terminate the lease if the building is totally damaged in a force majeure situation (triple net leases).

Lease contracts for office buildings will normally be relatively long term leases (10, 15 or 20 years), not subject to termination during the agreed period, combined with options for the tenant to renew the contract on the same-, or market terms for one or more shorter periods. The parties will, as a standard term, agree to an annual regulation of the lease upwards in accordance with the consumption price index.

Registration of the title in the land register is subject to a stamp duty amounting to 2.5 percent of the purchase prise, and a registration fee of approximately Euro 200. For registration of mortgages and other rights, only the registration fee applies.

In contrast to other jurisdictions, there is generally no legal obligation to register title or any interests, benefits, rights or encumbrances in the land register. However, since registered property is protected against acquisition and registration of rights by third parties acting in good faith, registration is strongly recommended. Moreover, mortgages only become legally effective upon registration.

Where the shares in a property owning company are sold, the title does not change and no stamp duty will be triggered.

In order to avoid the stamp duty on the direct sale of commercial real property, the title is often registered for the benefit of a single purpose company only holding the title to the property. The shares of such a title holding company may be acquired free of any stamp duty.

Under Norwegian internal tax law, income and gains deriving from real estate located in Norway, are taxable to Norway, regardless of the domicile of the land owner. The tax rate is 28 percent. This right to taxation at source will not be deviated from in double taxation agreements.

Interests and other expenses are deductible from taxable income and gains from real estate. Buildings, storehouses, hotels and office buildings can be depreciated by 2 or 4 percent under a declining balance method.

As mentioned above, a Norwegian corporate shareholder does not pay taxes upon the sale of shares, including the sale of shares in a single purpose property owning company. This also applies to foreign shareholders, as Norway does not, in general, tax gains earned by a foreign resident shareholder’s sale of shares in a Norwegian company.

Real estate located in Norway is subject to net wealth tax at a maximum rate of 1.1 percent, if the owner is a Norwegian or foreign person. Companies are not subject to wealth tax.

Property located in Norway may be subject to a municipal property tax of between 0,2 and 0,7 percent of the assessed property value. The imposition of municipal property taxes lies in the discretion of the municipalities. Oslo has not implemented a municipal property tax. The trend is, however, that a growing number of local municipalities are implementing property taxes. All long term leases should therefore include a provision regarding municipal property tax, if the landlord wishes to be reimbursed for this cost by the tenant.

The acquisition and rent of property are, as a main rule, not VAT-able under Norwegian law. However, if the tenant is liable to VAT, the landlord may register voluntarily, thereby acquiring the right to deduct input VAT on construction and maintenance costs. If a property that has been built or rebuilt during the last three years is sold, the right to retain deducted input VAT is subject to the consent of the local VAT authorities. This does not apply to the sale of shares or parts in property owning companies. Change of the use of a property from VAT-able to non VAT-able use during the three year time limit, will trigger an obligation to pay back refunded VAT on construction cost.

An often seen requirement of foreign investors in Norway is local taxation of income, meaning that the investor prefers to be taxed only under the regulation in his state of residency. This is often due to special and favourable tax treatment for the investor locally, which is the case for a number of institutional investors such as life insurance companies, SICAVs etc.

Norway does not offer tax transparent real estate vehicles, such as REITs. Income relating to real estate is taxed at source. Foreign investors are therefore left with other alternatives to structure the investment so that it becomes close to zero taxed in Norway.

The common way of structuring such transactions, is to establish an acquisition vehicle, being a Norwegian limited liability holding company. This acquisition vehicle acquires the real estate, either by way of acquiring shares/parts in property owning real estate companies, or by direct acquisition where the property thereafter is placed in a subsidiary of the acquisition vehicle.

The acquisition of property is financed by an inter company loan from the foreign investor to the acquisition vehicle. Within the frame of thin capitalization rules (see below), the interest paid on the loan is deductible for the acquisition vehicle. Norway does not levy withholding taxes on dividends. The interests are served by group contributions received from the subsidiary/subsidiaries to the acquisition vehicle. These group contributions are, within certain limits, deductible for the subsidiary/subsidiaries. By structuring the investment this way, one can thus more or less neutralize Norwegian tax on the investment, and provide for local taxation for the investor.

The Norwegian Companies Act generally states that transactions between companies in the same group shall be based on market terms. Any agreement on acquisition of assets, services or performances from a shareholder against consideration from the company involving more than a tenth of the share capital at the time of the acquisition, must be approved by the shareholder’s meeting. Furthermore, a statement regarding the agreement must be provided and confirmed by an auditor. Whether the consideration from the company exceeds a tenth of the share capital will in particular depend on the total amount of interest to be paid in the notice period of the loan. An exception applies to business agreements which fall within the normal activities of the company and contain a price and other terms and conditions which are normal for such agreements.

The Companies Act also sets out rules applying to loans involving an interest rate which is wholly or partly dependant on the distribution of dividend to the shareholders or on the company’s result. Such loans must be resolved by the shareholder’s meeting or by the board of directors in accordance with a power of attorney granted by the shareholder’s meeting. The shareholder’s meeting’s resolution must be passed with the same majority as required for amendments to the company’s articles of association, i.e. 2/3 of the votes cast and 2/3 of the share capital represented at the meeting.

The relevant "tax question" will be whether the interest rate and the gearing are on arms length/in accordance with market terms for similar loans, meaning that an unrelated party would have granted the loan on such terms. This must be assessed based on an overall evaluation.

With regard to thin capitalisation, the rule of thumb, based on case law especially within the oil industry, has been 20/80 percent. However, investments in the Norwegian real estate market have lately been geared higher than 80 percent (sometimes up to 100 percent) for properties with long lasting leases to solid tenants. Thus, it may be difficult to apply thin-cap rules on real estate investments these days.

If the interest rate or the gearing is regarded too high compared to market terms for similar loans, the borrowing company will not be allowed to deduct the part of the interest payments that exceeds the market interest rate. If the company is not allowed deduction of all of the interest payments, the question is how the rest shall be treated for tax purposes at the hands of the lender. The starting point is that the loan must be treated as a loan, and not as equity. However, if the loan is more similar to equity than to a loan, there is a possibility that interest payments exceeding the market rate will be considered as dividend.

The tax consequences for the lender will depend on whether the lender is a Norwegian resident entity or a foreign entity. A Norwegian resident entity (and a foreign entity with a permanent establishment in Norway) will be taxable for the received interest payments at a tax rate of 28 percent. The same taxation will apply for any parts of the interest payments that are considered as dividends. Dividends received by a resident limited liability company are generally exempted from taxation in Norway, but the exemption does not apply to unlawfully distributed dividend, including interest payments reclassified as dividend.

For a foreign resident entity, the interest payments will not be taxable in Norway, provided that the loan is not connected to a permanent establishment in Norway, ref. above. There is no withholding tax in Norway for interest payments to foreign entities. However, the foreign resident entity may be subject to withholding tax in Norway if any parts of the interest payments are considered as dividends. The withholding tax rate is 25 percent but may be reduced in applicable tax treaty. Foreign entities resident in the EEA are, as a starting point, exempted from withholding tax in Norway, but this is provided that the dividend is lawfully distributed. Thus, the withholding tax can be applicable to the parts of the interest payments that are considered as dividend.

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.