Word is spreading that Germany is no longer a high tax jurisdiction. Indeed, with an aggregate profit tax rate of slightly below 30 %, Germany currently has one of the lowest profit tax rates among the industrialised G7 countries. With such rate Germany is on a similar level with countries generally perceived as low tax jurisdictions, e. g. Luxembourg.
Few know that it gets even better than that when looking at German rental income or capital gains from sale of German real property. Low taxation combined with Germany’s comparatively low property pricings and upside potential are quite an attraction for international property players. Ample reason to take a closer look at the details as well as tax planning options from the perspective of foreign investors.
If structured diligently, income from real property is only taxed at 15.825 % in Germany. It is important to note (i) that this rate not only applies to rental income but also to capital gains from the sale of property, (ii) that offshore investors lacking tax treaty protection are not discriminated and (iii) that the legal status of the investor (individual or corporate entity) is irrelevant – all, if designed with care.
The crucial trick is that investors need to avoid being treated as a trade or service business. If that is achieved, rental income and capital gains will be exempt from German Trade Tax of around 15 %. In effect, such Trade Tax exempt investment income would then only be subject to the 15.825 % Corporate Income Tax mentioned above.
Given the drastic tax difference between trading income (≈30 %) and investment income (≈15 %) anyone can imagine that Germany’s tax authorities are not very relaxed in conceding investment income. Quite the contrary, the taxman is more than happy to take advantage of the most minimal "technicalities" of the property investment which may trigger trading type income. A good example is a recent case in which the investor not only rented out real property for EUR 13.000 per month but also movable property for EUR 230 per month. The Supreme Tax Court held that the lease of movable property constitutes trade income
and that the investor is thus treated as trader making him subject to Trade Tax on his entire income – including of course the rental income.
This case shows that avoiding such pitfalls is crucial to the low tax rate. The idea is to structure the investment with as many defence lines against trading income as possible. In this context, the following should be considered:
German or foreign acquisition entity ?
EU acquisition entities for example are protected by various EU legislation from discrimination in Germany. The same is true for taxation as EU entities enjoy tax treaty protection. In contrast, German entities are subject to any and all negative domestic tax changes – without any benefit of an EU or tax treaty protection. Thus, a foreign acquisition vehicle is typically preferred.
New German thin capitalisation rules
These new regulations restrict interest deductions exceeding 30 % of EBITDA. It is important to know that these restrictions apply to the complete incurred interest whether paid to a shareholder or to a bank. Given the traditionally high leverage used in property investments, the new thin cap regulations need to be considered carefully and the prescribed annual interest threshold of EUR 3 million per entity should be taken advantage of. Thus, for example, a leverage of EUR 60 million at an interest rate of 5 % will be completely disregarded and all interest will be deemed deductible no matter what the EBITDA may be. However, if the interest amount exceeds the prescribed threshold only by EUR 1, the general regime is applicable and the 30 % of EBITDA rule applies to the whole interest amount. Thus, we will likely see a trend to splitting up investments and to single property vehicles because the EUR 3 million threshold applies on a per company basis.
EU holding location?
Although not strictly required, traditional EU entry points for offshore investors have been Luxembourg and the Netherlands. Both have increased its weight by recently signing a tax treaty with Hong Kong through which a lot of funds are channelled. Cyprus is also a jurisdiction to look at as it does not tax foreign source income or apply dividend withholding tax on the transfer of profits to an offshore location lacking a tax treaty.
These consist of real estate transfer tax and VAT. The former amounts to 3.5 % and up to 5 % (depending on location) of the transaction value. Tax planning opportunities exist, e. g. if the investor is willing to only acquire 94 % of a property holding company. VAT can be managed, however, due to the sheer magnitude of the rate of 19 % on the transaction value – again with care.