German tax alert – real estate transfer tax

The German state treasurers have yesterday (June 21, 2018) agreed to amend the German real estate transfer tax (RETT) provisions applicable for share transactions. In a nutshell the proposals are:

1. Threshold of 95 per cent will be reduced to 90 per cent,
2. holding period of 5 years will be extended to 10 years and
3. the rules for partnerships will be extended to companies, i.e. transfer of 90 per cent of the shares in companies within any 10-year period to new shareholders will trigger RETT.

Those changes are not as significant as expected given that a reduction of the threshold to 75 per cent or even 50 per cent had been publicly discussed. Nevertheless, the changes should significantly impact the way share deals can be structured in future. Apparently, there has not been a political agreement reached to accompany those changes by a reduction of the applicable RETT rates or an exemptions for private property acquisitions, which is disappointing given that the German government is not under political pressure to increase its tax revenues.

So far only the political agreement on the core changes have been published. It is now up to the Federal Finance Ministry to prepare draft legislation to implement those changes. Up to the point in time when the draft legislation has been submitted to the Parliament, the old rules should still apply, so there is still a short window to make changes to existing structures, to optimize and prepare for the future rules.

Currently there are basically two RETT rules applicable to share deals:

Unification rule

The current so called unification rule applies to companies and partnerships. If a minimum of 95 per cent of the shares in a property owning entity is unified in the hands of one acquirer or a related group of acquirers, this triggers RETT. Such unification can occur directly or indirectly and also applies to certain economic indirect unifications. As a consequence, no RETT is triggered if two independent acquirers, one holding at least 5.1 per cent of the shares and one holding a maximum of 94.9 per cent of the shares, buy the shares in a property owning entity. This rule applies irrespective of any holding period.

Partnership rule

The so called partnership rule applies only to partnerships. It sounds similar but is still slightly different from the unification rule. Under the partnership rule RETT is currently triggered, if a minimum of 95 per cent of the partnership interests in a property owning partnership is transferred to new partners in any given 5-year period. The difference to the unification rule is that it cannot be avoided by the acquisition of two independent acquirers. Rather it requires that the seller retains at least 5.1 per cent of the partnership interests for more than 5 years. After expiry of the 5 years, the new partners can acquire the remaining 5.1 per cent and will only trigger RETT on the 5.1 per cent under the Unification Rule, as the 94.9 per cent acquired more than 5 years ago now benefit from a certain tax exemption for partnerships.

Partnership exemptions

It is noteworthy, that the current rules indeed provide for certain tax exemptions for transfers of real estate between partnerships and their partners. Those exemptions have also been applied to certain share deal scenarios and have thereby exempted certain structures which would otherwise have triggered RETT under the Unification or Partnership Rule. Those exemptions required either pre-holding periods of post-holding periods of 5 years before or after certain transactions.

90 per cent threshold

The political agreement states that for both, the Unification rule and the Partnership Rule, that the threshold will be reduced to 90 per cent. This does not sound as bad as the 75 per cent and 50 per cent which were publicly discussed and which would have been accompanied with a rule that the RETT would only apply proportionately. However, significant doubts had been mentioned that a reduction to 75 per cent or 50 per cent could be unconstitutional, because the tax would not qualify as a real estate transfer tax anymore, but a share transfer tax. The similarity of the share deal to a sale of real property would not bhave been given anymore. Apparently the state treasurers take the view, that a threshold of 90 per cent will be regarded as constitutional. But we can imagine that this can still be challenged.

10 year holding periods

The proposal of the state treasurers says that all 5-year periods in the RETT Act shall be extended to 10 years. In our understanding this means that the Partnership Rule will be triggered if 90 per cent of the partnership interests are transferred to new partners within any 10-year period. But it most likely also means that the 5-year holding periods applicable to the Partnership Exemptions will be extended to 10 years.

This is quite a harsh change, as hardly any business can remain unchanged for 10 years in the current fast growing and changing business environment. We would hope that this extension will still be subject of a parliamentary debate in which either the holding period will be reduced to 7 years, which would still be a very long time or maybe at least the changes to the Partnership Exemptions are kept at 5 years or extended to 7 years only.

We would also expect that those changes will apply to 5 year periods which have already started to run. This would be quite dramatic for those structures where a seller has been granted a put-option for the partnership interests after expiry of 5 years. If the rules are now changed it may be possible that the seller can still exercise its put option, but RETT will now be triggered under the new rules. Purchasers and Sellers will have to negotiate whether such put-options can be extended to 10 years following the changes to the RETT Act.

Application of Partnership Rule to companies

The state treasures proposed that the Partnership Rule shall also apply to companies, not only to partnerships. This is maybe the most significant change, because it would change the entire systematic of the RETT law. So far the RETT rules differentiate in a quite sophisticated way between the rules applicable to property owning companies and property owning partnerships. The Unification Rule is set up as a fiction according to which the property is deemed to be sold or transferred to the ultimate acquirer in whose hands 95 per cent (or in future 90 per cent) or more of the shares are unified. As a consequence, it is the acquirer who is liable for the RETT. In contrast, the Partnership Rule follows a different fiction. It assumes that if 95 per cent (in future 90 per cent) or more of the partnership interests are transferred to new partners within 5 (in future 10) years, then the property is deemed to be transferred to a new partnership formed by the new partners. Consequently, under the Partnership Rule the partnership is liable for the RETT and not the acquirers of the partnership interests.

If the concept of the Partnership Rule is now extended to companies, this is a systematical game changer. It will be interesting to see how the German Finance Ministry proposes to implement this change. It could go as far as eliminating all changes between partnerships and companies in the RETT Act, if it introduces also for companies the fiction that the property is transferred to a new company if 90 per cent of the shareholders of a company change.

If this is thought through, then the Federal Finance Ministry should take the other consequence, and also apply the Partnership Exemptions to companies and not only to partnerships, as this would be the logical consequence of the systematical change. The political agreement does not mention this consequence and it is likely that this has not been though through. We therefore may end up in some discussions around the introduction of the specific legislation or in a worst case scenario a quite unsystematic change to the RETT Act which would make future structurings even more challenging and court decisions on RETT even more unpredictable.

So far only a political agreement has been published by the state treasurers. They have now asked the Federal Finance Ministry to prepare draft legislation. Such draft legislation would then have to be submitted to the German Parliament for approval and the German Federal Council also needs to approve the law. We would estimate the political likelihood of the changes coming into law as quite high, as this has now been discussed for some 2 years. It may take some weeks to draft the legislation, so the question is whether this will still be submitted to the Parliament before the summer break of after the summer break. We would then expect the rules to come into effect retroactively, but only back to the date, when the draft legislation is submitted to the German Parliament. There may therefore still be a window until that date to make changes to existing structures to prepare for the future legislation.