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What structures do you recommend international investors use to facilitate an efficient investment?

August 2019 - Real Estate & Property. Legal Developments by IR Global.

More articles by this firm.

The following article discusses session three in the IR Global Virtual Series on ' Investment Incentives - Assessing international real estate programmes'

U.S - California - JO In evaluating available investment structures for an international investor, important considerations typically include tax consequences, privacy concerns, liability protection, and US filing requirements.

As a general rule, international investors are subject to a flat 30 per cent withholding tax on United States source fixed or determinable, annual or periodical (FDAP) income that is not effectively connected to a United States trade or business. FDAP income includes rental income from real property. The FDAP tax rate may be reduced by an applicable treaty for investors from certain countries.

If the income is effectively connected to a US trade or business, foreign investors are taxed under the same rules as US taxpayers, paying income tax at graduated rates up to a maximum of 37 per cent. In addition, under the Foreign Investment in Real Property Tax Act (FIRTPA), a foreign investor selling US real estate is required to withhold a tax on the amount realised, generally at a rate of 15 per cent. US estate and gift tax is also imposed on any US situs property included in a non-resident alien’s gross estate at the time of death.

Investment directly through a US corporation or other entity is still subject to FIRPTA and will subject the investor to US estate and gift tax. As a result, a better option is to hold the real estate through a “’blocker’ structure in which the investor invests through a foreign entity which owns the US entity holding the real estate. This provides the benefits of owning the property through a US entity, while preventing application of US estate and gift tax and potentially mitigating FIRPTA.

Investors generally use a two-tier corporate structure, but in some circumstances, a partnership structure may also be appropriate. Under the Tax Cuts and Jobs Act, the corporate income tax rate was reduced to a flat rate of 21 per cent, which provides a significant benefit to corporations. Investing through a corporation, generally subjects the investor to double taxation, however, proper structuring using qualified debt instruments can entirely or substantially eliminate double taxation.

Finally, international investors may also consider investing in US real estate through a domestically-controlled Real Estate Investment Trust (REIT). A REIT is an entity otherwise taxable as a US corporation that elects REIT status and is permitted a tax deduction for dividends paid to its shareholders. A REIT is ‘domestically controlled’ if more than 50 per cent of the stock is owned by US persons.

A major advantage to investing through a domestically-controlled REIT is that the investor can sell the stock in the REIT without incurring federal income tax under the FIRPTA. In addition, because the REIT is eligible for a deduction for dividends paid, it will generally have little or no US federal income tax liability. However, REITS are designed for passive investors and thus provide investors with significantly less control over their investments.

Luxembourg - MT Private, professional and institutional investments can be made in a wide range of investment vehicles in Luxembourg. Most of these can be used to establish a real estate portfolio.

Such a corporate structure may be incorporated in the form of a non-regulated or a regulated entity.

Depending on the size of the acquisition project, this will be via a corporate form such as a Public Limited Company (SA), Private Limited Company by Shares (SARL); a corporate partnership limited by shares (Société en Commandite par actions) or the special limited partnership (Société en Commandite Spéciale, SCSp.

The common limited partnership (Société en Commandite Simple, SCS) or non-trading company (Société Civile) are also commonly chosen for companies investing in real estate.

A real estate investment fund, such as the Specialised Investment Fund ‘FIS’, Risk Capital Investment Company (SICAR), Alternative Fund-AIF ‘Fonds Alternatifs’ (RAIF) can also be used. Such vehicles present the private, professional and institutional investor with many advantages, inter alia tax optimisation including arrangements within the framework of estate planning.

Germany - PD From a German tax perspective, offshore structures are basically not beneficial for German real estate investments as the profits are subject to German income tax anyway.

The investment as an individual can be disadvantageous with regard to the income tax rate on a nameable current rental income, as the tax rate is linear-progressive and may increase up to more than 47 per cent for very high income. On the other hand, an individual may sell his German property income tax-free after more than 10 years, if it is owned as a private asset.

In contrast, investment via a corporation may be advantageous with regard to current rental income, as a flat rate of 15.825 per cent corporate income tax is applicable, even for very high incomes. This tax burden may further be reduced by interest on (shareholder) loans. In extreme cases, taxable profits in Germany may be neutralised, provided the loans were granted under arm´s length conditions and the interest payable is not subject to the Earning Stripping Rule.

On the other side, a sale profit will always be subject to corporate income tax as the property of a corporation is considered as a commercial asset. When investing via a special purpose vehicle (SPV), we recommend the use of a foreign SPV, without a permanent establishment in Germany, in order to avoid German trade tax as well as withholding tax on dividends.

Trade tax is an additional municipal tax with varying rates, depending on the municipality of the permanent establishment. It is only triggered on commercial income, i. e. derived from a commercial activity, or on certain legal forms of the property-owning company (e.g. corporation or commercially infected partnership).

Alternatively, the investment may be made with a non-commercial partnership. Such a partnership is considered as transparent for income tax purposes. Any profits are directly attributed to and taxed at its partners, so that no withholding tax is triggered by profit distributions.

U.S - New York - ML There is a substantial benefit to foreign investors having their structures as debt structures versus equity structures, because you can avoid having to pay income taxes based on the interest earned. This structures the US income tax into a debt vehicle versus an equity vehicle. There are certain cases in which the purchaser of a property in New York and the US is required to withhold taxes where the seller is not a US taxpayer, but it really depends on the situation.

CONTRIBUTORS

Michael E. Lefkowitz (ML) Rosenberg & Estis, P.C. – U.S – New York www.irglobal.com/advisor/michael-e-lefkowitz

Marc Theisen (MT) Theisen & Marques Advocats a la Cour – Luxembourg www.irglobal.com/advisor/marc-theisen

Jo Farr (JF) Barlow Robbins – England www.barlowrobbins.com/people/jo-farr

Richard Sussman (RS) Rosenberg & Estis, P.C. – U.S – New York www.irglobal.com/advisor/richard-l-sussman

Dr. Peter Diedrich (PD) DSC LEGAL Rechtsanwaltsgesellschaft mbH – Germany www.irglobal.com/advisor/dr-peter-diedrich

Jordan Ondatje (JO) Blanchard, Krasner & French – U.S – California www.irglobal.com/advisor/jordan-e-ondatje

Robert Blanchard Blanchard, Krasner & French – U.S – California www.irglobal.com/advisor/robert-blanchard