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Are tax-efficient vehicles available to investors? Which are most common in your jurisdiction & why?

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

More articles by this firm.

The following article discusses session two in the IR Global Virtual Series on 'Preferential Portfolios: Tax efficiency in international real estate investments'

Spain – GHY Tax-efficient vehicles are used in Spain, but first of all, we need to differentiate between general and special tax regimes.

The general regime states that when foreign investment funds make a direct investment in real estate, we need to know if they have a legal or tax personality and a permanent establishment (PE) in Spain.

As a general rule, if the investment fund has the corresponding human and material resources in Spain, they can have a

PE in our country for tax purposes. This makes a big difference in Spain, because capital gains tax (CGT) for non-resident corporations without PE is 19 per cent, while for Spanish corporations or PE-owned by non-residents it is 25 per cent. Despite the tax rate difference, the foreign investment funds or companies usually set up a PE or a limited liability company (LLC) to invest in Spain, since there is more certainty in connection with the application of the internal tax regulation that may apply.

As to the special tax regimes, there is a specific corporate vehicle known as ‘SOCIMI’, which is a company that operates in the trademark regulated market. This is not a regular stock market, so it’s much easier to get into. The corporation tax is zero and there is only special taxation on the distribution of dividends, depending on the application of double taxation treaties (DTT).

There are, however, certain conditions that these companies must comply with, such as minimum share capital of five million euros, a minimum number of shareholders and a minimum level of dividend distribution each year. It is an interesting vehicle to consider for investment in Spain.

We also have a special tax regime for dwelling and home rental in Spain, which is not well known between foreign investors yet. If the investor sets up a corporate in Spain with eight units or more that are dedicated to home rental, or at least offer in the real estate market for this purpose, then the effective corporate tax rate is only three or four per cent. That is a reduction in the taxable base of 85 per cent and is usually done via a limited liability company (LLC).

USA – RB In the US, the most common vehicle is what is known as a blocker structure that involves setting up a US corporation to hold the property in the US and have that US corporation is owned by a non-US corporation or another form of an entity organised outside the US.

The non-US entity is owned by the foreign investor. The purpose of the structure is, firstly to avoid inheritance tax, because the stock of the foreign corporation that owns the US corporation would not be treated as US property for purposes of US inheritance tax.

It is also used to avoid the withholding tax that applies to both rents and sales proceeds because the disposition of stock after the property is sold is not treated as a sale of real property, but a sale of investment security. It is, therefore, not subject to capital gains tax, unless modified by treaty between the US and the country of the investor.

The typical method of funding the US corporation is with equity and also a debt instrument. The debt instrument is designed such that interest paid is deductible to the US corporation but not taxed to the foreign corporation unless that tax is imposed by the treaty.

The structure allows the flow of rental and other operating income from the property to move through the blocker corporation and on to the foreign owners without being subject to either US withholding tax or US income tax.

This blocker structure has become even more popular since the tax reforms which reduced the US corporate tax rate from 35 per cent to 21 per cent. When real property is sold, the US corporation will pay tax on the gain realised, but the investors avoid withholding tax, inheritance tax and the capital gains tax on the stock of the US corporation that might otherwise apply.

Germany – DL As I mentioned earlier, our view on taxation differs in Germany, depending on who the investor is. I have both high net worth (HNW) individuals and institutional investors as clients, particularly many US HNWs who invest in Berlin. HNWs can benefit from a special regime in Germany that allows the tax-free sale of property by individuals after 10 years of ownership.

Investing via a corporation can reduce the income tax burden to 15 per cent by avoiding trade tax via a foreign-based corporation without a branch in Germany. There will, however, be an exit tax of 15 per cent, which can be optimised via the deduction of expenses and interest.

Many foreign investors will use a German limited liability partnership (GmbH & Co. KG) to optimise tax efficiency. This structure allows investors to ‘double dip’ on expenses, claiming them twice in two different countries. German tax law is changing though, with some anti-avoidance legislation likely to affect this practice.

If the property sale is structured via a foreign share deal, this is usually not taxed in Germany, but some double taxation treaties are changing to allow tax in the country where the property is located. Holding structures allowing share deals in Germany are also tax exempt, although selling at least 95 per cent of the corporation triggers German real estate transfer tax (RETT) in the amount of 3.5 – 6.5 per cent, depending on the location of the property. It is planned by the government to reduce the limit down from 95 to 90 per cent to reduce harmful tax practices. The real estate transfer tax is triggered regardless of the fiscal residence of the owner of the property.

Real estate investment trusts (REITS) are tax-efficient but are only applicable to institutional investors. They must be listed on a stock exchange, have a minimum equity of 15 million euros and be in the form of a public limited company.

Canada – JS Non-residents of Canada (NRCs) may hold property in a number of different ways.

There is the Canadian Corporation (CC) which is subject to the general corporate tax rate of 26.5 per cent in the province of Ontario on any income. On repatriation of funds by dividend to the NRC, there will be a withholding tax of 25 per cent. The withholding tax may be reduced under a treaty between Canada and the country of residence of the NRC.

When investing via a non-resident corporation (NRCC), rental payments are subject to a Canadian withholding tax of 25 per cent, but this is often reduced by a treaty. As is the case with an individual non-resident, an NRCC can make the net income election by filing a Canadian income tax return if the net rental income is less than the withholding tax.

The NRCC yields the lowest overall effective tax rates when earning income from the property. One benefit of using an NRCC to invest in Canadian real estate is the ability to have multiple shareholders but leave the compliance burden with only one entity.

When comparing CCs and NRCCs or special purpose vehicles (SPVs) (from a purely Canadian tax perspective) the NRCC has the lowest overall effective tax rates when earning income from property and comparable effective tax rates to a CC when earning income from a business.

Non-residents can also invest via partnership, special purpose vehicle or shares.

The members of a partnership will be taxed in Canada on their share of the taxable income earned by the partnership. If the partnership earns property income, the non-resident partners will be subject to Canadian withholding tax on the gross rentals. In addition, there may be interest in tax costs using this format.

An SPV established in a jurisdiction with both a favourable tax treaty and favourable treatment to the shareholders, based on their residency by the country of residence of the SPV may be advantageous. This can be achieved by careful utilisation of the broad spectrum of talent available from IR Global. Choosing the appropriate tax advisor in combination with a Canadian counterpart is something that is available to reduce the burden of taxation.

Shares of an NRCC are considered taxable Canadian property (TCP), if, within sixty months prior to the date of disposition, more than 50 per cent of the fair market value of the shares is derived from real property situated in Canada. Many of Canada’s tax treaties exempt from taxation in Canada again on the sale of shares of a non-resident corporation owning Canadian real estate. This needs to be considered in light of the other comments above.

New Zealand – RA In NZ, the most common ownership structures for a property are individual names (sole or joint), companies, limited partnerships and trusts. For larger development projects, joint venture structures (incorporated/unincorporated) may also be used.

New Zealand’s income tax rates are fairly similar between the various taxpayer types at the top end of the income scale (individual and trustees are taxed at 33 per cent, and companies at 28 per cent). The choice of the use of the structure itself is important, as the owner of the property assets may not generate significant tax efficiencies alone.

Where a company ownership structure is used, certain tax efficiencies could arise for the investor disposing of the shares (because NZ has no capital gains tax in relation to share disposals) in the asset-owning company as opposed to the company selling the asset itself and then distributing the cash to the investor. Experience would suggest most purchasers just want to buy the asset, essentially unencumbered from any hidden issues they may unwittingly assume when acquiring shares.

New Zealand does allow the use of a couple of tax look-through structures, which can provide both tax efficiencies and legal separation benefits for non-resident investors.

While a company is a fairly common ownership vehicle for NZ property, particularly commercial real estate where the limited liability status afforded to the shareholders protects their personal assets from the reach of creditors, it is not without its complexities from a taxation perspective.

There are two main issues in this regard. Firstly, if the company owns more than one investment property at the same time, it cannot sell one and distribute an otherwise non-taxable capital gain to its shareholders without having to pay income tax at the time of the distribution. Secondly, most taxing jurisdictions do not recognise the 28 per cent NZ company tax paid on any company profit which is subsequently distributed to shareholders, as a tax credit against the tax payable on that distribution in the non-resident’s home jurisdiction. This naturally increases the cost of profit repatriation for the non-resident investor, thereby reducing their net investment return.

The ability to use either a look-through company (LTC) or a limited partnership can, at times, significantly increase the non-resident investors return. While maintaining the limited liability protection from a commercial perspective, the look through status of the entity from a NZ tax perspective, means that no 28 per cent company income tax is paid, and, instead, the non-resident investor can essentially choose the ownership vehicle for their LTC/partnership interest, which will then maximise their tax position in their home taxing jurisdiction.

Distributed to shareholders, as a tax credit against the tax payable on that distribution in the non-resident’s home jurisdiction. This naturally increases the cost of profit repatriation for the non-resident investor, thereby reducing their net investment return.

The ability to use either a look-through company (LTC) or a limited partnership can, at times, significantly increase the non-resident investors return. While maintaining the limited liability protection from a commercial perspective, the look through status of the entity from a NZ tax perspective, means that no 28 per cent company income tax is paid, and, instead, the non-resident investor can essentially choose the ownership vehicle for their LTC/partnership interest, which will then maximise their tax position in their home taxing jurisdiction.

Contributors

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

Gustavo Yanes Hernández (GYH) Monereo Meyer Abogados – Spain www.lawyers-spain/lawyer-spain-gustavo-yanes-madrid     

Jayson Schwarz (JS) Schwarz Law – Canada www.irglobal.com/advisor/jayson-schwarz

Richard Ashby (RA) Gilligan Sheppard – New Zealand www.irglobal.com/advisor/richard-ashby

Dirk Lehmann (DL) Wagemann + Partner PartG mbB – Germany www.irglobal.com/advisor/dirk-lehmann