Germany-France cross border real estate transactions may need to be restructured, say experts

French tax expert Franck Lagorce and German tax expert Werner Geisselmeier, both of Pinsent Masons, the law firm behind Out-law.com, said the changes will impact upon German companies selling shares in companies owning real estate in France and German investors in French REITs.

Werner Geisselmeier said that under the current double tax treaty, if an entity resident in Germany sells shares in a company owning real estate in France, only Germany has the right to tax the gain. He said where the shares are sold by a corporate investor, the German tax system taxes only 5% of the gain, resulting in a corporate tax exposure of only around 0.79 %.

In the same way, the gains made by a French corporate entity selling shares in a company owning real estate in Germany are subject only to French tax. However, in contrast to the German position, Franck Lagorce said that France would usually tax the gain at around 34%.

A protocol amending the France/Germany double tax treaty was signed on 31 March. When it comes into force, one of the changes this will make to the double tax treaty is that when a resident of one state sells shares in a company that owns real estate located in the other state, any gains made on the shares will be taxable in the state where the real estate is located and not the state where the seller is resident.

The change will only apply to share sales where the assets of the target company predominantly comprise real estate located in the other state or derive directly or indirectly more than 50% of their value from real estate in the other state. There is an exclusion where the real estate is used for the purposes of a business, such as a hotel.

Franck Lagorce said that for German entities owning shares in companies owning French real estate, this will mean a "significant increase" in the tax charge on the gain from less than 1% to possibly 34%. For French entities owning shares in companies investing in German real estate, he said the change could also prove significant.

The change follows a similar change to the France/Luxembourg double tax treaty, which has not yet come into force.

Another change to the treaty will mean that some distributions arising from certain real estate vehicles will become subject to the ordinary rate of distribution tax levied by the treaty state of source. Where the state of source is France this will be 30% and in case of Germany generally 26.375% withholding tax, save for some exemptions such as for qualifying minimum stake holders, according to Werner Geisselmeier.

The distributions affected by the change are those from entities which distribute annually most of their income; or entities which are exempt from corporate income tax on income derived from real estate assets. In each case the change will apply only when the beneficial owner of the distribution owns directly or indirectly more than 10% of the distributing vehicle’s share capital. 

Franck Lagorce said that "in practice, this will impact upon German investors who own stakes in regulated French real estate vehicles, essentially the listed REIT like the 'Foncières côtées' – which have elected for the SIIC regime (created in 2003); and the non-listed REITs (the OPCI/SPPICAV; created in 2005)".

Before the changes take effect the Protocol amending the treaty has to be ratified by both France and Germany and the ratification has to be notified. If both States are able to ratify the changes to the treaty and notify by 30 December 2015, the changes will affect distributions paid-out on or after 1 January 2016 and capital gains realised during financial years begun on or after 1 January 2016.

Franck Lagorce said "The changes will potentially affect all those concerned with real estate investments in either state – be they real estate investors, or simply individuals or companies who own real estate".  

"Cross border real estate owners carrying on a business will need to consider whether owning the business operations and the real estate in one single company, or separating operations from real estate makes sense, or not" Lagorce said.

"Those investing in real estate as an asset class will have to consider how they are affected by the changes. Some may want to think about reorganising or selling-off their interests in French real estate before the change takes effect. Anyone considering selling needs to take action now to ensure a sale goes through by the end of the year, as the earliest time the changes could take effect is January 2016" said Franck Lagorce.