At present, a foreign resident individual or company that is invested in German real estate via a foreign holding company may sell the shares in the foreign holding company without triggering any German income tax charges. According to Article 13, paragraph 4 of the OECD Model Tax Convention, gains derived by a resident of a Contracting State from the alienation of shares deriving more than 50% of their value directly or indirectly from immovable property situated in the other Contracting State may be taxed in that other State. The German legislator now has concrete plans to implement new wording in German law so that the treaty rule may become effective in German domestic law also with regard to foreign corporations holding German real estate.
The draft law which has already been passed by the German government foresees that Germany will implement a domestic taxing right for capital gains arising from the sale of shares in domestic or foreign corporations when the shareholder owns at least 1% of the shares and the value of the corporation consists of more than 50% of German real property once within 365 days before the sale. The new rules shall become effective as of 1 January 2019, and only with regard to increases in value after 31 December 2018. Therefore, it will become important to assess the value at year-end with respect to possible future taxable capital gains.
However, since existing tax treaties take priority over the new domestic rules and many treaties deviate from the OECD-Model Convention, one must look at each specific case to find out whether the new rules lead to taxation or not. Only looking at the domestic rules there is still much uncertainty in their interpretation, e.g. for a foreign two-tier structure, where the top-holding sells its shares in the real estate holding company, the application of Section 8b of the German Corporate Income Tax Act might lead to an overall avoidance of the taxation. When an individual holds the foreign shareholding and the applicable treaty allows for the German taxation, it is still unclear how the German authorities will be made aware of the tax event in many cases, especially when the individuals only have a minority shareholding. Another unsolved question is what happens if the value of the domestic real property within the company falls below 50%? Would that also be a taxable event, and if so what would happen if the domestic property portion subsequently rises above 50% again?
Certainly, foreign resident individuals who hold German real property via a foreign corporation should consider their actions before year-end. For example, making sure that the domestic property portion stays below 50%, and if it does fall below 50%, avoiding a sale within 365 days (however, most treaties will not have such a retroactive period and therefore one should be fine if the real property portion is below 50% at the date of sale) or interposing a top-holding to make use of the participation exemption provided by Section 8b of the German Corporate Income Tax Act. Moving to a country with favourable tax treaties before the new rules take effect might also be a solution.
In conclusion, foreign holders of German real property via a foreign corporation should at least monitor the developments closely.
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