Holding German real estate

DIRECT HOLDING OF REAL ESTATE

Resident and nonresident Individuals

Individual Income Tax

For resident individuals, the marginal tax rate is 14% and increases progressively to 42% for a taxable annual income of 57,052 Euro in 2020 and 114,104 Euro for married couples in 2020. Starting from a taxable annual income of 270,501 Euro in 2020 and 541,002 Euro for married couples in 2020, the highest tax rate of 45% applies for any additional income. A 5.5% solidarity surcharge is also levied on individual income tax in 2020. Also, a church tax of 9% (8% in Bavaria and Baden-Württemberg) can be levied in the income tax if the individual (resident or non-resident) has not resigned its church membership.

Trade Tax

All entrepreneurs with commercial activities carried out through a subsidiary or a nonresident’s commercial permanent establishment in Germany are liable for trade tax. Municipal trade tax is levied by the local authorities typically at rates between 14% and 17%, although in some cities it can be as high as 19%. Trade tax is based on taxable income as calculated for business income tax purposes with some modifications (e.g. a 25% add-back of interest expense, a 6.25% add-back of royalty payments, a 5% add-back of rental payments for movables and a 12.5% add-back of rental payments for immovables to the extent these add-backs in total exceed EUR 100,000). On the other hand, 1.2% of the unitary tax value (Einheitswert) of real property belonging to the business assets and not being exempted from real estate tax can be deducted from income for trade tax purposes. For individual income tax purposes, trade tax is generally deductible with a standardised calculation method.

In case a taxpayer's activities are, in principle, regarded as business income and liable for trade tax, tax may be avoided under the following conditions. A taxpayer that merely holds and administers their own real estate may apply for a so-called ‘extended trade tax deduction’ (Erweiterte Gewerbesteuer-Kürzung). Such a deduction is made from the tax base for trade tax purposes of income derived from merely passive rental activities, thereby reducing the tax base for such activities to zero and effectively leading to an exemption from trade tax. This exemption can also avoid trade tax on capital gains.  A number of restrictions or prerequisites have to be considered in order to benefit from this exemption.

Acquisition Costs

The purchase price and other acquisition costs which are allocated to buildings can be depreciated over the useful live with predefined depreciation periods for different types of buildings according to the tax law. However, land is not depreciable. Buildings are normally depreciated at a rate of 2% - 3% per year, based on the acquisition costs. Maintenance costs incurred within three years after the acquisition of the building are considered as acquisition costs if they exceed 15% of the original acquisition cost of the building. Renovation costs may be also considered as acquisition costs.

The tax law provides a special tax free reserve for profits from the sale of certain business assets (such as real property), which means that the realised proceeds of the sale, including the hidden reserves, can be used under certain circumstances in full to finance a new business investment, thus protecting the liquidity position. This rule applies business assets of individuals or partners of a partnerships liable for individual income tax and corporations liable for corporate income tax.

VAT

Renting out and leasing of real estate is generally tax exempt. However, it is possible to opt for VAT. A waiver is only permissible if the tenant makes use of or intends to make use of the plot of land, or parts of it, for transactions that entitle him to the deduction of input VAT. Letting of living and bedrooms for the purpose of short-term accommodation of guests, sites for parking vehicles or camping, tennis courts and permanently installed equipment (business fixtures) are subject to VAT.

Interest deduction limitation rule

Under the general interest deduction limitation rule, which covers interest payments made to both related and unrelated parties, the tax deductibility of net interest expense is limited to 30% of the tax EBITDA of a business. Exceptions to this general rule apply where (i) the annual net interest expense does not exceed EUR 3 million; (ii) the relevant business is not part of a “tax group”; or (iii) the “escape clause” conditions are satisfied, i.e. the German borrower’s equity ratio does not fall short by more than 2% (1% for the period covered by the assessment) of its worldwide equity ratio.

Loss Utilisation

The unused tax losses can be carried forward indefinitely to offset future taxable income for individual income tax purposes. Losses up to an amount of EUR 1,000,000 can be offset against the profits of the preceding year. Losses for trade tax purposes cannot be carried back. However, there is a minimum taxation rule and 40% of the income exceeding EUR 1,000,000 cannot be sheltered by tax loss carry forwards but is subject to taxation at regular rates.

Special Rules for Nonresident Individuals

Generally, non-resident individuals are treated in Germany in the same manner as resident individuals. The German right of taxation on rental income is in principle not restricted, even in the event of the existence of a double taxation agreement. However, losses can only be offset against other German taxable income. Furthermore, non-resident individuals will generally not be granted the so-called basic allowance of 9,168 euros (2019), that is exempted from tax. In case a foreign nonresident individual has only rental income without a permanent establishment in Germany (not providing any additional management or other services to the real property), the rental income is only liable for individual income tax but not for trade tax.

Resident and nonresident Businesses and Partnerships

For Individuals with rental income as part of their business income and for partners of a partnership the aforementioned tax consequences will also apply. In addition, and upon request, retained earnings are subject to a separate income tax rate of 28.25%. If retained earnings are withdrawn in subsequent years, they are taxed at a rate of 25%. Retained earnings distributions of corporations, such as dividends, are subject to withholding tax at a uniform rate of 26.375% including surcharge tax.

Resident and nonresident Corporation

Corporate Income Tax

For resident and nonresident corporations with a real property and rental income in Germany the corporate income tax rate is 15%, plus a 5.5% solidarity surcharge, which results in a combined rate of 15.825%. Rental income is part of the business income of a corporation. The effective corporate income tax rate in major cities (including the solidarity surcharge and trade tax) typically ranges between 30% and 33%. Resident corporations are taxed on their worldwide income. However, tax treaties may exclude foreign-source income from German taxation. Nonresident companies are taxed on certain German sourced business income, such as income from a German permanent establishment (PE).

Trade Tax

Resident and nonresident corporations are also liable for trade tax with the income attributable to their German permanent establishments. Municipal trade tax is also imposed, typically at rates between 14% and 17%, although in some cities it can be as high as 19%. For further details see above (in section “DIRECT HOLDING OF REAL ESTATE - Resident and nonresident Individuals”).

Acquisition Costs

The purchase price and other acquisition costs which are allocated to buildings can be depreciated over the useful live with predefined depreciation periods for different types of buildings according to the tax law. For further details see above (in section “DIRECT HOLDING OF REAL ESTATE - Resident and nonresident Individuals”).

VAT

Renting out and leasing of real estate is generally tax exempt. However, it is possible to opt for VAT. For further details see above (in section “DIRECT HOLDING OF REAL ESTATE - Resident and nonresident Individuals”).

Loss Utilisation

The unused tax losses of a German company can be carried forward indefinitely to offset future taxable income for corporate income tax purposes. For further details see above (in section “DIRECT HOLDING OF REAL ESTATE - Resident and nonresident Individuals”).

Interest deduction limitation rule

Under the general interest deduction limitation rule, which covers interest payments made to both related and unrelated parties, the tax deductibility of net interest expense is limited to 30% of the tax EBITDA of a business. For further details see above (in section “DIRECT HOLDING OF REAL ESTATE - Resident and nonresident Individuals”).

Special Rules for Nonresident Corporations

Nonresident corporations are generally treated like resident companies. The German right of taxation on rental income is in principle not restricted, even in the event of the existence of double taxation agreement. In case a foreign nonresident corporation has only rental income without a permanent establishment in Germany (not providing any additional management or other services to the real property), the rental income is only liable for corporate income tax but not for trade tax.

INDIRECT HOLDING OF REAL ESTATE

Resident and nonresident Individuals

Individual Income Tax

Dividend distributions to resident individuals in Germany are subject to withholding tax of 25% (flat tax) plus solidarity surcharge at a rate of 5.5% (uniformed tax rate of 26.375%). lf the shares are held as private assets the withholding tax becomes a final flat tax charge. Upon application, a change to the personal income tax rate on capital income is possible due to the so-called 'favorable' test. The tax office examines whether taxation with the personal progressive tax rate is 'favorable' for the taxpayer. This will usually be the case for individuals with low income. In this case, the withholding tax can be offset against the individual's income tax liability. If the dividend income qualifies as business income, 60% of the dividends are taxed at the regular (progressive) rate (partial-income method).

Deductibility of costs and interest payments

The deductibility of costs depends upon which of the above-mentioned tax regimes is applicable. Under the flat tax regime none of the expenses are deductible. Under the partial-income method 60% of the costs (such as interest) can be deducted.

Special Rules for Nonresident Individuals

Non-resident individuals are treated in a similar way as resident individuals. The applicable tax treaty usually limits the German withholding tax rights to certain percentage below the 26.375%.

Resident and nonresident Corporations

Corporate Income Tax

If shares are held by a resident corporation or are attributed to a German permanent establishment of a nonresident corporation, and if the shareholding is at least 10% of shares in the company paying the dividend since the beginning of the calendrer year, these dividends are effectively 95% corporate income tax exempted. For trade tax purposes the minimum participation is 15% to be effectively 95% tax exempted. Dividends received from shares below the minimum participation are liable for corporate income tax (and trade tax) at the regular rates.

Deductibility of costs and interest payments

Interest and other costs which are related to the shares are generally deductible.

Special Rules for Nonresident Corporations

Nonresident corporations are treated in a similar way as resident corporation if they have a permanent establishment in Germany and the shares are attributed to this permanent establishment. Nonresident corporations without a permanent establishment in Germany are only liable for a withholding tax in Germany. The applicable double tax treaty usually limits the German withholding tax rights to a withholding tax rate below the 26.375% if certain substance requirements are met. Under the EU parent-subsidiary directive the withholding tax is reduced to 0% under certain conditions.

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