REITs and other listed real estate companies operate and invest globally in real estate, often via corporate vehicles. While, in the past, indirect disposals of REITs or their subsidiaries have not been the target of real estate specific tax rules, the international tax issues raised in the OECD BEPS Project are rapidly redefining the taxation of cross-border disposals of shares in ‘real estate rich’ entities. This is the result of territories seeking to protect their tax base on gains connected to indirect sales of domestic real estate.
To assess the impact in practice, 36 territories in the PwC Real Estate Network completed a survey on how these changes are being implemented, what this means in how these transactions are taxed and the compliance obligations this creates.
The clear message is that there is a consistent approach forming in taxing these disposals, disrupting the status quo, which is creating an increased need for multi-jurisdictional investors to understand where they are ‘real estate rich’.
Which structures are being targeted?
The target of the changes are disposals of entities that are considered ‘real estate rich’ in one country, typically where an entity derives the majority of its value from real estate in that country.
These disposals have historically resulted in the location country not taxing increases in value on real estate if the disposal is by a non-resident outside of the scope of its taxation.
This has created a disequilibrium between the taxation of direct disposals of real estate assets by company A (taxable in country A) and the disposal of shares in company B by company C (which were generally taxable in country B), by a listed company or its shareholder, typically as a result of country A either not taxing this disposal from a domestic perspective or not having taxing rights in accordance with the applicable double tax treaty (DTT).
Countries that implement Art. 13 (4) align the treatment of the disposal of shares in ‘real estate rich’ entities with direct disposals of real estate. This creates the problem that, in multi-tier investment structures, it could catch the disposal of shares at any level (e.g. the disposal of shares in the listed company).
Results of the PwC Survey
Of the 36 countries surveyed, 16 countries already have domestic rules that would bring offshore indirect transfers of shares in ‘real estate rich’ entities under the tax regime in the location territory (subject to the relevant DTT). Regimes are coming into force for the UK and Germany in 2019, both representing the two largest European property markets.
While there are differences as to how these provisions operate, there are common themes in each of the countries with the effect that an offshore shareholder will, in principle, be subject to tax on a capital gain arising from the disposal of a ‘real estate rich’ company.
The nuances around the definition of ‘real estate rich’ vary between territories, but the charge is typically triggered where the market value (or in some territories, book value) of the shares is derived from 50% or more of real estate situated in that territory, irrespective of where these disposals occur in the investment ‘chain’.
This potentially catches a number of transactions and creates challenges for larger investment structures where a restructuring at one level could inadvertently trigger a taxable gain. Even smaller portfolio investors might be caught (the German rules even catch disposals of 1% interest).
The challenge for tax authorities will be how they enforce these rules and uphold the associated filing obligations, particularly in the context of a multi-tier global investment structure where disposal could take place several layers removed from and in a different territory to the real estate asset. This is particularly true for smaller investors who may be legally obliged to file a tax return.
What this means for investors and REITs
The increasing prevalence of these rules still leaves a number of questions open as to how the taxation of offshore indirect transfers will practically operate in each territory and what exemptions there may be in case of listed investments.
For investors, the broadly scoped rules we are seeing stress the importance of monitoring
direct and indirect ownership interests and the values of their real estate and fund investments to ensure they understand in which territories and in what entities they may be considered owners of ‘real estate rich’ shares. They should also consider the ensuing compliance obligations this might create at each stage of the investment cycle.
Listed companies will also need to consider if their structure results in ‘real estate rich’ listed shares for its investors and any treaty exemptions available in relation to shareholdings in other listed companies.