Real Estate: Taxation of capital gains

15.07.2015

The prevailing type of commercial properties disposal, in the Central and Eastern European Countries, is usually driven by financial – tax factors. For instance, in countries imposing property transfer tax, the most common type of transaction is usually the acquisition of a real estate company (share deal), as opposed to acquisition of individual assets (asset deal).

What is the current tax situation in Poland, Czech Republic, Slovakia and Romania?

On the other hand, in countries where asset deal transaction type prevails, the buyer places the property within its current structure and recognizes its value for tax purposes based on the acquisition price. Type of transaction chosen affects the way profits on commercial property disposal are taxed. How these choices are made?

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Asset deals in Poland

From the seller’s perspective, the taxation of gains on disposal of investment property is crucial. Taxation depends on the form in which the disposal is made. In Poland, in case of a disposal of individual asset (asset deal), the profit being subject to CIT tax at 19% is calculated as a difference between the revenue from the property disposal and the tax deductible costs. The sales price for the property, as indicated in the sale agreement, constitutes taxable revenue, provided that it corresponds with the market level. At the same time, the costs incurred on acquisition or construction of a property, decreased by the depreciation write-offs, constitute tax deductible costs.

Costs of a property acquisition

These costs, in case of a construction of a property, are usually significantly lower than the market value of the property at the moment of sale or putting it into use. Similarly, the costs of the property acquisition, which took place several years earlier, can also be significantly lower than its market value at the time of disposal. The optimal solution from the sellers’ s perspective would be, prior to the transaction, to reveal such a hidden reserve in a tax neutral way. It should be noted that despite the recent changes in the Polish tax law, as well as in the light of the planned actions, there are still available options allowing for a step-up in the tax value of a property prior to its disposal.

Avoiding hidden taxation with share deal transactions

Therefore, from the seller’s perspective, the share deal transaction are likely to be expected in order to avoid taxation of the hidden reserve. Properties disposed by certain types of investment funds are exceptions here, since the funds are exempt from corporate income tax (CIT). From the purchaser’s perspective, the opposite type of transaction is sought after, as by acquiring property in a form of individual asset the purchaser does not need to be concerned about hidden reserve and related deferred tax. Moreover, the purchaser does not take over the responsibility for the tax liabilities of the company holding the property.

Share deals in Poland

Selling shares in a real estate company constitute an alternative to a property disposal. The profit made on the share disposal is also subject to CIT tax at 19% in Poland. In this case the profit is calculated as the difference between the revenue from the sale of shares, equal to the price for the shares as indicated in the sale agreement, provided that it corresponds with the market level and the tax deductible costs determined depending of the form of the acquisition of shares. It should be noticed that the price of shares does not always reflect the value of property. Usually the real estate companies are leveraged through external debt, which decreases the value of shares. Depending on the agreement between the parties to transaction, price for shares may also be corrected by the part of deferred tax or latent capital gain tax.

OECD: Real Estate Clause

In case the shares being disposed were acquired through a purchase, the purchase/acquisition price should constitute tax deductible cost at the moment of their disposal. If the shares in a real estate company are disposed by a foreign company, the disposal should not be subject to tax in Poland, provided there is an agreement for the avoidance of double taxation between Poland and the country of residence of the seller, which does not include a “real estate clause”. In general, according to the real estate clause as described in the OECD Model Convention on Income and on Capital, sale of shares, deriving more than 50% of their value directly or indirectly from property situated in one state, can be taxed in such state.

Quite often the cost of shares’ acquisition in a company, which developed or acquired a property, due to the lapse of time, significantly diverge from the market value of the property. As a result, the disposal of shares entails a relatively high profit subject to tax. In practice, the share deals are sometimes preceded by actions aimed at increasing the tax acquisitions costs e.g. by exchange of shares. Nevertheless the sale of shares is the most common way of a property disposal in Poland. From the buyer’s perspective, apart from the responsibility for tax liabilities of the acquired company and the question of valuation of property and hidden reserve, the buyer needs to pay the irrecoverable tax on civil law transactions (1% of the market value of shares).

Rental guarantee schemes

Regardless of the form of disposal, the price for the property is calculated under the income based valuation. In practice, the price is usually calculated under the assumption the property is finished, equipped and fully let. Since at the date of transaction this may not be the case, in order to protect the buyer’s position the parties enter a rental and incentive guarantee agreement. Under the agreement in case a property is not fully let and the income, forecasted under the assumption it is, is not generated, the seller’s agrees to cover the difference in income and the fit-out costs for the period indicated in the agreement. It should also be noted that fulfilling such service should not, as a rule, be subject to VAT and should be documented by accounting note. However, this will always depend on the wording of the agreement itself.

Czech Republic, Slovakian and Romanian real estate property markets

Real Estate Transactions in the Czech Republic

In the Czech Republic the prevailing form of property disposal transactions is share deal. As indicated by Petr Karpeles, partner in TPA Czech Republic, the main reason behind is the 4% real estate acquisition tax applicable on asset deals, whereas no transfer tax applies on share deals. Moreover, whilst the capital gain arising on an asset deal is subject to CIT at 19%, the capital gains arising on a share dealmay be CIT exempt if further conditions are satisfied.

Transfer Taxes on Real Estate in Slovakia

Similarly in Slovakia, within the last few years the share deal has been predominant in comparison with the asset deal, even though the transfer tax on real estate is not in force in Slovakia since 1 January 2004. Peter Danovsky, partner in TPA Slovakia, explains that share deal offers many advantages (tax, administration), but the main reason for choosing share deal is that the tenants can terminate the lease contracts in case of an asset deal, which is not possible in a share deal. The change in the Slovak Income Tax Act starting 1 January 2015, should not change this situation, as under the amended provisions, tax deductible costs in form of a tax residual value re. office buildings, residential buildings, hotels, etc. (with 40 years of tax depreciation period) can be applied and recognised for tax purposes only up to the value of the income from disposal.

More Share Deals on the Romanian Property market

Share deals are also more often encountered in practice on the Romanian property market as opposed to asset deals. According to Andreea Florian, Senior Tax Manager in TPA Romania, starting January 2014, Romania aimed to introduce favourable tax treatment for holding companies (e.g. tax exemption for capital gains from the sale of shares, liquidation proceeds) which seemed to favour the share deal transactions. However, currently, due to unclear wording of the Romanian tax legislation, the tax exemption related to capital gains from the sale of shares in real estate companies is rather debatable. The controversial matter is expected to be settled by the end of the year, when significant amendments to the tax legislation would be introduced by approval of an amended and rewritten Fiscal Code. In terms of real estate transactions, the amended and rewritten Fiscal Code should also provide, starting January 2016, for the application of the VAT reverse charge mechanism for taxable supplies of land and constructions (measure aimed to incentivize the business environment by improving the cash-flows and to fight tax evasion as well).

Asset Deals and Shares in the Czech Republic, Slovakia and Romania

Below table compares the taxation of profits made on the property disposals in the three countries.

 

Czech Republic

Slovakia

Romania

DISPOSAL OF A PROPERTY (ASSET DEAL)

Applicable CIT rate

19%

22%

16%

Taxable revenue

Sale price as indicated in the sale agreement. Assessment possible if the price between related parties does not correspond to the market level without a justified reason. Sale price booked, which is agreed in the sale agreement. In case of  difference between market level and agreed price among the related parties (domestic as well as foreign), such difference represents the increasing item to be taxed. The sale price as agreed between parties. Potential adjustments of the taxable revenues are possible for transactions between related parties, where the price is not arm’s length.

Tax deductible costs

(i) Tax acquisition value of the property less any tax depreciation applied.

(ii) Real estate acquisition tax if paid to the tax office by  the seller.
(iii) Costs related to the sale of the property (e.g. legal  services, tax advisory, agent fee).

Tax residual value of the disposed property (tax acquisition price of the
property decreased by cumulative tax depreciation of the disposed property).
From 2015 the tax deductible costs in form of tax residual value for the office
buildings, residential buildings, hotels, etc. (40 years of tax depreciation period) can be applied up to the value of the revenues from disposal only.
The acquisition, production cost or the market value the property less the write-offs expenses (not less than the initial  acquisition/production costs). The tax treatment of revaluations has
suffered changes over time and therefore, depending on the moment
when the revaluation has been done, the fiscal value of the property includes or not the revaluation results.

Possible step-up in

tax value of property

Yes. (The tax value for the purchaser is the purchase price + incidental acquisition costs.) Yes Yes. However, starting 2009, the revaluation reserves are taxable along with deduction of tax depreciation charges or deduction of expenses with assets written off.

DISPOSAL OF SHARES IN COMPANY HOLDING A PROPERTY

Applicable CIT tax rate?

19%; CIT exemption may apply – generally, if at least 10% ownership interest is held for at least 12 months
period and the parent company selling the shares is a resident of a EU state, Norway or Iceland (further conditions apply), the sale of shares is CIT exempt.
22% 16%. Starting January 2014, under certain conditions, the capital gains from the sale of shares are tax exempt (tax exemption currently debatable in case of sale of shares in real estate
companies).

Taxable revenue

Sale price as indicated in the sale agreement. Assessment possible if the price between related parties does not correspond to the market level without a justified reason. Sale price booked, which is agreed in the sale agreement. In case of  difference between market level and agreed price among the related parties (domestic as well as foreign), such difference represents the increasing item to be taxed The sale price as agreed between parties. Potential adjustments of the taxable revenues are possible for transactions between related parties, where the price is not arm’s length.

Tax deductible costs

The following costs are tax deductible (unless the sale is CIT exempt, then none of the below is tax deductible):
(i) tax acquisition value of shares up to the amount of the taxable revenue from the sale;
(ii) incidental sale costs (e.g. legal services, tax advisory, agent fee).
Acquisition costs up to the value of the revenues from disposal only. The acquisition or contribution value of the shares, including transaction costs.

 

The authors of the article, that was published in the 'Almanac of Shopping Centres' are both tax advisors at TPA Poland and experts of the Real Estate Group:

  • Malgorzata Dankowska, Tax Advisor, Partner. Ma³gorzata specializes in transactional and restructuring advisory.
  • Piotr Jakutowicz, Manager. Piotr is a Manager at TPA 's Warsaw tax office and has a broad experience in the area of tax advisory, for both domestic and foreign entities, mainly in CIT and VAT.
Download the article 'Taxation of capital gains on disposal of real estate property' - Almanac of Shopping Centres 2015