the 2010 global guide to tax

The 2010 Global Guide to Tax

Levying the worldTaxand’s Keith

O’Donnell on the global trends that fund managers need to know

Debt dealingThe impact of

purchasing distressed loans

in the US

The big tax takeCompare

the world’s markets with

Taxand’s data

Country updates Key developments

in China, India, France, Germany

and beyond

Plus: Five issues to worry UK investors Page 22

Page 3 Page 6 0 Page 24

The Global MaGazine for PrivaTe real esTaTe invesTMenT & finance

Executive Editor David Snow +1 212 633 1455 [email protected] Editor (Americas) Zoe Hughes +1 212 633 2907 [email protected]

Editor (Europe) Robin Marriott +44 20 7566 5452 [email protected]

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No statement made in this magazine is to be construed as a recommendation to buy or sell securities. Neither this publica-tion nor any part of it may be reproduced or transmitted in any form or by any means, electronic or mechanical, includ-ing photocopying, recording, or by any information storage or retrieval system, without the prior permission of the publisher. While every effort has been made to ensure its accuracy, the publisher and contributors accept no responsibility for the ac-curacy of the content in this magazine. Readers should also be aware that external contributors may represent firms that may have an interest in companies and/or their securities mentioned in their contributions herein.

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COVER STORY

2 GLOBAL TRENDS We interview Taxand’s head of real estate Keith O’Donnell on the grand tax themes taking shape globally

COUNTRY REPORTS

6 US A question and answer guide to buying distressed loans in north America, as well as a look at new tax rules allowing distressed property owners to talk to special servicers without penalty. Also, we examine signals from Capitol Hill that politicians will overhaul an outdated property tax act

10 CHINA We focus on a recent example where a tax authority cracked down on an offshore structure

12 FRANCE The OPCI is on the rise in France, leading tax brains to work outthebestoverallstructureforprivateequityrealestatefirms

14 GERMANY Moves to restrict the deductibility of interest are causing a headache in Europe’s largest economy

16 INDIA The new Draft Direct Taxes Code 2009, and what it means for private equity real estate

18 LUxEMBOURG One of the most popular jurisdictions for holding companies is coming under pressure from foreign countries. We take a look at what can be done

20 SwITZERLAND Why a law passed before the credit crunch is gaining attention

22 UK The country’s tax authority, Her Majesty’s Revenue and Customs (HMRC) has been busy bringing in new rules affecting fund structuring and the taxation of debt

DATA AND RESEARCH

24 DATA Weexclusivelyrevealinitialfindingsfromnewglobalresearch tool Taxand T3, showing the world’s most expensive jurisdictions in terms of tax-take

Table of Contents

Theinformationcontainedinthispublicationisintendedonlytobeaguide.Itmustnotbereliedonin,orappliedto,specificsituationswithoutpreviouslyseekingproperprofessionaladvice.Eventhoughreasonable care has been taken in its preparation, the publishers, Taxand and all the members of the Taxand network do not accept any liability for any errors that it may contain or lack of update before going to press, whether caused by negligence or otherwise, or for any losses, however caused, or sustained by any person. Descriptions of, or references or access to, other publications within this publication do not imply endorsement of them. As provided in the US Treasury Department Circular 230, this publication is not intended to be used by any person or entity for the purpose of avoiding tax penalties that may be imposedonanytaxpayer.ThepublishersandTaxandfirmshaveproducedthispublicationinconnectionwiththemarketingofTaxandfirms’taxservicesrelatingtomattersdiscussedherein.Taxandisaglobalnetworkoftaxadvisorymemberfirms.Eachmemberfirmisaseparateandindependentlegalentityresponsiblefordeliveringclientservices.©TaxandEconomicInterestGrouping2009.Registeredoffice:1B Heienhaff, L-1736 Senningerberg – RCS Luxembourg C68.

November 2009 PERE 1

In the autumn of 2009, the long lull in private equity real estate transactions seemed to be nearing an end.

The Blackstone Group, for example, acquired a 50 percent stake in London’s Broadgate office complex in a £2.12 billion (€2.37 billion; $3.4 billion) joint venture, while in Italy, Goldman Sachs’ Whitehall Funds acquired almost 900 non-performing and sub-performing loans from an insolvent company.

Plenty more deals have been reported by PERENews.com not only in Europe, but in North America and Asia.

So what’s the sting in the tail? Well, where there are deals, the taxman is close behind in every jurisdiction. Politicians need to refill their country’s fast emptying coffers with fresh sources of revenue. And given that a crackdown on some of real estate’s favourite tax-efficient inventions began even before the credit crunch, it stands to reason that more effort than ever before is being exerted by tax authorities on taxing the value creators.

Mindful that this era should usher in a return to super returns, and by definition, potentially super tax revenue for jurisdictions, what better time to publish a detailed and practical guide to the tax issues our readers are going to be encountering?

The 2010 Global Guide to Tax - published by PERE and Taxand - is a global publication that touches on the big issues all firms must grapple with. To begin with, Taxand’s global head of real estate, Keith O’Donnell, highlights the macro trends in an interview with PERE, on p. 2.

With debt being the new equity, we then look at the tax treatment in the US of buying loans - something that many funds are currently considering. And regardless of what 2010 brings, our country tax profiles will help alert firms to local tax issues in these important markets. We think you will find this of benefit at both a strategic and operational level, need it be said, but in real estate the difference between winning and losing can often be shaped by tax strategy.

Enjoy the guide,

Robin MarriottEditor (Europe)PERE Magazine

Editor’s Letter


INTERVIEw


The Taxander takeFrom crackdowns on abuse of tax treaties to attacks on interest deductibility of intra-company loans and the taxation of debt investments, there is plenty to concern private equity real estate. Robin Marriott catches up with Keith O’Donnell, the global head of real estate at Taxand, to discuss the grand tax themes shaping the industry.



It is August 26 in Luxembourg and Taxand’s leader of global real estate, Keith O’Donnell, is getting animated. You see, he and other Taxanders (the name given to those that belong to the global Taxand network), are increasingly seeing deal–making activity among private equity real estate clients. This extends beyond Europe to the US and Asia too.

This is clearly good news. From his vantage point, more deals equates to more tax advice required.

But before we delve too deeply into the machinations of structuring tax efficient vehicles for, say, cross-border distressed debt deals, there are more fundamental macro issues to discuss. The broad point is that private equity real estate firms can expect to come under greater pressure from the local taxman, something all real estate firms need to be aware of, and possibly act on. What hasn’t changed is that cross-border real estate investing can come with a major tax cost. Taxand research has shown that without careful handling, taxes can exceed 80 percent of the return on any given investment.

To an ex ten t , loca l t ax jurisdictions were paying more attention to private equity structures even before the credit crunch, says O’Donnell.

In a typical investor group, a large proportion of investors will consider foreign taxes as an absolute cost, requiring the private equity firm to avoid unnecessary local taxes as a fiduciary matter. Private equity houses have to strike a delicate balance between what is fair and reasonable in the local jurisdiction and the fiduciary duty to investors.

In the heyday of private equity from 2004 to 2006, the typical modus operandi for firms was to take the tax-base down as low as possible in local jurisdictions. The typical model was to use debt funding as extensively as possible as it creates a deductible expense in the local country. The debt was a combination of third party debt and debt drawn from fund commitments – so called “internal debt”. This model was

common to traditional LBOs of operating companies and to the private equity real estate sector.

However, the problem is that success of some structures has become a slight curse. It has drawn the attention of governments, press and the tax authorities, exemplified by the takeover of telecoms company TDC by KKR and a consortium of fellow LBO titans. In this case, the extensive use of debt led to a disappearing tax base in what was a high profile local company. The reaction was swift with new “earnings stripping” legislation being introduced in June 2007. Germany and Italy followed with similar legislation. The UK and the Netherlands have proposed similar limits, adds O’Donnell.

But besides populist point-scoring, governments now have the added reason to watch private equity real estate funds

more closely: they need to replenish their cash vaults given the scale of the national bailout schemes put into place. Private equity real estate firms are unlikely to be key voters and do not win many popularity contests either, so they are a soft target.

To an extent, the evidence is already before us. Local jurisdictions in some parts of the world are increasingly challenging the “substance” of foreign entities incorporated to take advantage of cross-border tax treaties. This can be seen in various jurisdictions, China included.

Get organised

“It is a big issue for the private equity real estate world,” argues O’Donnell. “There have been several cases where

private equity investors have been heavily challenged by local jurisdictions. The firms were expecting to exit from a particular investment without any tax, applying clear legislation, but the local tax authority has challenged the ‘substance’ of the foreign companies and treated it like a ‘letterbox company’. This happened in a very high profile manner to one of Lone Star’s real estate transactions in Korea recently, but for every case that hits the press there are many more that are not public. In addition, some of these cases can take on a political dimension that can be very tricky to manage.”

Why does this happen? By their nature private equity real estate houses are geographically dispersed and manage large amounts of assets with relatively small teams. Tax authorities frequently mount

challenges to investment structures using legislation and standards drawn from the industrial age, arguing that because an individual legal entity does not have large offices, employees, or own infrastructure, it is not entitled to tax attributes. “This line of argument may ignore commercial reality, but it has become a fact of life,” says O’Donnell. The warning is clearly: get your house in order.

Says O’Donnell: “Private equity real estate houses have to accept this fact of life and organise accordingly.”

Operating within this constraint is a real challenge and may require private equity real estate firms to organise themselves in ways that can feel “unnatural” at first, the typical example is the balance between insourcing and outsourcing of activities.

Taxing sitting ducks

While tax authorities are looking to ramp up efforts to enforce existing tax regimes and challenge cross-border structures, O’Donnell also says there is likely to be more competition between countries to pull tax revenue in from their own back yard at the expense of others. So select your jurisdiction with care.

INTERVIEw


Immovable objects such as offices and logistics facilities are sitting ducks for the taxman at the behest of political masters.

O’Donnell is at pains to point out that there is a dilemma here. In the eyes of many, real estate created the global credit bubble. Now that it has burst, governments do not want to further depress property values. Increasing tax barriers to cross-border investment could lower values further however.

Yet on the other hand, governments understandably want to use real estate as a tool to boost revenue.

Whether that comes through tax changes or just greater enforcement of rules, says O’Donnell, is a “moot point”. He argues: “I think it will be a blend of the two.” The signs are already there, though. They can be seen in more challenges to investment structures in Germany, France and Italy and legislative proposals around the globe from the US to the UK through to India.

If this all seems a little gloomy, then when the conversation returns to the theme of transactions, O’Donnell’s tone begins to lift. Taxanders are reporting from around the world signs of more activity than in the recent past, with an emphasis on core

property assets. Taxand is increasingly busy advising private equity clients on the acquisition of well-let buildings in prime locations whose values have already plummeted.

Beside core property, the good news is that the opportunities for buying distressed assets, including distressed debt, are dumbfounding, as many GPs are aware.

If a firm is lucky enough to have a deal in front of it, the chances are that the discount is amazingly high. However, this raises the prospect of potentially huge capital gains tax bills being charged upon exit. Many jurisdictions treat such capital gains on equity investments favourably, applying some form of “participation exemption” to dividends and or gains on significant shareholdings. The theory is that the underlying profits have been already taxed at the level of the company. But it is not the same for debt which tends to be subject to normal taxation. This means a lot of grey matter is going into constructing the right platform to invest in assets in order to escape being taxed too highly on the expected pick up in values. Says O’Donnell: “This is a global issue because the typical

profile of entities in these deals is private equity funds with investors in multiple jurisdictions.”

Though huge profits have been made in the past – think of the early 1990s and the RTC – the additional challenge of distressed real estate debt investing is that in the interlude, domestic tax laws and regulatory frameworks have been changed (and in some cases improved). The advice required is complex because advisors have to marry the tax analysis of legal and regulatory constraints with any analysis of bankruptcy issues. With some understatement, he says: “It gets challenging.”

This looks likely to remain one of the key areas of tax for private equity real estate firms to grapple with in coming months. When combined with governments looking to challenge tax structures and possibly introducing new rules, real estate tax advisors might need to be wizards if they are to succeed in reducing the tax burden of investing. The wands are out.

CONTACT:

Taxand Luxembourg Keith O’Donnell T. +352 26 940 257E. [email protected]

BIOGRAPHY

In July 2004, Keith created Atoz Tax Advisors with five other partners. Atoz was a founder member of Taxand, the first global network of over 2,000 leading tax advisers, represented in nearly 50 countries. Taxand, founded in March 2005, is headquartered in Luxembourg and provides international tax advice to global clients through its member firms. Keith is the leader of the global real estate team of Taxand. Previously, Keith was a tax partner in Andersen and subsequently in Ernst & Young. Keith had senior regional responsibilities in the investment management and real estate industries within both firms. Keith studied law at the National University of Ireland

(Dublin), and subsequently qualified as a Chartered Accountant, as a member of the Institute of Taxation in Ireland and as member of the Luxembourg Ordre des Experts Comptables. In Luxembourg, he is a member of the ALFI (Luxembourg Investment Fund Association) tax commission, chairman of the Double Tax Treaty Sub-Commission and participates in various ad hoc consultative bodies. He was responsible for drafting the tax provisions of the SICAR (private equity fund) legislation on behalf of industry bodies. Recently he has represented ALFI on the OECD workgroup on the application of Double Tax Treaties to Collective Investment Vehicles and was a member of the EU Commission expert group on Open Ended Real Estate Funds.



If there is one type of deal activity Frank Walker is deep into, it is advising private equity real estate firms on the tax aspects of buying distressed debt.Walker, the Atlanta-based managing director of Alvarez & Marsal Taxand US, says clients all over the US are looking at engineering such

deals, and at deep discounts too. Whether there is an adequate volume of attractive debt out there to truly satisfy all those chasing it is certainly one debate raging in the

market. Sam Zell is one such doubter, judging from recent comments he made to PERE’s US Editor Zoe Hughes in this month’s issue. But a separate question (and the one tax experts are struggling with) is how a firm should structure a deal if indeed it is fortunate enough

to find an attractive opportunity before it. As a teaser: if you think that the taxman is only interested in US investors, you would be wrong.Below is a question and answer session on this important issue. See also p. 8 for a legal update.

Q. What happens when an investor buys debt at a discount and follows through with significant debt modifications?

A. This may result in ‘phantom income’ to the borrower and the investor.

Q. When would both the borrower and investor be taxed?

A. If the modification of the debt instrument is deemed to be “significant modification” as defined by US law, this is treated as a deemed exchange of the old debt instrument for the new one. This is generally taxable for both the borrower and the investor. It may also result in some additional complexity if the new debt is considered an “applicable high-yield discount obligation” (AHYDO) for tax purposes, although Congress has provided some temporary relief for some of these complications.

Q. What is modification?

A. It is generally defined as any alteration, including any deletion or addition, in whole or in part, of a legal right or obligation of the issuer or holder of a

debt instrument. That alteration could be evidenced by an express agreement – oral or written down – or by the conduct of the parties or otherwise.

Q. What tax does the investor face?

A. The investor is required to recognise a taxable gain on a sale or exchange gain if the new redetermined principal exceeds the tax basis to the investor of the old debt. Assuming the debt is not publicly traded and has “adequate stated interest” under US tax laws, a deemed gain to the investor is generally equal to the difference between the face amount of the modified loan note and the investor’s tax basis in the original note.

Q. Can this ‘phantom income’ created by a deemed exchange gain be significant if the investor is a REIT?

A. Yes. A REIT is required to distribute 100 percent of its taxable income in order to avoid a corporate level income tax. However, the deemed exchange gain may result in capital gain income for the REIT with no corresponding cash to make a distribution. Or, the deemed exchange gain may result in

a REIT prohibited transaction. That could mean 100 percent tax on the net gain.

Q. Is it always clear which one it is?

A. No. Several industry groups such as NAREIT have requested guidance on a number of issues with distressed debt but it is difficult for the IRS to publish any meaningful guidance with the prohibited transaction issue. REITs that are concerned about the prohibited transaction risk with their transactions may conduct these activities in a taxable REIT subsidiary.

Q. What happens when debt instruments are purchased in the secondary market?

A. The investor may be subject to the market discount rules. Market discount would be in an amount equal to the discount. What happens is that the market discount accrues over the remaining term of the debt instrument and the amortised discount is required to be recognised as ordinary income as opposed to a capital gain upon repayment, redemption or disposition of the instrument.

A Q&A session with Frank Walker, Taxand’s head of real estate in the US

Debt dealing

COUNTRY REPORT: USBuying distressed loans


Q. Does this market discount rule apply to all forms of debt?

A. It generally applies to all non short term debt acquired at a discount. The investor may have to work out if it is better to modify the acquired loan (subject to the modification rules), or hold the loan to maturity, redemption, and/or disposition with its current terms and potentially face ordinary income treatment as opposed to capital gain treatment.

Q. How are foreign investors treated?

A. If a foreign entity acquires and modifies a debt instrument it may affect the applicable withholding tax rates on the interest income for the investor under US tax law and/or a treaty between the US and the foreign country relevant to the buyer.

Q. What is the withholding tax level?

A. Non-US entities are generally subject to 30 percent withholding tax on the receipt of certain passive interest income unless they meet the portfolio interest exception, though the rate could be subject to a reduction under the relevant income tax treaty.

Q. Are there any other issues for foreign investors?

A. There may be. Say a foreign investor buys a portfolio of distressed debt, and then modifies the loans significantly. It may be deemed to be engaging in a “US trade or business” for US income tax purposes. As a result, certain income earned in connection with the business could be taxed in the US as Effectively Connected Income.

Q. Is this for sure?

A. This is a facts and circumstances analysis. That is, it is not completely clear whether the acquisition of a loan with a view towards or expectation of a significant modification rises to the level of a US trade or business. If it does, then the non US investor may ultimately be required to file US federal and/or state income tax returns and be subject to tax as a US taxpayer as Effectively Connected Income. To the extent that a portfolio of defaulted loans is actively managed with a large number of significant modifications and subsequent sales of the modified loans

then the activities may rise to the level of a US trade or business. Foreign investors concerned about this risk may use a blocker corporation to manage that risk.

Q. What if the foreign firm invested in debt indirectly through a US partnership?

A. Then the income earned may also be subject to withholding tax under the Branch Profits Tax regime. This is an additional 30 percent tax levied on net income after Effectively Connected Income withholding tax which is subject to reduction under income tax treaty.

Q. And what if the foreign investor forecloses on the collateral of a loan?

A. This will generally subject the foreign investor to US income tax consequences such as federal and state income tax obligations, tax return reporting requirements, the branch profits tax regime and/or the Foreign Investment in Real Property Tax Act (FIRPTA) on future real property income.

Q. Lastly, we hear a lot about the potential for firms to buy back their own debt at discounts. What are the tax consequences?

A. A borrower who repurchases or retires it owns debt for an amount less that the outstanding principal amount of the debt will generally be required to recognise ‘cancellation of indebtedness income’ (COD) for the difference. It is generally taxable income unless certain exceptions are met.

Q. What if the borrower buys back its debt but doesn’t make a change to the outstanding principal balance?

A. The borrower may still be required to recognise COD. There is an issue involving ‘related parties’ buying back debt. Working out whether a party is ‘related’ can be a highly complicated task full of traps. In a general sense, US tax law would treat two parties as being related if the same person or persons owning more than 50 percent of the borrower directly or indirectly own more than 50 percent of the investor/acquirer. It is, as they say, complicated.

CASE STUDy A A REIT buying non-performing loans at a discount

A Public REIT acquires non-performing, non-publicly traded debt with an outstanding principal balance of $100 for $60 cash in the expectation that the loans will be modified through a reduction in principal. The REIT writes the loan principal balance down to $70. All of the other terms of the debt including interest and the term remain unchanged. The REIT has a potential gain of $10 for which there is no corresponding current or future cash payment. The $10 is either 1) Capital gain income which must be distributed or subject to a corporate level income tax, or 2) Prohibited transaction subject to 100% tax.

Planning note: To avoid the risk of 100% tax on the net income from a prohibited transaction, many REITs acquire these types of debt instruments through their taxable REIT subsidiaries. By doing this, they concede to a 35% US federal corporate level income tax rate on the net profit, but the potential for a 100% tax is eliminated.

CASE STUDy B Buying back your own debt at a discount

A corporation owns greater than 50% of the capital or profits of a borrower partnership. An investor partnership in which the same corporation owns 49% of the capital or profits decides to acquire the debt of the borrower partnership from the lender at a discount. Cancellation of indebtedness income (COD) likely results to the borrower partnership in the amount of 49% of the discount on the debt purchased by the investor partnership. If the corporation had owned more than 50% of the capital or profits of both the investor partnership and the borrower partnership, then COD income would have resulted in the amount of 100% of the discount on the debt acquired. If the corporation had owned less than 50% of both partnerships, then no COD income would have resulted. The case study assumes that the other owner(s) in both partnerships are unrelated to the corporate partner. If they are related directly or indirectly, the situation becomes more complicated to analyse.

Taxand US Frank WalkerT. +1 404 260 4086E. [email protected]


New US tax rules will make it easier for distressed real estate owners to restructure securitised loans not in imminent danger of default.

To date, owners of loans that had been rolled up into securitisation vehicles, such as investment trusts and real estate mortgage investment conduits (REMICs), couldn’t modify a loan until they were about to, or had, defaulted without triggering tax penalties.

Those rules made it difficult for borrowers current on their payments to hold restructuring talks with special servicers.

However , in September the US government issued guidance that will allow loan servicers to modify loans where it “reasonably believes there is a significant risk of default … upon maturity of the loan or at an earlier date”, without triggering tax penalties.

The US lobby group, the Real Estate

Roundtable, welcomed the move – but it was criticised by some as reinforcing the industry’s attitude of “extend and pretend”.

Roundtable chief executive Jeffrey DeBoer said the move was needed to prevent a massive wave of commercial real estate debt defaults. “Borrowers need to be able to talk with their loan servicers about restructurings in a timely manner, before the point of default. The [Internal Revenue Service] has taken a very positive step toward easing today’s crushing liquidity crisis in commercial real estate.”

Securitised “conduit” debt accounted for more than 60 percent of the commercial real estate mortgage market during the first half of 2007, according to the Roundtable, which predicted defaults and late payments on securitised loans could surpass 7 percent by the end of the year.

Distressed US property owners will now be allowed to talk to special servicers about restructuring securitised loans before imminent default without triggering tax penalties. The move has been criticised for reinforcing the ‘extend and pretend’ attitude of the financial industry. By Zoe Hughes, PERE Editor (Americas)

Restructuring securitised loans rules eased

COUNTRY REPORT: USRestructuring loans

ZELL: SCALE of DEBT oppoRTUnITy Won’T BE AS ‘SIgnIfICAnT’ AS RTC

Sam Zell, the co-founder of Equity Group Investments has cautioned that the scale of the debt opportunity in US real estate won’t be as “significant” as many predict – insisting extend and pretend will see many borrowers try to hang on to assets.

Interviewed by PERE magazine at the 4th Annual Kirkland & Ellis Real Estate Private Equity Symposium in New York, Zell said many borrowers had been given a “hope certificate” by financial institutions, which are willing to extend maturities when debt service payments are current.

To read the full interview with Zell, see the November issue of PERE published with this guide

when it was introduced in 1980, the Foreign Investment in Real Property Tax Act (FIRPTA) was intended to prevent farmland in America’s heartland from being consumed wholesale by overseas investors.

Almost 30 years since its enactment and FIRPTA is known to have had much wider consequences than prohibiting the acquisition of agricultural land and operations. Billed as an outdated, i rre levant , protect ionis t measure , opponents say FIRPTA has had a detrimental impact on US residential and commercial real estate markets by restricting additional equity investment in the asset class.

Until the credit crisis, such arguments gained little, if any, traction on Capitol Hill. However, in the wake of the collapse of real estate markets across the US, there are not only fresh calls for change – but signs that lawmakers may be paying attention.

The FIRPTA tax requires sellers of real estate assets in the US, who are not resident aliens or US citizens, to allow buyers to withhold part of the gains from any disposition for taxable purposes. The tax is usually 10 percent of the sales price but can be up to 35 percent – and comes on top of all other US taxes paid by the overseas investor or foreign corporation.

Although difficult to quantify, most real estate investors, especially foreign investors in US real estate, insist it does discourage investment in North American assets and

for some a significant barrier to entry. “If FIRPTA ever had a purpose it has

long outlived it and now needs to be substantially reformed if not completely repealed,” says Jeffrey DeBoer, chief executive of the industry lobby group, the Real Estate Roundtable.

The Roundtable has been a long-time proponent of change on the issue, and this year included repeal of the tax in its five-point plan aimed at restoring liquidity to the US real estate markets.

“we now live in a global economy where capital should be flowing with as little burden as possible and the current rules are clearly an impediment to foreign investment in US equity real estate transactions,” says DeBoer.

The credit crisis isn’t the sole catalyst of demands for reform. Concerns over the tax were heightened in 2007 when the Internal Revenue Service (IRS) ruled against the use of private REITs by sovereign wealth funds as a means of avoiding FIRPTA. Foreign investors will often invest in US-controlled real estate investment trusts and blocker corporations to mitigate FIRPTA. IRS Notice 2007-55 though further muddied already murky waters by ruling that distributions from such entities to foreign shareholders were taxable.

“This ruling reawakened the debate about the tax in 2007,” explains Jay Zagoren, a partner at law firm Dechert’s finance and real estate group. But as he

adds: “Now with real estate markets experiencing firesale situations, there is a greater urgency to calls for change.”

As DeBoer says, with politicians among those calling for new investment and capital to be injected into real estate, excluding foreign investors is simply counter-intuitive. “There is a tremendous need for new equity into US real estate owing to the dramatic deleveraging and repricing of the asset class.”

Conversations with politicians on Capitol Hill are in their formative stages but DeBoer says legislators are keen to learn more about FIRPTA and its impact on US real estate. “The meetings we have had have been very productive and engaging and I think they will ultimately result in some change to FIRPTA,” he says.

DeBoer concedes that whether the debate will translate into repeal or “something short of that”, it is too early to say. But to help further the debate, the Roundtable was due at press time to publish a survey quantifying the amount of additional equity US real estate could attract if FIRPTA was changed.

“A lot of our members meet with non-US investors who would like to invest more in the US, but are discouraged from doing so by FIRPTA,” DeBoer says. “This tax is discriminatory and needs to be repealed. Lowering this burden against foreign capital will help ultimately and be very positive for US economic growth.”

Calls for reform of the US FIRPTA taxation rules have fallen on deaf ears for decades. Now though change could be in the making. By Zoe Hughes, PERE Editor (Americas)

Breaking through the trade barriers



Peering out of the window of a 52-storey Shanghai skyscraper, Dennis Xu, the leader of Taxand China, has a better view than most of the infrastructure miracle that has taken place in China’s cities. Glitzy mall shopping, five star hotels and the main East-West thoroughfare, Yan’an Elevated Highway, tell the story of how Shanghai in particular has modernised.

Foreign investors have been playing their part too, buying up or improving assets. But what is also noticeable is that some of the earliest firms into the city are now beginning to exit investments, such as Morgan Stanley and Netherlands-based ING Real Estate. This is turning the spotlight on the tax treatment of transactions involving foreign firms.

It is especially the case seeing as there is recent evidence of a crackdown in one of the favourite centres foreign investors have being using to structure funds or transactions – Barbados. Just last year, the government decided that a US private equity firm would have to pay local tax on a non-real estate transaction despite the firm in question believing it could avoid withholding tax based on the tax treaty between Barbados and China. This is the same treaty that some foreign private equity

real estate investors are relying on to avoid the same levy.

The private equity example involves a company from the Xinjiang area of China and a company from Urumqi that formed a joint venture in March 2003.

In 2006, a US private equity firm

established an entity in Barbados and through this acquired a one third interest in the JV from the Xinjiang company.

Less than a month later according to Taxand, the Chinese company increased its registered capital in the JV. In 2007, the private equity firm’s Barbados company then altered the capital structure. It transferred all of its equity interest back to the Xinjiang company making a capital gain of $12 million in the process. Not a bad profit in less than 12 months.

It was then that the Chinese authorities began to take notice, because the JV

applied on behalf of the Barbados company for tax exemption from the capital gain.

To the dismay of the US company, the Xinjiang tax bureau rejected the application. Here was an example of the Chinese authorities deciding the Barbados entity was not ‘of substance’.

Hence, it said the Barbados company could not be treated as being tax resident in Barbados because it had no management there. In fact, all three of its directors were US nationals. In addition, the capital gain was not made from actual operations but a pre-agreed contractual arrangement. To make matters worse, it was difficult to determine the nature of the

Barbados company’s investment. The cost? Witholding tax of 10 percent should be imposed on the capital gain.

As Taxand’s Xu explains, though this was a private equity deal, the Chinese authorities could also challenge private equity real estate structures used for investing in China as well.

Generally, foreign firms will set up a fund offshore either in the form of a limited company or limited partnership (Super holdco) in domiciles such as Barbados, the Cayman Islands, Mauritius, or the British Virgin islands where there is a favourable tax

There is now a risk that the tax authorities of China may rely more on GAAR to challenge transactions or structures that lack substance.”

China’s offshore chillA recent private equity deal that invoked China’s tax treaty with Barbados shows firms need to structure their offshore vehicles carefully

COUNTRY REPORT: CHINAChallenging offshore structures


treaty with China. Barbados used to be the preferred domicile as it ranks better in tax rate in terms of tax on dividends and capital gain tax, but Barbados is losing its appeal as its tax treaty is under negotiations for renewal.

Companies will also set up special purpose vehicles under the fund for each investment into China for better tax planning, financial accountability and risk control.

But China has now introduced General Anti-Avoidance Rules (GAAR) under the new Enterprise Income Tax Law.

Says Xu: “There is now a risk that the tax authorities of China may rely more on GAAR to challenge transactions or structures that lack substance.”

Echoing what Taxand’s head of real estate Keith O’Donnell says on p. 2, Xu says foreign investors should review their investment structures for investments in China in light of the recent changes.

So far, private equity real estate firms do not have a significant presence in China, according to Xu. He says the real estate market is highly relationship driven. “Most of the successful players are from Hong Kong, Taiwan and Asian countries with some Chinese roots.”

That said, Taxand has worked in the country for international players such as GE Real Estate and JP Morgan’s real estate department. “I think it takes a significant amount of time on the learning curve here. They are not really in the development business, but are looking for mostly commercial buildings that can be leased and then sold.”

“The whole question is: ‘What is the government’s attitude towards foreign

investors?’”There are quite a lot of restrictions for

foreign companies coming into this sector.Xu says the Government has made

it clear that foreign investors need to demonstrate a strong background in real estate. It has also restricted firms so that no 100 percent foreign real estate company is allowed to operate. Hint: they should tie up with a local company.

If anything, says Xu, the People’s Republic is getting hotter on foreign companies trying to operate in the country. This is partly because the government is scared of repeating mistakes made in emerging markets regarding property speculation.

On tax issues as a whole, China is moving towards a more international tax system. In other words, there’s a lot of anti-treaty shopping regulations coming up.

“Let’s say a foreign investor owns a building in Shanghai through a holding and financing structure involving a Barbados company. Let’s say the Barbados company is sold to the buyer, as an easy way to effect a sale of a package of equity and finance instruments that have funded the building. Legally, there should be no tax paid. But the new ruling on similar structures would suggest that if the authorities decided that the Barbados company were just a ‘shell ’ or ‘paper’ entity and most of the activity is in China, the Barbados company would be disregarded. So the investor could end up paying capital gains tax.”

Xu adds: “From our perspective, private equity is going to experience more difficult times for structuring their assets. On the one hand central and local governments

want to encourage foreign investment. On the other hand there is always the temptation to seek more taxes where a transaction is visibly profitable. ”

This will be important for new players. As PERE has reported in the recent past, despite the economic slowdown, there are fresh examples of foreign investors trying to invest in China for the first time. AXA Real Estate Investment Managers, for example, has plans to raise a China-focused fund.

It seems that foreign companies are still keen to invest in the long term growth story. But they will have to make sure they get their structures right. Otherwise, the clunking fist of the People’s Republic of China will come down hard. The good news is that real estate is important to China. There are about 400 industrial classifications in China, and around 240 are related to the real estate industry. With that in mind, the government will (hopefully) be careful in implementing and applying new regulations that affect the tax treatment of deals.

The challenge in China as one foreign investor puts it is that tax laws change quite frequently.

One fund sponsor told PERE: “The problems with structuring a China fund is that policies change quite often and secondly, it is more tax-efficient to customise the structure based on deals according to sectors, development, investments, source of capital, holding period, even the partners so there is really no one-size fits all solution.”

Taxand China Dennis XuT. +86 21 6447 7878E. [email protected]


Last year, when PERE magazine visited MIPIM, the world’s largest property trade show in France, we met a placement agent in a café. Having discussed the challenging global fundraising market, our contact suddenly became more enthusiastic. Talking about the future of funds in France, our source said new rules on OPCIs or Organisme de Placement Collectif Immobilier was a big event and that we should expect dozens of firms to establish themselves under this structure. He was right.

Since then, dozens of funds have adopted the OPCI regime. These include private equity and real estate firm Weinberg Capital Partners, GE Real Estate’s French business,

the French real estate asset manager team at Societe Generale, Invesco Real Estate and partner Ciloger, and plenty more besides. Now there are signs of a return to deal activity. In September, for example, a French investment group led by an OPCI managed by asset manager UFG paid global hospitality group Accor €272 million for a portfolio of budget F1 hotels spread out across France.

It is little wonder why the new structure is becoming popular.

Tax benefits

The structure benefits from the same tax

regime as the well-known French SIIC regime (the French equivalent of REITs) which was replicated recently in Germany and in the UK. But contrary to SIIC, OPCIs are not listed vehicles. This allows private equity real estate houses to set up their own OPCI. They are regulated real estate funds set up in UCI form, but with a specific simplified form available for the real estate fund managers (the so-called SPPICAV RFA). In tax terms they are attractive because they are exempt from corporate income tax, the objective of the regime being to have a single taxation at the level of the unit holders.

In particular, the vehicles are exempt

France recently introduced OPCIs as a tax-friendly way of investing in real estate. Now, foreign investors are figuring out if they can use this structure and still get a tax efficient return on investment

Friendly France

COUNTRY REPORT: FRANCEOPCIs (Organisme de Placement

Collectif Immobilier)

The French Foreign Legion

Invesco Real Estate: Dallas-based Invesco Real Estate established a partnership with French asset manager Ciloger in May 2008 to launch a range of OPCIs. Ciloger was the first fund manager in France to transform an existing fund into an OPCI.

GE Real Estate France: The Connecticut firm’s French subsidiary won approval in June 2008 from France’s Autorite des Marches Financiers (AMF) to set up GE Real Estate Management (GEREM) France so that it can create, promote and manage OPCI funds.

Tishman Speyer: New York-based

developer and fund manager Tishman Speyer set up an OPCI in the first quarter of 2008. At the time it was among the first approved.

The Blackstone Group: The real estate group of the New York-based private equity firm went very far towards setting up an OPIC in the autumn of 2008, but did not go all the way because it could not find a deal to make it worthwhile.

F&C Investments: Ofi REIM Paris has been set up as a joint venture between French asset manager Ofi and London-based asset manager F&C to invest in France.

OPCIs shift gear: an OPCI-led investor group recently acquired a portfolio of Hotel Formule1s from Accor in one of the first of the anticipated deals to come

provided they fulfill distribution duties: 85 percent of the rental income, 50 percent of the capital gains and 100 percent of the dividends received from tax exempt subsidiaries (95 percent owned subsidiaries normally subject to corporate income tax may also elect for the exemption regime provided they fulfill the distribution duties at their level as well). So, the taxation burden falls to the unit holders and there is no exemption relief. If the shareholders are French corporations, the dividends received from the OPCI will be taxed at the standard rate of 33.3 percent. The tax advantages do not stop only at the fund managers of OPCIs. There is a strong incentive for real estate sellers to dispose their real estate assets or shares in real estate companies to an OPCI (though the same incentive exists for the SIIC). This is because a seller’s capital gain tax rate of 33.3 percent is reduced to 19 percent exit tax upon the sale or contribution of real estate assets to an OPCI provided that the real estate assets are kept for 5 years by the OPCI. If the OPCI keeps it for less, it must pay a 25 percent penalty.

Franck Llinas, tax manager with Taxand France, says there are two types of OPCI – one for club deals with few investors, and one open to retail investors. “What we see is the real estate players trying to implement them using

just a few investors in France,” says Llinas. OPCIs are not a complete panacea, however.

There are challenges. As a regulated fund, they are subject to several constraints in terms of administrative work and communication to investors. In brief, OPCIs must have an independent management company approved by the French market regulator the AMF, and a depository that ensures assets conservation and compliance of decisions made by the management company. OPCIs must have statutory auditors and must disclose their “valeur liquidative” (share price): with a frequency of between two weeks and six months based on one appraisal (“expertise”) and three updates (“evaluations”) per year carried out by two experts acting independently from each other.

Getting a double dip

From a tax perspective, though, the main problem with foreign funds establishing OPCIs is the tax withheld by France at the time of the distribution of dividends. Indeed, unless provided otherwise in the tax treaty concluded between France and the state of the dividends’ recipient, dividends are subject to a 25 percent withholding tax. As regards

tax treaty-protected investors, the latter may benefit from an exemption or reduction of withholding tax (generally reduced to 10 or even 5 percent) only in very limited cases as the OPCI is generally a vehicle not eligible to tax treaties based on the OECD model.

Most of the time, the country of the investors will tax the dividend. However, that is not to say that tax experts cannot find solutions.

The OPCI can still offer some interesting net after tax returns compared to other traditional fund vehicles if structured right.

Taxand’s Llinas says: “When there are sound business reasons, we are trying to get foreign investors routing their investments through countries that have old tax treaties with France that do not impose an effective taxation to invest in a French OPCI, then apply the tax treaty between France and the country. From a technical point of view, the benefit of these tax treaties does not seem to be subject to any objections but we do not know how long it will last.”

Private equity real estate firms with ambitions in France will be watching closely.

Taxand France François LugandT. +33 1 70 38 88 21 E. [email protected]

Through the years, France has found some tough ways to make sure investors pay its wealth tax.

The famous 3 percent annual tax on the market value of real estate was a way to ensure individuals did not try to hide behind complex company structures in order to escape the levy.

Though it has always had the potential to act as a brake on foreign investment, investors do have a way around it. They can take advantage of an exemption by disclosing the identities of individual investors. In this way, the French authorities can go after those shareholders to levy its wealth tax.

Revealing all shareholders for private equity real estate funds might be an administrative burden, and it needs careful attention from tax experts.

In 2008, the rules were reformed to make it easier, but for certain funds – namely German open-ended real estate funds – it is still an absolute nightmare.

By their nature, German open-ended funds have so many investors – sometimes running into the thousands – that it is practically impossible for a fund to identify all the shareholders to the satisfaction of the French authorities.

Aware of this major obstacle, the 2008 reform provided for a

specific and automatic exemption for the French OPCIs (when they are public OPCIs, not the club deal version) and foreign funds governed by equivalent rules.

As German open-ended funds are governed by rules very close to France’s OPCI ones, they assumed they could benefit from the same exemption. However, officially questioned on this issue, the French tax authorities have denied the automatic exemption on the ground that the German rules were not strictly the same as for OPCIs. Here is an important example of tax hypocrisy: enacting a rule to be in line with the EU rules (allowing the European funds to benefit from the same exemption in theory) and refusing its applicability for obscure reasons in practice.

This is serious. German open-ended funds are hugely important to the French real estate market.

In normal times, they regularly invest billions of euros into the sector. As of the end of 2007, their French investments represented around €20 billion. Not only might the French decision curtail future investment, the issue has also apparently reached a diplomatic level. Here real estate tax has impinged on relations.

why OPCIs have created a diplomatic row



There is a real hunger for updates about deductibility of interest in Germany. PERE has spoken with one large global buyout firm with significant assets in the country which describes the way the German government has limited the deductibility as being a “headache”.

The problem is that in recent times, Germany made moves to restrict the ability of investors to deduct interest from debt repayments from their corporate tax bill base. Like some other jurisdictions, the country wanted to limit the ability of foreign groups to move profits out, and so it broadened German thin-cap (thin capitalisation) rules in the 2004 Tax Reforms Act. This was happening at the same time as some of the biggest private equity real estate houses acquired mega portfolios. Goldman Sachs’ Whitehall funds, Lone Star, The Blackstone Group and Morgan Stanley to name but

four firms which acquired offices, residential property retail and industrial assets (see box below).

The hunger for further updates has become intense because it is making life tougher for investors. So when the rules were changed in the beginning of 2008, Taxand was quick to feed it to clients.

Taxand’s German real estate head, Ulrich Siegemund, says: “All of our private equity real estate clients are worried about this.”

Interest barrier rule

Siegemund explains the thin-cap rules contain a so-called ‘interest barrier rule’ which basically allows the deduction of interest in the amount of 30 percent of EBITDA.

This is important as real estate investors have been particularly hard hit in recent times because EBITDA from investments is falling.

Since real estate investments were so highly leveraged and EDITDA has been falling because of the economic downturn, the interest charge far exceeds the 30 percent ‘barrier’.

No wonder Taxand clients sat up when in July this year a small exemption to the 30 percent EBITDA rule was allowed.

The change expanded full deductibility for a tax paying entity that pays less than €1 million interest annually to a higher figure of €3 million. This rule change increased the threshold to €3 million for the years 2008 and 2009.

This is clearly good news for real estate funds with smaller investments. Funds that set up special purpose vehicles investing up to approximately €40 million to €60 million resulting in an annual interest charge below €3 million due to the new rule can fully deduct the interest from the tax base.

Germany has made recent changes to the deductibility of interest, but investors are still worried about their tax bill

A headache in Germany

COUNTRY REPORT: GERMANYInterest deductibility

10 LANDMARK DEALS IN GERMANY

2000: Nomura International’s Principal Finance

Group signs the largest private equity deal in

Germany buying Deutsche Annington Immobilien.

It was the beginning of a string of billion-plus

privatisation plays of German residential compa-

nies. Guy Hand’s London-based firm, Terra Firma,

subsequently combined that with Viterra for €7

billion to expand the group to 230,000 flats.

2004: Dallas-based Lone Star bought a $4.4 billion

book of German loans from Hypo Real Estate.

The vast majority were sub performing or non

performing loans.

2004: The Blackstone Group struck its first residen-

tial deal in Germany, buying around 31,300 rental

apartments mainly in the Northern and Western

parts of Germany for €1.39 billion. The previous

year the firm acquired a portfolio of office proper-

ties from Deutsche Bank for about €1 billion.

2005: Fortress Investment Group’s Eurocastle fund

bought 303 commerical properties from Dresdner

Bank in a huge €2 billion sale and leaseback trans-

action.

2006: Morgan Stanley Real Estate Investing formed

a joint venture with RREEF to acquire commercial


Larger investments

However, for firms with larger investments, the exemption is not of benefit. Those investors who made deals in the multi hundred million bracket (and above) need not hurt their eyes looking at the small print of the exemption.

Says Siegemund: “For smaller investments it is not that big a problem because you have this €1 million threshold. Now that has been increased to €3 million you might be fine up until €60 million. But for the €100 million, €200 million bracket, it is really changing the profitability of real estate investments.”

At its worst, players in Germany might find they are in a loss-position but still have to pay taxes because of the non-deductibility of interest.

There are even problems for those who might be exempt using the €3 million rule. The wording of the law says the €3 million threshold is applicable until 2009 only. Says Siegemund, the previous €1 million threshold is not mentioned in the law any more so it seems that there is no threshold beginning from 2010.

“To abolish the €1 million threshold was not the intention of the parliament, but it has created uncertainty and it may take some time after the recent German election to clarify this through another tax reform act,” he adds.

It is of real concern to Taxand’s clients. One is a state-owned Asia fund that invested heavily in German real estate.

Siegemund says if a firm cannot benefit from the €1 million to €3 million threshold, it needs to think about structures to work the interest area.

The good news is that there are structured solutions that Taxanders have been able to provide and advise on that seem to work.

This involves having to negotiate with the lending bank, explains Siegemund, and the bank would have to accept restructuring in order to benefit from that. That is not a foregone conclusion, however, as anyone dealing with a bank with a real estate problem can attest.

Other exceptions from the 30 percent EBITDA rule are called ‘escape clauses’ which allow the taxpayer to prove that the leverage of the German tax-paying vehicle is not exceeding the leverage of the consolidated group. Not all firms will be able to use this as an escape hatch either.

One large global private equity franchise PERE spoke with said: “The country has an exemption and escape clause but for an organisation like ours with considerable holdings it is very hard to rely on. Has it meant we have had to pay more tax in

Germany? Yes.” The firm said it would have to feed the limit

into its financial models when pricing new investments in Germany.

Comments Siegemund: “Firms have to consider this when modeling new investments. It even more severely hurts them when looking at their existing portfolio investments because the rule applies to those investments as well.”

They will certainly make investments in Germany less profitable. The challenge then is to minimise the bill and find extremely profitable deals. That’s where the tax adviser and the manager comes in.

properties owned by Germany property company

DGAG. The deal was simultaneous to the takeover

of DGAG by RREEF and Italy’s Pirelli Real Estate.

2006: Oaktree Capital Management bought the

fiercely contested €1 billion ‘Hercules’ portfolio

consisting of 45 assets from Deka Immobilien

Investment.

2007: Italy’s Pirelli Real Estate and Deutsche

Bank’s RREEF agreed to buy German residential

property group BauBeCon from New York private

investment firm Cerberus Capital Management for

€1.6 billion.

2007: The Blackstone Group

sold its stake in its German

residential portfolio, the Vitus

group, to a consortium of

investors including Round

Hill Capital and Morley Fund

Management in a transaction

valued at approximately €1.6

billion. The deal was made just ahead of the credit

crunch.

2008: Goldman Sachs’ Whitehall Funds

acquired a German residential company

LEG-Verkaufsverfahren with

an enterprise value of €3.4bn,

in one of the last remaining

deals of its kind in the country.

The company owned 93,000

apartments.

2008: Morgan Stanley

acquired the eight-building

Sony Center in Berlin along with Corpus Sireo and

an affiliate of The John Buck Company for MSREF

Fund VI International for around €600 million, one

of the largest ever single asset deals in Germany.

Taxand Germany Ulrich SiegemundT. + 49 6196 592 16364E. [email protected]



In early October, PERE’s owner, PEI Media, hosted its second annual private equity conference in India.

Among the burning issues raised by delegates at Mumbai’s Taj Mahal Palace & Tower was India’s new Draft Direct Taxes Code, 2009.

India, it should be noted, is overhauling its entire direct tax system – something that affects Indian corporations as well as the ordinary man on the street. However, if passed in its current form, the Code also has implications for foreign private equity and private equity real estate firms. This is because it would curtail the tax breaks foreign companies currently enjoy by establishing structures in Mauritius, which is the most popular jurisdiction used by foreign investors into India. This is yet another example of a country looking to install anti-avoidance

measures to prevent tax leakage. There is no doubt the Code would be a major

milestone in India’s development. After all, more than 50 years have passed since the country passed the Income Tax Act and the Wealth Tax Act, so a move to simplify and update the rules broadly seems overdue. If it progresses as planned, the Code will become law in 2011.

It is something that foreign investors would do well to heed, for it will radically alter the outcome of capital gains treatment.

Abhishek Goenka, a partner at Taxand India, explains that foreign investments in India have traditionally been made through an offshore holding company.

The holding company would typically be in tax havens such as the Cayman Islands and the British Virgins Islands. Cyprus, Singapore and The Netherlands are also often used. But

Goenka says Mauritius has been the most popular jurisdiction because of its favourable tax treaty.

Selling shares directly

In many cases, a foreign firm might be making a capital gain on the direct sale of shares in an Indian company. The treaty is clear: any gain on the transfer of shares in an Indian company by a Mauritius holding entity is not taxable in India. It is taxable in Mauritius, but capital gains are not taxable in Mauritius either. It seems to be an easy win.

That said, there have always existed certain hurdles to overcome in order to benefit from the tax treaty.

In order to get the capital gains tax exemption under the treaty, the Mauritius (or Cyprus entity) must not have a ‘permanent establishment’ in India. This means, it cannot be controlled and managed from India.

This can present a specific headache for real estate funds, because as one often hears, in order to be successful in property an investor needs local knowledge of the property market.

For some, having a large team on the ground could mean that more decisions are taken in India, and that might prevent a firm meeting the permanent establishment rule.

In tax parlance, permanent establishment is a ‘fact driven analysis’. This simply means that tax authorities will look at how deal decisions are made on behalf of a private equity real estate fund.

But a bigger obstacle would be presented if the new Code were introduced in its current guise. Says Goenka: “If the Code comes through and if the treaties are overridden, the current benefit available under the treaties will no longer be available.” The change could

India only opened up its real estate to foreign investors in 2005. In the initial years, the conditions for private equity investors expressed in the so-called ‘Press Note 2’ seemed easy enough to understand. Press Note 2, which guides foreign direct investment in Indian townships, housing, built-up infrastructure and development projects, provided that the ‘original investment’ made by a foreign investor in an Indian developer would be locked in for three years. It seemed to be accepted that the investment that would be subject to the lock-in would only be the prescribed minimum capital of $5 million for joint ventures and $10 million for wholly-owned ventures.

However, over the last few months several issues have emerged that are giving investors sleepless nights. One of them is that in July, the Government contradicted the accepted view and stated that the entire investment made by a

foreign investor would be subject to the lock-in of three years. The clarification does not seem to indicate that the revised interpretation would apply only to new investments and this changed position has left several investors having to recalculate their internal rate of return. More particularly, in cases where the investment was made in residential developments, with an upswing in the demand for housing, several projects have started generating surplus cash flows and the absence of an exit mechanism has resulted in the capital being locked in for longer periods. In India, the government has signaled that it sees investment in real estate as a long term play. There are restrictions on the use of external debt, for example. The absence of a domestic REIT model and the limited sources of domestic private equity add to the problems for investors with shorter investment horizons.

TAx noTE: LoCk-In pERIoDS Abhishek Goenka details the new law for foreigners

India shuts gateBad news for investors as India drafts a law that would close off benefits of a tax treaty with Mauritius

COUNTRY REPORT: INDIADraft Direct Taxes Code 2009


affect the treaty with Cyprus as well as with Mauritius, he adds.

Sale of shares of the company outside India

The new Code would also affect tax treatment of capital gains when a foreign investor sells shares of a company outside India that holds the shares in the Indian company.

This kind of offshore gain can also be a tax trap. The way the law works is like this: non-residents are taxable on income accruing ‘directly or indirectly’ from ‘any business connection’ in India or through or from any property or asset or source of income in India or transfer of a capital asset situated in India. Under the Indian law, the ‘situs’ of the shares is where the company is located.

Goenka says that the Draft Code would specifically make indirect transfers taxable.

This would at least clarify the position, because it is not completely clear at the moment following a recent legal case brought by the Indian government against UK mobile phone giant, Vodafone.

The Indian Revenue fought Vodafone over what it saw as a failure to withhold and deposit taxes on the capital gain that accrued from an Indian mobile phone company it took over in 2007 called Hutch. The capital gain arose on the sale of shares in an offshore company through a complex web of intermediate offshore and onshore entities which ultimately held shares in an Indian telecom company.

The Indian Revenue sought to tax the sale of Cayman Island company shares as it ultimately led to the sale of a controlling interest in the Indian joint venture. The Supreme Court of India effectively upheld the action of the Indian Revenue in a follow up procedure.

However, the Supreme Court did not lay out any definitive conclusions as regards taxability of the transaction.

The final outcome of this case could impact the taxability of all offshore transactions with underlying Indian shares. However, as Taxand’s Goenka explains, the new Code would make such indirect transfers specifically taxable.

At PEI Media’s conference in Mumbai, the government was keen to say that the Code was at present just a draft.

Montek Singh Ahluwalia, the former finance secretary at the Ministry of Finance

and current deputy chairman of the planning commission of India, addressed concerned delegates via video link.

He said the draft was in consultation stages and that the Indian government would listen to the voice of foreign investors. The message to delegates, though delivered pleasantly enough at the conference, was not entirely reassuring.

InDIAn fUnDRAISIng noTES: India has been a focus for funds of late, but some have been caught up by investor fatigue*

Firm: AXA Real Estate Investment Managers HQ: ParisNotes: has a plan, though not immediate, for a mid tier residential property fund. Frank Khoo, head of Asia, tells PERE magazine this month that local people are queuing up to buy new homes. “We were visiting some mid tier residential developers recently. It was crazy. There was just a queue of people lining up to buy stuff.”

Firm: Rutley Capital Partners HQ: LondonNotes: decided to shelve a residential opportunity fund in August, blaming investor fatigue. Nick Burnell, managing parter, said: “Clearly it was the wrong time. The supply-demand imbalance for low to mid-range housing is still there. This was just about what international investors want to do right now.”

Firm: HSH Nordbank HQ: Hamburg Notes: in July, Germany’s HSH Nordbank and Kuwait’s Noor Financial Investment Company revealed a partnership to raise $500 million for the India Infrastructure Development Fund with UTI Asset Management Company, one of India’s largest asset management companies.

Firm: Catalyst Capital HQ: LondonNotes: suspended fundraising with joint venture partner Samsara Capital in March 2009. Executive director, Jonathan Petit, said: “The mood in the market is restrained. We are not doing anything on this right now as the confidence is just not there.”

Firm: AREA Property Partners HQ: New York Notes: formed a fund with Indian conglomerate SUN Group in 2006. Together the joint venture raised $630 million for the SUN Apollo Indian Real Estate Fund. It closed to investors in January 2007.

*as of October 9, 2009 Source: PERENews.com


Taxand India Abhishek GoenkaT. +91 80 4032 0000E. [email protected]

Shaping up Current buzz words such a ‘pyramid’ and ‘rake’ are being used in tax circles in Luxembourg – they refer to strategies to fend off challenges from foreign jurisdictions

COUNTRY REPORT: LUxEMBOURG Fund structuring

Are you taking the “rake” or a “pyramid” approach to structuring your holding company? The chances are that unless you are a tax specialist, you will not be sure. But maybe you should know because they are both possible solutions for companies that have not structured correctly. This issue has taken on great importance recently, because foreign jurisdictions are increasingly cracking down on shell entities established in a jurisdiction in order to benefit from a tax treaty. If the foreign jurisdiction can show the company in question is not of ‘substance’ then it might be able to enforce local tax upon a transaction.

Luxembourg is the main place for private equity real estate firms to establish themselves, so the threat of challenges to structures is particularly acute here.

Though Luxembourg is tiny (it is only 82 kilometres long) and has a population of less than half a million, it has grown into the epicentre for European private equity real estate firms. One could say that what Luxembourg lacks in size, it makes up for in stature.

The country has been a very good place to site real estate funds investing across the world for the last 15 years. It was traditionally known as the world’s largest domicile for cross-border mutual funds, but real estate funds began moving in when the asset class gained institutional credibility. Taxand’s leader of global real estate Keith O’Donnell, who is based in the country, says: “When we analysed the first funds from a tax perspective, our conclusion was that one could achieve the same tax result or better in many other jurisdictions.

However, the blend of the law, regulation, infrastructure and a benign tax environment seemed very appealing.” The biggest real estate funds in the world flocked to Luxembourg. Over recent years, the range of funds has expanded. It went from European vehicles to global funds and closed-ended opportunistic funds to open-ended core funds. Finally, says O’Donnell, European property companies that looked like REITS but were not technically so, established themselves in the country. That included GAGFAH, the German property portfolio company of New York-based alternatives firm, Fortress Investment Group.

The problem is that while investors may have become global, the countries they invest in remain nationalistic. Generally, they do not want to lose tax from real estate in their own back yard.

And so, some jurisdictions have increasingly sought to do something about it. They have challenged international investment structures.

Challenged

There have been several cases where private equity real estate firms have been heavily challenged by a tax authority. The firms in question were expecting to exit from a particular investment without any tax, but the local tax authority has challenged the ‘substance’ of the foreign entity and treated it like a ‘letterbox company’. It can be high profile and borderline political. For example, the Korean authorities publicly announced in 2005 that five foreign firms – The Carlyle Group, Lone Star, Goldman,

AIG Real Estate and Westbrook Partners – had attempted to avoid taxes through foreign entities. There have been numerous other similar challenges across the globe, although most haven’t involved the same megaphone tactics.

In turn, enlightened private equity real estate firms (admittedly with more time on their hands) have been addressing this structural issue in case of such a challenge by a local authority.

PERE spoke with one global firm which likened the issue to a “time bomb”. “We hear from our own tax advisers that many firms have not structured their companies correctly,” said the firm which wanted to remain anonymous. While today’s problem may be dealing with loan-to-value issues and write downs in general, tomorrow’s issue might well be discovering that the return on an investment is way less than originally planned because of an unexpected tax bill. It stands to reason that some firms may not have correctly set up tax-efficient structures. In 2004, 2005, 2006 and 2007 in the vortex of highly-leveraged real estate deals and LBOs, firms allowed back office functions to play second fiddle to the functions of the front office deal machine to help speed the feast on transactions. In some cases, the back office became the front office. One can easily imagine a prolific private equity real estate firm operating in Luxembourg employing 10 people spread over five funds and 50 companies. If a tax authority decides to challenge just one of those companies, it might decide it has not sufficient ‘substance’. In that case, the unlucky firm might find the tax treaty


benefits of whatever inter-Luxembourg tax treaty withdrawn from it. Ouch.

The trend is now for tax advisers to tell their clients they better shape up.

House in order

Says O’Donnell: “Over the last 12 months, firms have had a lot more time to start examining whether some of the structures have actually been implemented correctly. Perhaps firms haven’t finalised accounts, or haven’t held board meetings, or employees are still on the payroll of the foreign firm. This is what clients have been spending some time on.”

This where the “rake” or the “pyramid” comes in. These are the names given to just

two approaches that tax experts can take to structure companies so that should they be challenged, they will pass a ‘substance’ test.

The “rake” is where say five sister companies all individually hire a smaller number of employees and individually occupy premises. This is a somewhat awkward approach, but at least one that may make the individual companies safer from the perspective of some foreign jurisdictions.

Alternatively, in a “Superholdco” or “pyramid” structure, all five companies might be bundled into a single company with all the activities combined, which gives a more logical operational fit and a generally better tax answer. That said, it may also create banking issues around cross collateralisation.

A third approach would be a “service co” where a single operational company with employees and infrastructure may provide services to several other companies. This is a good operational answer, but needs careful handling, otherwise the other companies could lose their substance. Whatever the solution, this is exactly the issue keeping private equity firms and their tax advisers occupied in Luxembourg.

Taxand LuxembourgKeith O’DonnellT. +352 26 940 257E. [email protected]


Swiss collection

Switzerland, it seems, is having the last laugh. On 8 September at the World Economic Forum’s “Summer Davos” in Dalian, China, the country was named the most competitive economy in the world.

For the Swiss, taking top spot was made all the sweeter because it managed to dethrone the US in the process. Just a few days earlier, America won its battle to force UBS, the Swiss banking giant, to disclose tax details of around 4,450 wealthy American citizens. This was a blow to Swiss credibility and to its self esteem.

For that reason, coming first in the World Economic Forum’s Global Competiveness Report was important to help restore pride.

Notably, the country was placed first for remaining stable and for its ability to innovate.

And in a way, this is mirrored by the real estate market.

Having spoken with real estate professionals in the country, it is clear they believe the country has remained steadfast. Switzerland has not developed into either the most distressed or the least distressed market

in the world, they argue. In part, this is persuading some foreign

firms to take a fresh look at the country. And what they discover is that a tax law introduced just before the credit crunch could potentially make the country even more interesting in tax terms.

At the start of 2007, the Swiss government introduced the Federal Act on Collective Investment Schemes. Tax practitioners say this should bring the overall tax burden down to an average rate of approximately 12 percent for real estate investors, under reservation of higher capital gains tax, depending on the location of the properties in the various Swiss cantons. Twelve percent is a low threshold when compared with markets around the world.

There has been so little transactional activity since last autumn and too many unsolved legal and tax questions related to the new scheme that the act has not really been on the radar of many private equity real estate firms. However, during 2008 and 2009 the new scheme gained transparency and clarity due to a lot of tax questions being answered.

For this reason, and Switzerland’s apparent ability to keep its real estate market stable, investors are again taking note.

Taxand’s real estate leader in Switzerland, Stephan Pfenninger, confirms clients are beginning to rekindle interest in the real estate market, and while few have dived back in, they are taking note of the new tax scheme because of its advantages.

Transactions that have occurred in Switzerland traditionally have followed the usual pattern to be found elsewhere in Europe. These tended to be share deals with tax implications for the Swiss and foreign investors.

Foreign acquirers of real estate – for example from Israel, the Middle East and Nordic countries – have been using single asset entities relying on the tried and tested holding structure in Luxembourg or the Netherlands for example, which would normally allow a tax efficient exit.

However, this route for many jurisdictions – the Netherlands included – will not apply any more due to a change of the tax treaties. The OECD Model Tax Convention no longer forsees that capital gains on shares in real estate

Investors are taking an interest in a pre-credit crunch law on collective investment schemes which are more attractive than REITs

COUNTRY REPORT: SwITZERLANDCollective Investment Schemes


companies are taxed in the home country of the investor but in the state where the properties held by the company are located.

For this reason, tax structures under the new law on collective investment vehicles offer attractive alternative set-ups.

Better than REITs

Investors need to know that there is no REIT structure in Switzerland because the government decided against introducing them earlier this decade. At the time, this disappointed some real estate investors and advisors. However, as Pfenninger points out, this has put the spotlight on the collective investment schemes, which could turn out to be even more attractive than REITs.

As GPs and limited partners know very well, what all REITs have in common is they do not pay any income tax on their real estate income as well as on real estate capital gains. However, profit distributions made by the REIT to its investors may be subject to withholding tax. [When a dividend or interest is paid internationally, the country from which the payment is made usually taxes the payment as it leaves, by withholding a proportion of it, usually between 10 percent and 30 percent.]

Contrary to the REIT concept, though, the Swiss real estate income is taxed at the level of the collective investment vehicles. Distributions of real estate income by a Swiss collective investment vehicle to the investor are not subject to any Swiss withholding tax.

Explains Pfenninger, Swiss investors do not pay any income tax on the income received from the investment vehicle. This also applies to foreign investors depending on the local tax law of their home country or if they hold a fiscally transparent investment vehicle. This is because under the Swiss double taxation treaties the home country of the investor should not tax the Swiss real estate income received by the investor.

The investor will then end up with an overall tax rate of 12 percent depending on location of the asset.

In some countries, the investor may be taxed for the income received from the investment vehicle but get a tax credit for the Swiss income tax paid by the collective

investment vehicle. Hence the overall worldwide tax burden achieved under a Swiss collective investment scheme on the investment income is extremely attractive compared to a foreign REIT concept.

Pfenninger says the above schemes are attractive because they foresee various legal forms for collective investment vehicles under Swiss civil law. The investment vehicle may be an investment fund, a corporation (comparable to a Luxembourg SICAV “société d’investissement à

capital variable”) or a partnership (comparable to the Anglo-Saxon Limited Partnership). Hence, the new law leads to a great flexibility with regard to legal form of the vehicle and the specific needs of the investors.

Tax-wise all these types of collective investment vehicles are treated principally in the same way – they can all benefit from the efficient taxation scheme for Swiss real estate investment funds.

“Quite a lot of real estate clients are envisaging setting up such a collective investment vehicle,” says Pfenninger. “People are talking about it. Comparable to REITs in foreign countries, the Swiss collective investment vehicle for real estate is a popular topic.”

Still, there are not many investors who have

implemented such real estate structures yet because a lot of legal and tax issues were only clarified in 2008 and 2009.

Taxand has implemented it with one client, Pfenninger says. However, he adds: “This is still very new and we are in the planning stages with a lot of clients.”

Old and the new

The Swiss set-up is certainly ideal for corporate and individual investors newly establishing a real estate portfolio in Switzerland. However, also pre-existing portfolios may benefit and be converted into a collective investment scheme. Individual investors holding a big portfolio of Swiss properties in their private wealth may be interested in changing this portfolio

into “liquid” assets, that is, tradable securities. Also corporate investors may seek to

transform their Swiss real estate portfolio held by a corporation into a more flexible and tax efficient vehicle.

Says Pfenninger, the transformation of a pre-existing real estate structure into a collective investment vehicle legally and tax-wise is still complex.

In this respect, legal issues, transformation costs and tax consequences need to be looked at carefully.

That said, there are possibilities for tax and cost efficient transformations, and tax advisors together with the Swiss tax administrations are looking at ways to smooth the way.

It is very clear in Switzerland, says Pfenninger, that the Swiss scheme for collective investment vehicles is important and attractive for investors and that further improvement of the scheme – combined with the stable Swiss real estate market – will attract even more investors.

This will no doubt please Switzerland as it seeks to remain the world’s most competitive economy next year.

Pfenninger: clients are taking note

Taxand SwitzerlandStephan PfenningerT. +41 44 215 77 03E. [email protected]


COUNTRY REPORT: UKDebt and fund structuring

Recent changes by HMRC concerning administrative aspects of tax compliance for UK investment partnerships have caused some concern amongst the UK investment community. However, there has been some good news here.

The backdrop is that English limited partnerships (“ELP”) are commonly used co-ownership vehicles in fund structuring. Provided that they have no source of income taxable in the UK, non-UK LPs would not historically have been subject to any tax filing obligation. However recent changes have meant that in order for the ELP to be capable of filing its own tax return it would need to include a Unique Tax Reference number (“UTR”) in respect of each of its investors. Whilst this does not seem unduly onerous, there has been concern that the perception by non-resident investors would be that this would constitute a UK filing requirement, and worse, that they may consider this to be at odds with the tax treatment they were promised when the fund was being marketed. This would potentially lead to tension between the investors and the managers. Indeed, the partnership agreement would probably not allow fund managers to compel their investors to apply for UTRs.

Following the recent changes, UK investment industry representative bodies have now reached a compromise with HMRC. The investor does not need to apply for a UTR directly but rather the ELP can obtain a ‘dummy’ UTR on behalf of each of the partners purely to enable it to file its own return. As the UTR would not be issued to the non resident investor, nothing will have actually changed from their perspective. This is a welcome move that should counter any perceived loss of competitiveness within the investment industry arising from this change in practice.

You only have to look to see how much thicker the tax law books are to see how complicated things have become in the UK. Whatever the good intentions may be behind the constant introduction of new rules and regulations by Her Majesty’s Revenue and Customs (HMRC), they have the potential to add administrative burden for private equity real estate funds and their portfolio investments. In the worst case, as well as damaging the UK’s international reputation as a location in which to hold assets and establish co-ownership vehicles for investment in real estate, the changes might give rise to additional overall tax costs. Here are five key issues.

On Her Majesty’s service

Rules affecting UK fund structuring:

New offshore fund legislation has been introduced by HMRC that is due to come into force on 1 December 2009. The offshore fund legislation was originally introduced to prevent UK resident investors rolling up income in offshore funds and effectively converting it into a capital gain by disposing of the interest in the fund. Previously the legislation was only applicable to collective investment schemes as defined for regulatory purposes and so it was relatively easy for fund managers to understand whether they were in the regime or not. The new definition of “offshore fund” is, however, wider ranging and the issue now for managers of closed-ended vehicles that would not previously have been in the regime is to work out if they are caught.

Taking the new definition literally, commonly used structures for offshore private equity investment in UK real estate assets could now be in the scope of the rules. Any UK resident investor may face adverse tax consequences unless the fund managers adhere to some complex reporting requirements. Ahead of further guidance from HMRC, Taxand’s clients are having to factor in a consideration of the new rules into structures they are designing and implementing at the moment.

Doubt over offshore funds

Earlier this year, the HMRC introduced a ‘behavioural-based’ penalty regime which could lead to a 30 percent charge or more of any unpaid tax arising from the excessive interest deduction of shareholder debt.

The backdrop to this is that often some of a fund’s equity in a deal will be interest-bearing shareholder debt. Even before the introduction of the new behavioural-based penalty, there were detailed rules on the tax deductibility of such associated interest cost against the income generated by the asset.

One rule is that no deduction is allowed for interest that exceeds the amount of interest that a firm would have to pay to an unconnected third party in an ‘arm’s length’ situation.

This means that in working out the tax return, one has to consider how much a third party lender would have been prepared to advance it and on what terms in today’s market.

The problem is that given the changes experienced in the external debt markets

since the credit crunch, investors are finding that some of the conventional ‘rule of thumb’ wisdom regarding how much additional debt can be introduced into a typical UK real estate investment structure may no longer be appropriate.

The amount of shareholder debt that is within the ‘arm’s length’ limit of borrowing is likely to now be lower than previously. The days of banks of lending 100 percent of the value have been replaced with a more conservative 75-80 percent LTV.

Any deduction claimed by a private equity real estate firm in its tax returns must consider an appropriate level of debt.

In the past, the HMRC penalty regime was often considered to be fairly toothless but since the new penalty regime this year that view has changed. Were HMRC to view that a tax return included ‘excessive’ finance deduction on the shareholder debt it will now look at why that adjustment is required.

It will determine whether claiming

‘excessive’ finance deduction was careless error by the taxpayer. If the taxpayer failed to take reasonable care in determining an arm’s length level of borrowing then this would probably be construed by HMRC as careless behaviour. It could then levy a penalty of up to 30 percent of the unpaid tax arising from the excessive interest deduction. If a taxpayer can be shown to have deliberately claimed a deduction for an amount they knew to be excessive the financial penalties can be even more severe.

For this reason, Taxand’s clients are increasingly instructing it to perform credit rating analyses and other economic modelling to show that the underlying cash-flows from a particular investment can sustain the shareholder debt tranche.

These issues are always subjective but in the case of a tax adjustment a fund that has performed such a comparability analysis has a penalty mitigation position because it can show it acted in good faith.

Rules affecting the UK taxation of debt

Many of Taxand’s clients are concerned with how these new rules are going to affect the tax deductibility of financing costs. HMRC will introduce the Worldwide Debt Cap from 1 January 2010 in what is the most fundamental change to the taxation of debt since 1996. In general terms, the UK’s tax authority wants to deny international t axpayers a deduction for ‘excessive’ borrowing costs allocated against their UK activities.

Bearing in mind the leveraged nature of real estate investments it is understandable that many of Taxand’s clients are concerned.

However, the regime only really bites where the UK taxpayer’s financing costs exceed the external borrowing costs of the taxpayers ‘group’ as a whole. Given the high

amount of external debt that is usually present in most real estate ownership scenarios the rules may be of limited application.

That said, the worldwide debt cap could still be an issue because a firm will still have to determine what constitutes external debt. For this, they have to work out which entities form the ‘group’ of which a particular investment vehicle is a member and this is by no means a straightforward task.

There might also be problems for taxpayers with particular structures in place. For example, a UK company that is used in order to hold non-UK investments might have a structure in which the investments lend cash back up the ownership chain to enable the UK parent to service its debt.

Many senior lenders Taxand speaks to are reluctant to foreclose on loans and enforce their security over the underlying property assets. This is particularly the case where there have been LTV covenant breaches but the borrower remains able to service interest payments on the debt.

One of the alternatives may be a partial debt for equity swap where the lender opts to convert some of the loan into equity in the investment. Debt for equity swaps can contain tax traps for the unwary which can be avoided if the transaction is structured correctly.

It is that element of the debt effectively ‘forgiven’ that can give rise to a tax charge for the borrowing entity. It is a similar problem to what Taxand is dealing with in the US (see p. 6). In addition, there is a potential tax charge when a lender wants to exit an underperforming investment and is willing to accept a cash amount that represents significant discount to the face value of the loan.

Again, the borrower could be faced with a large tax bill on the amount of the discount if proactive steps are not taken to structure around the problem.

Debt for equity swaps



Taxand UKJonathan Hornby

T. (+44) 207 715 5255E. [email protected]

As value creators, private equity real estate firms and their investors need to be aware of how much income from investment goes to the taxman.

With that in mind, Taxand has plugged into its global real estate team to collect and analyse data from all the major jurisdictions. For the first time, we can exclusively present the initial findings. Readers will discover on the following pages a comparison of non-recoverable tax on income from office property, residential assets and healthcare-related property in the major markets around the world.

Comparing taxes on income from property in multiple jurisdictions is inevitably a tricky exercise, to say the least. Bear in mind, for example, that laws and tax rules can differ even depending on the location of an asset within a certain country.

Nevertheless, Taxand has weighed all these complicating factors and a multitude of other factors in its “Taxand T3” research.

Beginning with the chart on the opposite page, Taxand concludes that in terms of income from office property, the US is the most expensive location in the world.

Some 43.3 percent of rental income – taking into consideration any construction costs – is lost to the taxman.

The reason for this is as follows: the high rate of income tax (35 percent), additional state taxes (6.6 percent) and non-recoverable sales taxes on construction, all contribute to the high rate.

On the following page, we present findings for residential property and health-related assets such as medical centres. There are some differing results, as readers will discover.

Though not analysed specifically, it is notable that the US is both the largest developed commercial real estate market in the world, and the country that levies the most amount of tax on office property.

Three countries with the highest tax-take from office property are also in the top ten largest real estate markets: the US, UK, and China.

At the other end of the spectrum, India appears to have a low tax-take compared to major markets around the world. It hardly need be said that India requires massive expenditure (and perhaps incentives for investors) to develop and upgrade its office market. Happily, at least the tax-side of the equation seems to be in line with this aim. Taxand’s data suggests the total non-recoverable tax from leasing an office building in India is just 5 percent. But this is because of the high annual depreciation rate, which largely wipes out income tax.

Taxand has collated and analysed data from around the world to rank the most expensive locations in terms of tax-take from property income. Here we exclusively present the initial findings

Tax-take around the world

TAxAND T3 RESEARCH

Methodology

To arrive at the figures, Taxand has taken into account VAT (or its local equivalent), corporate income tax, and property taxes. The property taxes were usually subject to country-specific assumptions and modifications as they often differ on a municipality basis or sometimes just location basis. These were reviewed by the coordinating Taxand team to assure comparability. Administrative fees, notary fees, court fees were excluded as they have a relatively low impact on the overall tax-take.

To ensure comparability of the results, certain data has been fixed such as size of the building, investment costs, and 100 percent non-interest bearing equity financing.

With all of that built into the model, each real estate team from Taxand adapted it to the local law. For more information about the methodology and for further findings stemming from the global Taxand T3 research, please contact Abigail Tarren at [email protected] or Lynne Sandland at [email protected].

And now, without further ado, here are the most expensive tax jurisdictions in the world.


TAx on offICE InComE

This chart compares the tax-take on the income (the rent) from an office building depending on its location in the world. In the US, 43.3 percent of the income from an office lease is swallowed up by tax, the highest rate in the world.

TAx on offICE InComE vERSUS SIZE of mARkET

Here is a comparison between the largest investible real estate markets in the world and the tax-take from office property income in those jurisdictions. The US is the largest market and also has the greatest tax on income.

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$0.0$10.0$20.0$30.0$40.0$50.0$60.0$70.0$80.0$90.0

Average annual commitments 3-7 years prior to real estate fundsAnnual transaction volume - 2.5% turnover rate

Annual transaction volume - 5.0% turnover rate

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RAnkIng of LARgEST REAL ESTATE RAnkIng In TERmS of

mARkETS In THE WoRLD TAx-TAkE fRom offICE InComE RATIo (%)

1. US 1 43.33

2. Uk 4 33.80

3. CHInA 8 29.04

4. gERmAny 16 20.66

5. fRAnCE 12 24.50


TAx on RESIDEnTIAL pRopERTy InComE

This graph compares the tax-take on the rent from residential property depending on location. In the US, 42 percent of the income is absorbed by tax. The UK’s low rate is explained by the lack of VAT on construction and medium income tax rate.

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TAx on HEALTHCARE-RELATED pRopERTy

Here is a comparison of the tax-take on income from healthcare related assets. Again, the US has the greatest ratio of tax-take. Compared with office income, which is taxed at an average of 25 percent, healthcare property is taxed more heavily at an average of 30 percent.

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TAx on SELLIng A RESIDEnTIAL pRopERTy

When it comes to selling a home, France is the most expensive country with 22.03 percent swallowed by tax. This is mainly caused by the high rate of income tax (33 percent) and VAT rate of 20 percent on the sale of residential units.


Taxand is a global network of leading tax advisors from independent member firms in more than 50 countries. Our tax professionals – more than 300 tax partners and 2,000 tax advisors – grasp both the fine points of tax and the broader strategic implications, helping you mitigate risk, manage your tax burden and drive the performance of your business.

we’re passionate about tax. we col laborate and share knowledge, capitalising on our collective expertise to provide you with high quality, tailored advice that helps relieve the pressures associated with making complex tax decisions.

we’re also independent – ensuring that you adhere both to best practice and to tax law and that we remain free from time-consuming audit-based conflict checks. This, coupled with the compact structure of our member firms, enables us to deliver practical advice, responsively.

we provide services our clients seek at the global level, on a global scale. wherever you face tax issues, we can help – by providing high quality advice that addresses your strategic concerns.

Real Estate has become an international asset class – and real estate transactions have become more complex than ever before. To make sure your investments in property achieve the best possible after-tax performance, you need dependable, practical cross-border tax advice throughout the entire lifecycle of your investment.

The extreme sensitivity of real estate makes quality tax advice paramount. The effective tax rate on an otherwise profitable deal can exceed 80 percent with poor counsel while good advice can push that rate below 10 percent. The models for owning, developing and holding real estate are changing around the world. Increasingly, investors require liquidity in an asset class that was traditionally illiquid. Taxand advisors help you profit from shifting market dynamics by minimising the tax obstacles to real estate transactions.

Taxand’s understanding of the tax advantages for sellers and purchasers gives you the advantage in negotiating prices and closing deals. Our approach is tailored to every circumstance – for example, we facilitate the acquisition of properties through corporate structures to protect capital

gains on disposal and optimise income flows to owners. At every turn, our objective is to maximise the value of your investment.

Our extensive real estate tax experience gives you the advantage in negotiating prices and closing deals. we draw on specialist transaction level knowledge and create acquisition and holding structures that make business sense and keep tax costs down. we help you determine the best ways to address the current market conditions of today and in the future.

Taxand’s independence advantage means we can act quickly to deliver the answers you need and avoid audit-based conflict.

At Taxand we deliver:• Tax efficient real estate structures

including investment funds and REITs• Tax advice surrounding transactions,

disposals and spin offs • Construction and development

project related tax strategies • Tax neutral financing arrangements • VAT planning • Tax due diligence • Tax litigation• Tax compliance

ABOUT TAxAND


Article contributors:

CHINADennis XuT. +86 21 6447 7878E. [email protected] is the key Chinese member of Taxand’s global real estate tax team. He is also a founding partner of Hendersen Taxand based in Shanghai. He maintains good relationships with Chinese state and local governments and has been advising the government on a number of projects.

FRANCEFrançois LugandT. +33 1 70 38 88 21E. [email protected]çois is the key French member of Taxand’s global real estate tax team. He is also a partner of Arsene Taxand where he set up the real estate practice in Paris. François delivers tax advice to key real estate entities from developers to REITs and foreign real estate funds.

GERMANYUlrich Siegemund T. + 49 6196 592 16364E. [email protected] is the key German member of Taxand’s global real estate tax team and heads Taxand’s German tax practice, Luther. He has 18 years experience in national and international tax law, acquisitions, structurings and restructurings. He has served foreign multinational groups in different industries investing in Germany, and German groups of companies investing abroad.

INDIAAbhishek GoenkaT. +91 80 4032 0000E. [email protected] Abhishek is the key Indian member of Taxand’s global real estate tax team. He is also a partner of BMR Advisors, Taxand India, where he heads up the firm’s real estate and technology industry practices. Abhishek has more than 12 years experience advising a number of international and domestic companies particularly in the real estate and technology sectors.

LUxEMBOURGKeith O’DonnellT. +352 26 940 257E. [email protected] Keith leads Taxand’s global real estate tax team and is now the managing partner of Atoz, Taxand Luxembourg. Keith has advised many global groups on the design and implementation of tax strategies and has been instrumental in shaping legislative change in coordination with industry groups.

SwITZERLANDStephan PfenningerT. +41 44 215 77 03E. [email protected] Stephan is the key Swiss member of Taxand’s global real estate tax team. He is also a partner of Tax Partner AG Taxand, the leading independent Swiss firm of tax advisors. Stephan particularly focuses on the planning and implementation of Swiss real estate transactions,

the creation of Swiss tax-efficient real estate investment products and the coordination of foreign real estate transactions.

UKJonathan HornbyT: (+44) 207 715 5255E: [email protected] Jonathan is the key UK member of Taxand’s global real estate tax team. Jonathan is also a Senior Director with Alvarez & Marsal Taxand UK LLP and brings more than 13 years of corporate and international tax experience. Throughout his career he has worked extensively with multinational organisations operating across a range of industry sectors. Jonathan leads the real estate tax practice in the UK advising clients on all aspects of the investment life cycle from initial structuring considerations through ongoing operational issues and tax efficient exit scenarios.

USFrank WalkerT. +1 404 260 4086E. [email protected] Frank is the key US member of Taxand’s global real estate tax team. He is also a Managing Director with Alvarez & Marsal Taxand LLC and has over 35 years experience working for clients across the real estate, hospitality and construction industries. He has been deeply involved in structuring and implementing transactions for public and private companies including delivering advice on REITs.

TAxAND’S GLOBAL REAL ESTATE TEAM

This guide is brought to you by Taxand’s global real estate tax team comprising expert advisors from nearly 50 countries worldwide. we provide well considered tax advice to a wide range of clients including listed and non-listed real estate companies, developers, financial institutions, pension funds, real estate investment trusts and funds, management companies and high-net-worth individuals.

TAxAND’S GLOBAL REAL ESTATE TEAM

ARGENTINAEzequiel Lipovetzky T. +54 11 4021 2300E. [email protected]

AUSTRALIASimon ClarkT. +61 2 92 25 59 57E. [email protected]

BELGIUMEric PicavetT. +32 2 761 11 32E. [email protected]

BRAZILDébora BacellarT. +55 11 21 79 46 00E. [email protected]

CANADAVince ImertiT. +1 416 369 7100E. [email protected]

CHILEFernando BarrosT. +56 2 378 8907E. [email protected]

CHINAKevin WangT. +86 21 6447 7878E. [email protected]

COLOMBIAMauricio PiñerosT. +573 321 02 95 ext 221E. [email protected]

CYPRUSChristodoulos DamianouT. +357 22 699 222E. [email protected]

DENMARKAnders Oreby HansenT. +45 72273602E. [email protected]

FINLANDJanne JuuselaT. +358 9 6153 3431E. [email protected]

FRANCEFrançois LugandT. + 33 1 70 38 88 21E. [email protected]

GERMANYUlrich SiegemundT. +49 6196 592 16364E. [email protected]

GREECEMarina AllamaniT. +30 210 6967 000 E. [email protected]

INDIAAbhishek GoenkaT. +91 80 4032 0000E. [email protected]

INDONESIAPrijohandojo KristantoT. +62 21 8399 9919E. [email protected]

IRELANDBrian DuffyT. +353 1 6395 157E. [email protected]

ITALYGuido Arie PetraroliT. +39 02 7260591E. [email protected]

JAPANEiki KawakamiT. +81 3 3222 1401E. [email protected]

KOREAStephan KimT. +82 2 2112 1144E. [email protected]

LUXEMBOURGKeith O’DonnellT. +352 26 940 257E. [email protected]

MALAYSIARenuka BhupalanT. +603 2032 2799E. [email protected]

MALTAMary Anne InguanezT. +356 2278 7700E. [email protected]

MAURITIUSGary Gowrea T. +230 405 2002E. [email protected]

MEXICOManuel TamezT. +52 55 5201 7403E. [email protected]

NETHERLANDSFrans DuynsteeT. +31 10 201 05 00E. [email protected]

NORWAYJon VinjeT. +47 23 11 65 00E. [email protected]

PAKISTANDr. Ikram-ul-HaqT. +9242 530 0721E. [email protected]

PERUPablo SotomayorT. +511 610 4747 E. [email protected]

PHILIPPINESEuney Mata-PerezT. +632 811 25 00 E. [email protected]

POLANDAndrzej PuncewiczT. +48 22 324 59 00E. [email protected]

PORTUGALFernando Castro SilvaT. +351 21 382 12 00E. [email protected]

PUERTO RICOEdgardo SanabriaT. +787 999 4400E. [email protected]

ROMANIAAngela RoscaT. +40 21 316 04 93E. [email protected]

RUSSIAAndrey TereschenkoT. +7 495 967 0007E. [email protected]

SINGAPORESundareswara SharmaT. +65 6238 3083E. [email protected]

SPAINManel MaragallT. +34 253 37 00 E. [email protected]

SWEDENMikael LöwhagenT. +46 8 522 441 45E. [email protected]

SWITZERLANDStephan PfenningerT. +41 44 215 77 77E. [email protected]

THAILANDHatasakdi Na PombejraT. +66 (0) 2632-1800 ext 111E. [email protected]

TURKEYUluc OzcanT. +90 212 337 00 23 E. [email protected]

UKJonathan HornbyT. +44 207 715 5255E. [email protected]

UKRAINEOleh MarchenkoT. +380 44 492 8282E. [email protected]

USAFrank WalkerT. +1 404 260 4086E. [email protected]

VENEZUELAManuel CandalT. +58 212 750 00 95 ext 101E. [email protected]

Visit www.taxand.com to access your global network of more than 2,000 leading tax advisors across nearly 50 countries.

Keith O’DonnellLuxembourgT. +352 26 940 257E. [email protected]

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Visit www.taxand.com/privateequitytaxguide to download this 2010 guide to tax for private equity real estate – published by PERE & Taxand.

the 2010 global guide to tax

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