REAL ESTATE FINANCING – CRITICAL TAX Input from T axand ASPECTS Switzerland, France, Germany , Spain and Luxembourg based on new developments under OECD Guidelines Webinar 30 September 2020
INTRODUCTION
AGENDA 1. Introduction 2. Presentation of base case: intra-group real estate financing 3. Key tax issues for PropCos and reference to OECD Guidelines on Financial Transactions, e.g. in Switzerland 4. News on OECD Guidelines on Financial Transactions 5. Handling of issues for PropCo Borrower in France 6. Handling of issues for PropCo Borrower in Germany 7. Handling of issues for PropCo Borrower in Spain 8. Handling of issues for Lender in Luxembourg Taxand: Your global tax partner @taxand 3
CASE STUDY Characteristics of the IC Loan Guarantee, Top Holding Co Issue date 1 January 2020 0.5% fee Maturity 1 January 2025 Loan, 5.0% interest Amount 50 m Schedule of repayment Bullet Interest rate Fixed Subholding Subordinated, 2 nd rank after Bank Seniority Loan, Collateral None, unsecured 5.25% interest Business sector Real estate PropCos Bank Retail property FMV 100 m 50 m, 2% interest Top Holding Co provides guarantee to Bank with respect to 50 m mortgage loan, guarantee fee: 0.5%. Taxand: Your global tax partner @taxand 4
BIRD‘S EYE VIEW – POTENTIAL T AX ISSUES Shareholder loans are often under scrutiny of tax authorities. Tax disputes range broadly from tax authorities deeming the character of shareholder loans to be equity rather than debt challenging the interest rates and/or deeming the guarantees rendering no benefit to PropCo. Subholding Co’s loan to be reclassified into equity? Guarantee provided by Holding Co to be a shareholder transaction? Pricing? • How to determine arm’s length interest rate • How to determine arm’s length guarantee fee Taxand: Your global tax partner @taxand 5
CASE STUDY – REAL ESTA TE FINANCING IN SWITZERLAND
CASE STUDY – Switzerland Preliminary remarks on local regulations Financial transactions under the Swiss Tax Authorities’ radar: • Swiss Tax Authorities increasingly focus their attention on intercompany financial transactions. Swiss regulations based on two pillars: Safe Harbour vs Arm’s length principle • Thin capital: Maximum debt financing of commercial property is 80% of market value, as per Circular letter issued by Swiss Federal Tax Administration = safe harbour ratio. • Excess IC loan after taking into account all liabilities of PropCo as per its statutory balance sheet is treated as deemed equity. No interest deduction on loan qualifying as deemed equity. Deemed equity is subject to annual capital tax. • Thin capitalisation rules aim to avoid tax evasion with respect to set-up of sufficient equity. • Higher IC debt financing may be accepted for tax purposes if tax payer proves that such financing is at arm’s length, e.g. bridge financing. Taxand: Your global tax partner @taxand 7
CASE STUDY – Switzerland Preliminary remarks on local regulations Swiss regulations based on two pillars: Safe Harbour vs Arm’s length principle • Interest rates: Circular letters issued annually by Swiss Federal Tax Administration foresee maximum IC interest rates for property financing (for commercial property / CHF loan in 2020): 1.5% on LTV up to 66%, as of LTV 67% 2.25% p.a. • IC loan = loan from related party or loan from third party secured by IC guarantee collateral. • Interest rates as per Circular letters = safe harbour rates. • Tax payer may apply higher interest rates but carries burden of proof for rate being at arm’s length. • Guarantee fees: No safe harbour rules regarding guarantee fees. Commercial justification of fee may only be proved by bench mark study, e.g. study comparing market interest rate on loan with and without guarantee fee. Market guarantee fee equals delta between the two options, as a maximum. Taxand: Your global tax partner @taxand 8
CASE STUDY – Switzerland Preliminary remarks on local regulations Arm’s length test • The Swiss Tax Authorities are significantly challenging the benchmarking studies performed by taxpayers and refuse – first of all – studies provided by foreign specialists. • However, Swiss federal court decisions support benchmarking studies based on OECD guidelines as a proof for commercial justification of financing charges. Swiss tax rules in connection with real estate financing in theory very clear, in practice difficult to handle with tax authorities. It should be recommended to strengthen transfer pricing studies justifying the remuneration of intercompany financial transactions. Taxand: Your global tax partner @taxand 9
NEW OECD GUIDELINES ON FINANCIAL TRANSACTIONS FOCUS ON INTRA-GROUP LOAN PRICING
OECD Guidance The Transfer Pricing Guidance on Financial Transactions (TPG FT) is an update of the 2017 OECD Transfer Pricing Guidelines (Guidelines). The report’s focus is on loan transactions, financial guarantees, cash-pooling, hedging and captive insurance companies. It includes analytical framework which should result in the delineation of the financing transaction (delineation) and it provides guidance on how to price the financial transaction. Guidance on how to characterize debt versus equity • Loan Characteristics, • Ability to bear debt, Subholding Co’s loan to be • Reasonable alternative and reclassified into equity? • Ongoing behavior of the Parties. However, it is also acknowledged by OECD that there may be other approaches (e.g. D-E ratios) to address the debt to equity of an entity under domestic legislation. The OECD guidance does not prevent countries from implementing these other approaches. Evaluation similar to an original borrower Economic Benefit: Guarantee provided by Top Holding Co to be reclassified • Enhancement of the terms of the borrowing? as shareholder transaction? • Access to a larger amount of borrowing? Is guarantor able to bear the risk (financial capacity)? Taxand: Your global tax partner @taxand 11
OECD Guidance Detailed transactional analysis is starting point Shareholder loan from Consider both the perspective of borrower and lender and all options realistically available to each of them Subholding Co to be Analysis includes: reclassified into debt instrument with different • An assessment of the borrower’s credit risks (e.g. Covid) and the risks related to that particular loan characteristics? • The borrower’s considerations in optimising its cost of capital and in having the right funding available to meet both short-term and long-term needs Guarantees? • A comparison with other realistic alternative funding options available • Similar analysis guarantee => benefits guarantee - Financial Capacity Guarantor The determination of the arm’s length interest rates ultimately requires the identification of so called comparable transactions: • Internal comparables preferred • External comparables Pricing • Comparability adjustments often needed Guarantee fees: Various methods are mentioned: CUP Method/ Yield Approach/ Cost Approach/ Valuation of Expected Loss/ Capital Support Method Taxand: Your global tax partner @taxand 12
OECD Guidance OECD provides a detailed analytical framework To determine the arms length price a detailed transactional analysis as well as an interest rate analysis are required The detailed guidance benefits tax payers AND tax authorities Country views/experiences? Taxand: Your global tax partner @taxand 13
CASE STUDY – REAL ESTA TE FINANCING IN OTHER COUNTRIES: FRANCE, GERMANY , SPAIN AND LUXEMBOURG
CASE STUDY – France Preliminary remarks on local regulations French current tax context • The French governments / French tax authorities recently increased their focus on intra-group financial flows: • Pre ATAD regulations that are challenged based on EU principles • Post ATAD regulations is still under review and comments • Tax audits and reassessments are growing in regularity, accuracy and aggressivity, in particular in the RE&PE sectors where the Funds do not really have their own financing structures using public notes or bonds and easy access to comparables. This reveals also the lack of knowledge of our Tax services as regards the fund industry. • French tax rules are very unstable but looking into the future should tend to closer harmony with effect of BEPS/ATAD reforms. The deduction of financial costs is limited by several mechanisms in France (Anti-hybrid provisions, business interest requirements, etc) with two main focuses as regards related party debt structuration. Taxand: Your global tax partner @taxand 15
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