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A popular way of using foreign companies is for the direct ownership and exploitation of foreign real estate. Under this scenario, a foreign company acts as owner and exploiter of real estate.
1. Reasons for setting up foreign real estate companies
In general, the main reason for structuring the ownership of foreign real estate through a foreign company is tax optimization. This means that the foreign company will mainly be used for the tax-free collection and repatriation of rental income and gains upon the sale of the real estate.
Reasons such as confidentiality, reduction of withholding taxes in a treaty country and tax sparing credits may under circumstances also, to a more or lesser extent, play a role.
2. Important characteristics for a country to be regarded as tax advantageous jurisdiction for real estate ownership
A country should meet the following criteria in order to be regarded as tax efficient jurisdiction for real estate ownership:
it should ideally provide for a flat out exemption for any income from foreign real estate.
Alternatively, it should have a low corporate income tax rate combined with a credit facility for foreign tax paid over such income. Cyprus is a good example thereof. Even though Cyprus does not exempt income from foreign real estate (unless this qualifies as so-called ‘permanent establishment’), but grants a credit for foreign tax paid over the income instead, its low general corporate income tax rate of 12,5% usually provides for effective tax exemption for income from foreign real estate (although attention must be paid to an effective ‘defence tax’ levy of 2.25% that will usually be due over the gross rental income).
In case the real estate will be rented for a period of three years prior to the sale, a profit upon such sale will easily be exempt from taxation in Cyprus, as it should easily qualify as so-called ‘capital gain’ (although each individual case must be judged on its own merits).
ideally, the country of establishment of the real estate company would not have withholding taxation over dividend payments (or it should be relatively easy to circumvent such taxation)
ideally, the country of establishment of the real estate company would not levy tax over gains upon the sale of shares in local companies by non-resident shareholders.
Since acting as owner of foreign real estate requires relatively little human efforts, investors have a rather high flexibility when it comes to using foreign companies for real estate ownership. After all, the risk of the tax authorities in the investors’ home countries successfully arguing that these companies have a taxable presence (e.g. in the form of management and control or a permanent establishment) is relatively low. However, this does not disregard the fact these structures always must be set up with the outmost diligence, preferably in co-operation with a tax specialist in the investor’s home country.
3. Issues to consider
Before deciding to incorporate a foreign real estate investment company, other issues need to be considered as well. Below you will find an overview of a few of these issues.
A critical issue may first of all be whether the foreign real estate qualifies as so-called ‘permanent establishment’. The tax treatment of the income from the real estate may vary, both in the country where the real estate is located and in the country where the company owning the real estate is situated, depending on whether it qualifies as permanent establishment or real estate ‘per se’. It should also be kept in mind that tax treaties (in this case the tax treaty between the country of location of the real estate and the country of establishment of the company owning the estate would be relevant) usually have special provisions for profits from the sale of real estate, qualifying as permanent establishment and as real estate ‘per se’ at the same time. Based upon these treaties, the qualification as income from the sale of real estate should often prevail in both countries. In countries like Cyprus, with a different treatment of income from a foreign permanent establishment (exemption) and income from foreign real estate (credit) this might have an adverse fiscal impact.
In case of structuring of real estate investments, it is often preferable, if feasible for the client, to use a local company in the country where the real estate is situated with a holding company on top (or a foreign company owning the estate with a holding on top). In that way, provided that the holding company is based in a jurisdiction with a favorable participation exemption system and an appropriate tax treaty with the country where the real estate is situated, which allocates the right to levy tax over gains upon the real estate company to the country where the holding company is established, a tax optimal result (tax-free sale) can normally be achieved. Only in markets where buyers are merely interested in direct purchases of the ‘stones’ instead of companies owning the ‘stones’, one would then have to look at favorable jurisdictions for direct ownership of the real estate in question.
Very often, classical offshore companies are suitable for the function of direct ownership of real estate, although (and this is the next issue to consider), the investor’s home country may have so-called ‘CFC (controlled foreign corporation) legislation’, under circumstances leading to immediate taxation over profits realized by (lowly taxed) foreign real estate owning companies (even without distribution of such profits) in certain countries (these may be so-called ‘blacklisted countries’) owned by such investor. Therefore, it is always advisable for investors to liaise with local tax specialists before setting up foreign holding structures.
Investors should also be prepared for a possible challenge of the structure by the tax authorities in their home countries. The risk of such challenge depends on various factors, such as the attitude of these authorities in general towards foreign holding structures, their available audit tools and policy etc. Tax authorities could argue that the management and control of a foreign real estate investment company is de facto exercised in the country where the investor/owner of the holding company is based. A way to reduce the risk of success of such challenge may be the appointment of a majority of directors resident in the holding company’s preferred country of establishment on the board of directors of such company.
4. What we can do for you
Consulco has significant experience in the fiscal guidance of real estate investments (including investment funds) in many places in the world, including Athens, Bucharest, Budapest, Kyiv, London, Moscow, New York, Stockholm (Consulco has for example rendered tax advisory services on a transaction involving the sale of the most sizeable piece of commercial real estate in Stockholm) and Warsaw. Consulco has robust expertise in fiscal and in advisory tax and legal issues relating to real estate investments.