Beneficial amendment of regulations regarding extended trade tax reduction for real estate holding SPV`s and Co-letting of operating equipment: all’s well that ends well?
If let properties located in Germany are held by a property company, usually a limited liability company (GmbH), or a deemed commercial partnership with management based in Germany, the letting profits of these companies are generally subject to trade tax in full. An exception is the so-called extended trade tax reduction if these companies – exclusively – manage and use their own real estate or, in addition, their own capital assets. In addition to other pitfalls, a major problem here is the exclusivity requirement, which in the end means that even minor sideline activities result in the de facto trade tax exemption being dropped. Classic examples of such tax-detrimental sideline activities are, for example, the operation of photovoltaic systems for feeding electricity into the public grid or the co-letting of so-called operating equipment, such as freight elevators, air-conditioning systems in server rooms, as well as cold storage rooms or kitchen systems and grease separators in restaurants and canteens, but so-called kitchenettes in office buildings as well.
In this regard, the Federal Fiscal Court (BFH) most recently ruled in 3 landmark rulings on 11/04/2019 that,
- in the case of a hotel, co-letting a beer cellar refrigeration system, refrigerated rooms as well as refrigeration units for counters and buffet systems in the volume of approx. kEUR 134 or approx. 1.14% of the total acquisition or production costs of the building (III R 36/15), or
- in the case of a car dealership, co-letting paint booths with associated supply air and exhaust air facilities (III R 5/18), or
- in the case of a car dealership with a workshop, co-letting a gantry car wash, lifting platforms, compressed air refrigeration dryers as well as advertising facilities and an advertising tower (III R 6/18),
applying the extended reduction is to be refused for violation of the exclusivity requirement.
In a further ruling on 18/12/2019 (III R 36/17) regarding the letting a department store and a filling station, the BFH also qualified the filling station technology belonging to the latter (roadway, petrol pump, pipelines and tanks) as harmful operating equipment.
What was new in all the above decisions was the specification of the exclusivity requirement. Contrary to the previous case law of individual tax courts, the extended trade tax reduction is not applicable to any co-letting of operating equipment, irrespective of the scope of the co-transferred operating equipment. According to the BFH, the law expressly does not provide for a de minimis limit. This very restrictive case law was thus to be applied in all still pending cases. In our article in FYB 2021, we pointed out the persisting problem, in particular the fact that has long become common practice to hold domestic real estate via real estate companies domiciled abroad and also to exercise the management functions at the foreign registered office of the company, as a result of which the domestic permanent establishment is missing as a connecting factor for trade tax.
In this respect, the current Fund Jurisdiction Act has resulted in significant regulations that are advantageous for real estate owners.
If real estate companies have so far been operating the generation of electricity from renewable energy systems in terms of sect. 3(21.) EEG (Renewable Energies Act) or from the operation of charging stations for electric vehicles as well, they lost the possibility of claiming the extended reduction altogether.
Currently, the regulation of sect. 9(1.) sentence 2 GewStG (Trade Tax Act) has been extended in a new sentence 3 by an exemption for the supply of electricity and the operation of charging stations. This requires that it can be shown that the income generated in this way does not exceed 10% of the income from the transfer of use of the real estate in the business year. In addition, the electricity may only be fed into the grid or supplied to the tenants of the property company, but not to final consumers who are not tenants of the system operator (e.g. to the owner or the tenants of a neighbouring residential or office building). Operating charging stations for the public, in turn, remains an activity not eligible for tax relief, just like the operation of a combined heat and power plant (as a result of the explicit reference to sect. 3(21.) EEG).
Almost at the last minute, a further benefit with considerable practical significance was included in the law. According to the new sect. 9(1.) sentence 3, letter (c) GewStG, the extended reduction for real property will also be retained in future if the income from other activities in the financial year does not exceed 5% of the income from the transfer of use of the real property and originates from direct contractual relationships with the property tenants.
In plain English, this means that co-letting previously financially detrimental operating equipment, such as freight elevators, exhaust air systems and grease separators as well as kitchen equipment in the catering trade, but also cold storage rooms in supermarkets or kitchenettes in offices or air-conditioning systems in server rooms, is now possible without any problems in principle, provided that the limit of 5% of the income is complied with.
This regulation is most welcome, as it brings to an end the long-running dispute in the courts over the exclusivity requirement for letting.
It should be noted, however, that even if the income in question is exempt, no tax exemption applies in this respect. The exemption continues to apply only to direct letting income; the income from sideline activities must be determined separately and is subject to trade tax. As a rule, the profit attributable to the letting of the business equipment and thus the trade tax will probably be manageable in most cases.
In addition, the new regulation is also consistent with sect. 15 (3) InvStG (Investment Tax Act), which provides for a trade tax exemption for investment funds holding real estate since the InvStG 2018 if the share of the income generated from active entrepreneurial real estate management in a financial year is less than 5% (de minimis threshold) of the total income of the investment fund (for details, see the BMF letter dated 21 May 2019 on application issues relating to the Investment Tax Act in the version applicable as from 1 January 2018). The previous unequal treatment or preferential treatment of investment funds for trade tax purposes has now also been eliminated and equal treatment has been established irrespective of the legal form.
The bill was passed by the Bundesrat on 28 May; the new regulation on the extended reduction will apply as from the 2021 assessment period.
As much as the new regulation is to be welcomed, there is currently still no regulation as to how the limits of 10% or 5% of the “income from the transfer of use” are to be determined, here in particular whether it is the cold rent or whether apportionments for operating costs are to be included. In addition, it is unclear whether proceeds from the sale of operating equipment are still covered by the new regulation as well, which is doubtful when focusing on income from the mere transfer of use. Last but not least, it is also questionable how the agreed rent for a partial area or an entire building is to be used to determine the proportion of the rent that is attributable to the letting of the operating equipment included in the rent, especially as this is often not recorded separately in the fixed assets, particularly in the case of existing buildings, and data on historical acquisition and production costs are often not available, which means that the “valuation discussion” with the tax office is sure to follow here as well – as is so often the case in tax law, the pitfall is again in the detail.
In practical application, it must therefore continue to be ensured that
– the relevant percentage is not exceeded, even if the building is partially vacant,
– relevant income is subject to trade tax,
– equipment must therefore continue to be clearly identified, in particular at the time of purchase, and, where appropriate, the corresponding pro rata purchase prices must be shown in the purchase contract and
– operating facilities continue to be spun off to separate companies if the relevant limits are exceeded or if they are to be sold, separately or together with the real estate.
Further developments in this area therefore remain to be seen, and especially transactions should continue to be handled with a sense of proportion and, in case of doubt, with caution. Previous models will probably not lose their validity completely.