Real Estate: The Tax Landscape
Published in International Financial Law Review, 2008
Acquisition of shares in a real estate company
Investments in Romanian real estate assets are generally made either by acquiring shares in the Romanian company owning the asset or by setting up a Romanian company which subsequently purchases the real estate asset. While the transfer of shares is not subject to transfer taxes, the registration of the new shareholding with the Trade Registry is subject to fees of approximately €300 ($477).
In practice, the share price is often negotiated by taking into account the tax on capital gain due from the seller, especially when the seller is a Romanian individual. Thus, the gain derived by individuals selling shares held in open companies is subject to 1% tax provided the holding period exceeds 365 days, or to 16% tax where the holding lasts less than 365 days.
The gains derived by selling shares held in a closed company are subject to 16% tax if the seller is an individual or a foreign company, or it is included into the general taxable basis subject to the 16% corporate income tax if the seller is a Romanian legal entity. This tax treatment also applies if the Romanian legal entity sells shares held in open companies.
Under certain circumstances, the actual declaration and payment of tax are to be made through the intermediary of a fiscal representative.
The notary fee due when authenticating the transfer deed is computed depending on the value of the transfer. For instance, in the case of values exceeding RON550,000 ($245,000) the fee is RON5,300 plus 0.5% of the value exceeding RON550,000. In the case of swap arrangements, the relevant percentage is applied to the higher value of the two assets and the notary fee is found by adding 25% to the amount obtained. A judiciary stamp, which is a fixed lump sum stamp of small value, is also to be paid to the public notary authenticating the transfer deed. Also, notary fees are subject to VAT.
A registration tax is payable to the Office for Cadastre and Real Estate Publicity when registering the purchaser ownership right over the real estate property acquired. The quantum of the tax depends on the nature of the purchaser. Thus, the legal persons will pay a registration tax of 0.5% from the value referred to in the transfer deed, but not less that RON100.
Transactions with immovable goods are generally VAT exempt without credit. However, any taxable person performing such transactions may choose to subject the sale of these immovables to the 19% VAT. Sales of new buildings or parts of new buildings and the underlying land, as well as of any land which is destined for construction are not exempt from 19% VAT. Since January 1 2008, the special VAT simplification measures available in the past for the real estate transactions where both the seller and the buyer were registered in Romania for VAT purposes are no longer applied: any VAT-able transaction performed by a taxable person will imply VAT cash flow.
Acquisition and development financing
A Romanian company acquiring and operating real estate may be financed through either equity or debt. Financing through hybrid instruments has recently started to be envisaged.
Financing through equity
Equity financing is normally tax-neutral, as at present there is no Romanian tax on capital. The repatriation of such financing, achieved by way of social capital decrease, should also be tax-neutral to the extent that the capital envisaged is the one effectively contributed in the first place.
Financing through debt
It should be noted that during the construction period, the company may either capitalise the financing cost (that is, interest) in the cost of the immovable asset (to be further depreciated after the construction is finalised) or recognise the interest expense in the profit and loss account, subject to narrow capitalisation rules. After the construction is finalised, interest expenses will be recognised in the profit and loss account, also subject to capitalisation rules.
From a corporate income tax perspective, under the current narrow capitalisation rules, there are restrictions on the deductibility of interest expenses and foreign exchange losses. Generally, interest and foreign exchange expenses incurred by companies in relation to loans obtained from entities other than banks and financial institutions are subject to certain limitations, as below.
Interest expenses are deductible only if the debt-equity ratio is maximum 3:1. Where the ratio is higher than the aforementioned limit or has a negative value, interest expenses are non-deductible for corporate income tax purposes, but they can be carried forward until they are fully deductible under the same conditions. Also, the difference between foreign exchange losses and foreign exchange revenues relating to long-term loans is treated as interest expense and is subject to the debt-equity ratio limitation.
The interest rate relating to loans granted by companies other than financial institutions is deductible within the limit of a specific annual interest rate for loans denominated in foreign currencies. The annual interest rate applicable for 2008 is 7%. Note that the interest rate test adjustment should be made prior to the debt-equity ratio test. Thus, non-deductible interest expenses in relation to debt financing obtained by a Romanian company might be incurred whether or not the aforementioned restrictions are observed. The narrow capitalisation rules mentoned above are not applicable in relation to loans granted by banks and other financial institutions.
Financing through hybrid instruments
Investors more often consider the use of hybrid instruments, which have economic characteristics that are inconsistent, in whole or in part, with the classification implied by its legal form. Such instruments may possess characteristics that are consistent with more than one tax classification, or that are not clearly consistent with any classification, especially where a long term investment in the real estate industry is envisaged (that is, development and operation).
The use of hybrid instruments may create various benefits, such as: (i) higher credit rating from a financial and regulatory perspective; (ii) a risk transfer (risk sharing with other creditors) for the shareholders; (iii) higher flexibility from a financial and managerial standpoint; and (iv) last but not least, tax optimisation, as the result aimed at by such inancing is represented by the deductibility of an interest expense in one jurisdiction and the non-taxation of a dividend income in the other jurisdiction.
However, hybrid instruments are not yet clearly regulated in Romania from a legal or tax perspective. A few aspects are nevertheless mentioned in the secondary tax legislation, in the context of the determination of whether the operations between affiliated companies are performed at arm’s length. Thus, when a taxpayer receives a financing from an affiliate, irrespective of its scope or destination, the market price for such a service will be represented by the interest agreed between independent persons for services rendered under similar circumstances, including the commission for the administration of the respective financing.
Also, when allocating the revenues potentially generated by financing services rendered among affiliated persons, the following aspects must be attended to: (i) whether the finance is granted for business purposes and is utilised as such; and (ii) whether a profit distribution scheme is envisaged.
In the re-classification of a loan into a profit distribution scheme, it will be deemed whether, at the time of grant, the parties did not expect the loan to be reimbursed or if the financing agreement contains provisions that are disadvantageous for the payer. Notwithstanding the lack of clear regulation in respect of hybrids, should the tax authorities reclassify a hybrid loan into a profit distribution scheme and therefore characterise any interest paid as a dividend, the tax consequence would be the nondeductibility of the interest paid.
Other deductibility requirements
As a general rule, from a corporate income tax perspective, tax deductions are only available for expenses (that is, including interest expenses and foreign exchange losses) that relate to generating taxable revenues and that are incurred for business purposes, regardless of whether they are derived in connection with intra-group loans or bank loans (for example, interests derived in connection with loans granted for acquisitions of shares are not deductible). As well as the tax implications generated by narrow capitalisation rule, withholding tax implications should be considered in the case of cross border debt financing.
Development and operation
Certain taxes and fees are payable when developing a real estate project, such as fees for removal from agricultural use (zoning), for issuance of construction permit (preissuance fees), for urban planning certificates, for construction commencement, for construction progress, for connections and links to the public utilities system and for street name and address certificates.
Corporate income tax
The Romanian corporate income tax is currently 16%. Taxable incomes include, among others, rental incomes, incomes derived from selling real estate assets and incomes from real estate asset management services. The taxable base is represented by the accounting profits adjusted by nondeductible expenses and non-taxable income. The taxable income is computed as the difference between income realised from any source and expenses incurred by generating the income (profit and loss account factors) in a fiscal year. Such computed taxable income is decreased by non-taxable income and increased by nondeductible expenses.
From the deductibility rules perspective, expenses are generally deductible provided that they are incurred when earning taxable revenues. Expenses must be fully supported by appropriate invoices and documentation. Also, certain deductibility criteria apply for specific expenses (for example, interest, sponsorships, services and so on).
Real estate assets consisting of buildings are depreciable for corporate income tax purposes, while land assets are not. Currently, the tax losses incurred by a corporate income tax payer may be carried forward for five consecutive years and are available for set-off against the first available profit. However, from 2009, the period for which such loss can be carried forward will be extended to seven years. Tax consolidation is not allowed in Romania at present.
For transfer pricing purposes, Romania applies the usual arm’s length principles. Transactions between resident companies are presently considered outside the scope of transfer pricing reviews. However, as a general recommendation, the fees/prices payable by and between affiliated companies should observe the market price. Sellers of real estate assets should account for any deferred tax generated by revaluations of the respective assets. These are: (i) the revaluations made under certain circumstances were/are recognised for tax purposes; and (ii) upon the sale of the revaluated assets, the taxable gain is represented by the selling price less the fiscal value (that is, the revaluated value which is recognised for tax purposes, less the fiscally depreciated portion, as the case may be). The tax-triggering event in respect of the step-up in value will occur upon the change of the revaluation reserve destination.
The gross dividend available for distribution is determined in reference to the taxpayer’s accounting profit. Romanian companies (irrespective of their tax regime) may distribute dividends only at year-end, after having submitted the annual financial statements to the tax office. No interim dividends are allowed under the current Romanian legislation.
The following types of income derived from Romania by non-residents are generally subject to a 16% withholding tax: dividends, interest, royalties, capital gains, service fees (provided services are effectively performed in Romania), consulting and management fees (irrespective of their place of supply). In respect of dividends, since the domestic law provides for its own resident companies a reduced 10% dividend withholding tax rate, for nondiscrimination reasons, from 2009, the dividend distributions made to legal entities residing in EU member states are subject to 10% dividend withholding tax. Generally, the taxes payable in Romania are calculated and withheld at the income payment date and should be remitted to the state budget by the 25th of the month following the one during which the income is paid to the non-resident. However, there are cases where the withholding tax is due even if no cash payment is made to the non-resident. An example would involve the interests related to cross-border loans in cases of capitalisation, conversion or setoff. In such cases, the use of the interest for capitalisation/conversion/set-off purposes is seen as a realisation of incomes by the lender because the applicable withholding tax is payable to the state budget by the 25th of the month following the one during which the operation was recorded.
The domestic withholding tax rate may be reduced or even eliminated under the provisions of the 80-plus treaties for the avoidance of double taxation (Tax Treaties) concluded by Romania with other states. Domestic tax regulations are superseded by the relevant Tax Treaty, provided that the beneficiaries of the respective Romanianorigin incomes present to the payers or the tax authorities, as the case may be, a certificate of fiscal residence. The certificate must be issued by the proper home-country tax authority, and must attest that the respective persons are tax residents, from the relevant Tax Treaty perspective, of that country.
In the absence of such certificates, the domestic tax rate must be withheld from the payments made to non-resident recipients and only at a later date, within the five-year bar period, when the certificate is actually made available, the difference between the domestic rate and the Tax Treaty reduced rate may be recovered. In addition, from January 1 2007, the
date of Romania’s accession to the European Union, certain EU Directives were implemented into Romanian legislation. These EU Directives regulate a more favourable taxation regime with respect to dividend incomes, interest and royalties.
Thus, dividends paid by a Romanian entity to a company established in an EU member state will no longer be subject to withholding tax, provided that at the date of dividend payment the foreign entity receiving the dividends has continuously held at least 15% (10% from January 2009) of the share capital of the Romanian company paying the dividends for a period of at least 2 years. The dividend withholding tax due in Romania up to the date when the conditions set out above are met may be claimed back.
The interest and/or royalty payments made by a Romanian entity to an EUrelated party are subject to a reduced withholding tax rate of 10% provided that the beneficial owner of the respective interest and/or royalty holds at least 25% of the payer’s equity for an uninterrupted period of at least two years prior to the payment date. This is a transitory measure applied until full implementation into the Romanian legislation of the EU Interest and Royalties Directive (full exemption will apply from 2011). Also, any interest and/or royalties withholding tax due in Romania until the date when the conditions set out above will be met may be claimed back.
From 2009, the withholding tax regime applicable to dividends, interest and royalties obtained from Romania by legal persons residing in the EU will also apply to legal persons resident in one of the European Free Trade Association (EFTA) states, respectively Ireland, Liechtenstein and Norway.
The rental of immovable property is generally VAT exempt without credit. However, the legislation allows the landlord to opt for charging VAT on rentals. It is important to note that rentals exempt from VAT may negatively affect the input VAT incurred by the landlord on acquisition or construction of the real estate due to retroactive VAT adjustment. However, reimbursement of VAT is also available, subject to a tax audit performed by the taxauthorities.
Other local taxes
Legal persons owning buildings owe the local tax on buildings. This ranges from 0.25% to 1.5% of the book value or from 5% to 10% of the book value where the respective buildings were not revaluated in the last three consecutive years. The book value may represent: (i) the acquisition price for buildings acquired via an assets deal; (ii) the value of the in-kind contribution; (iii) the production costs for buildings erected by a legal person; (iv) the market value for buildings obtained free of charge; or (v) revaluated value for buildings subject to a revaluation performed in accordance with the law. The tax on land is also due from any legal person owning land in Romania. The tax is computed as a fixed amount per square
metre, the value being established according to criteria including location, type, area, and destination.
An investor can typically exit from a real estate investment either by selling the asset or by selling the shares of the real estate company.
Direct sale of the asset
Any proceeds resulting from the sale of the real estate asset would represent a taxable income. The Romanian company will be liable to pay the standard 16% corporate income tax applicable to the difference between incomes realised and related expenses recorded. The after tax profit will subsequently be distributed to shareholders, subject to the applicable Romanian withholding tax on dividends.
Sale of shares
The foreign legal persons obtaining gains from the sale of shares held in Romanian companies owe 16% corporate profit tax. However, the benefit of the relevant Tax Treaty may be claimed as under most Tax Treaties such gains are subject to tax only in the state where the seller resides. Attention should be paid to the Tax Treaties referring to companies owning real estate properties in principle, as the right to taxation is shifted to the country where the company is incorporated; however, there are few Tax Treaties providing for such a shifting of taxpayment.