Real estate transfer tax (RETT) exemption

In its decision of 30 May 2017 (II R 62/14), the German Federal Fiscal Court (Bundesfinanzhof [BFH]) had referred a question to the Court of Justice of the European Union (ECJ) as part of a request for a so-called preliminary ruling. The issue was whether the tax benefit applicable to real estate transfer tax in the case of a restructuring within a corporate group under § 6a German Real Estate Transfer Tax Act (Grunderwerbsteuergesetz [GrEStG]) constituted incompatible state aid under EU law.

On 25 November 2015, the BFH (II R 50/13 and II R 36/14) had preemptively called upon the Federal Ministry of Finance (Bundesministerium der Finanzen [BMF]) to join the appeal proceedings and asked for a statement as to whether a referral proceedings had already been brought before the ECJ. As a result of the BFH decision on the suspicion of state aid issued on 30 May 2017, § 6a GrEStG could no longer be applied. In its judgement of 19 December 2018, the European Court of Justice has now ruled that § 6 a GrEStG does not constitute state aid and may therefore be applied.

1. Background and requirements for tax benefits under § 6a GrEStG

In accordance with § 1 (1) No. 3, (2), (2a), (3) GrEStG, acquisitions resulting from reorganising companies as defined in § 1 (1) No. 1 to 3 Reorganisation Act (Umwandlungsgesetz) (e.g. the merger of companies) may trigger real estate transfer tax if the companies involved own real property. Section 6a GrEStG provides extensive tax exemptions for such cases in the event of a restructuring within a corporate group.

One of the requirements for a tax exemption under the so-called group clause is that only one controlling entity and one or more controlled entities of this controlling entity, or several controlled entities of a controlling entity are to be involved in a restructuring process (§ 6a sentence 3 GrEStG).This means that a reorganisation takes place either between a controlling entity and one or more controlled entities, or between different entities controlled by one entity. A company is considered to be controlled as defined in § 6a sentence 3 GrEstG if the controlling entity has held a direct or indirect investment of at least 95% in the controlled company five years prior to and five years subsequent to the reorganisation.

2. Issue

In the legal dispute to be settled by the BFH, the tax authorities and the Federal Fiscal Court disagreed on the interpretation of the law or on the requirements to be met by the controlling entity specified in § 6a GrEStG. The tax authorities only assumed the existence of a controlling entity under very strict requirements, which would greatly limit the scope of § 6a GrEStG to be applied. The BFH, on the other hand, interprets the concept of a controlling entity more broadly. As a result, it is now to be expected that the BFH will reject the revision of the tax authorities as being unfounded in the continuation of the proceedings. These had been suspended owing to the referral to the European Court of Justice, because the BFH had already stated that it would interpret the concept of a controlling entity more broadly contrary to the opinion of the tax authorities, and thus apply the tax exemption given in § 6a GrEStG more generously for the benefit of taxpayers.

However, the BFH feared that the tax exemption under § 6a GrEStG could qualify as being incompatible with state aid as defined in Art. 107 (1) of the Treaty on the Functioning of the European Union (TFEU). Article 107 (1) TFEU prohibits selective aid for certain companies or manufacturing sectors. The BFH referred this question to the ECJ: "The BFH considers it in need of clarification as to whether § 6a GrEStG provides an unauthorised selective advantage by the fact that the provision applies only to reorganisations based on an investment level of at least 95% and that it requires a minimum retention period of five years, but does not apply to other restructuring measures as well.” (BFH Press Release No. 38/17 of 14 June 2017).

In the current practice, this has led to the unsatisfactory situation to the extent that the group clause could no longer be applied in the case of a restructuring, since a negative decision by the ECJ would retroactively have rendered any tax exemption null and void, even if a tax authority had granted the tax exemption despite the pending legal issue. There is no protection of legitimate expectations in the granting of incompatible state aid under EU law, even if the recipient is not at all aware of the fact or did not know that incompatible state aid may have existed and that proceedings were pending before the ECJ. The aim is to ensure that the prohibition of incompatible state aid under EU law is effective.

3. ECJ: § 6 a GrEStG is incompatible with state aid as defined in Art. 107 (1) TFEU

The ECJ has now ruled that § 6a GrEStG does not constitute state aid contrary to EU law as defined in Article 107 (1) TFEU (ECJ judgement of 19 December 2018 - C - 374/17). A tax exemption such as the one granted in accordance with § 6a GrEStG does not fulfil the selectivity requirements of the benefit granted in Art. 107 (1) TFEU.

In accordance with settled case-law of the European Court of Justice, the classification of a national government measure as state aid within the meaning of Art. 107 (1) TFEU requires that four essential conditions are to be met. Firstly, it must be a government measure or a use of government resources. Secondly, the measure must be capable of infringing upon trade between member states. Thirdly, it must give the beneficiary a selective benefit and, fourthly, it must distort or at least threaten to distort competition.

In the present case the ECJ decided that § 6a GrEStG does not lead to any selective benefit so that the requirements for incompatible state aid as defined in Art. 107 (1) TFEU have not been met.

4. Consequences in practice

In current practice, the decision of the ECJ has the positive consequence that § 6a GrEStG may again be applied and that re-structuring measures governed by § 6a GrEStG do not trigger real estate transfer tax in a corporate group. This welcome news is, however, somewhat dampened by the fact that a number of important issues relating to the actual interpretation and application of the group clause by the tax authorities or the courts still need to be clarified in order to provide taxpayers with a secure legal basis for claiming the tax exemption. Examples of some important open questions are given below.

Open questions

Fortunately, the jurisprudence does not, in principle, follow the tax authorities' very restrictive application of the group clause.

The tax exemption benefits restructurings within a corporate group. However, the concept of a group as defined in § 6a GrEStG is ,however, subject to interpretation. In the opinion of the tax authorities, it is a so-called association consisting solely of a controlling entity, the controlled entities involved in the reorganisation process, and entities positioned in a shareholding structure in a tier between a controlling entity and controlled entities. In the opinion of the tax authorities, other companies not involved in the reorganisation process are explicitly not to be taken into account. Such a narrow interpretation of the concept of a group may not be appropriate. This point still has to be conclusively clarified (appeal pending before the BFH under II R 62/12).

Furthermore, the concept of a company is not defined in § 6a GrEStG. In the opinion of the BFH, it is therefore necessary to clarify the principles to be used in defining this term in pending proceedings (II R 50/13, II R 62/14 and II R 63/14). In its opinion, it is not mandatory that § 6a GrEStG applies only to entities as defined by the German Value Added Tax Act (Umsatzsteuergesetz). The BFH interprets the term rather broadly (II R 62/14), but it has not yet clearly specified the definition. In the opinion of the BFH (II R 53/15), an additional question should be clarified as to whether the five-year retention period given in § 6a sentence 4 GrEStG must apply and results in not being able to apply the tax exemption if a controlled entity holding real property is merged with a controlling entity and the so-called association is thus terminated. In order to clarify these questions, the BFH asked the BMF to join the proceedings and asked for a statement (II R 50/13). The proceedings II R 63/14 and II R 53/15 were suspended until the decision of the ECJ and should now be decided by the BFH. It is to be assumed that the Federal Court of Finance will interpret the group clause broadly in this respect and state that the group clause is applicable.

In addition, the BMF was requested by the BFH to join the appeal proceedings concerning file reference II R 36/14 and to state its position on § 6a sentences 3 and 4 GrEStG. They stated that § 6a GrEStG is not applicable to reorganisation processes in which a legal entity is terminated or newly created. On the other hand, § 6a sentence 1 GrEStG refers to § 1 (1) Nos. 1 to 3 of the Reorganisation Act (UmwG), which states that such reorganisation processes would also be included in the scope of applying the group clause. The wording of the law is therefore contradictory.

In the proceedings II R 58/14, the BFH has, moreover, to make a decision on the question of whether the five-year retention period of § 6a sentence 4 GrEStG is to be understood as property- related or investment-related. Eventually, the BFH must answer the question of whether the five-year retention period is based on the controlling entity's investment in the transferring company, or whether it is additionally necessary for the latter to have already disposed of the real estate to be transferred as part of the restructuring during the retention period. Ultimately, the BFH (II R 56/15) has to decide whether the application of the retention period in the case of a spin-off to create a new company leads, in accordance with the opinion of the tax authorities, to not being able to apply the group clause, or whether a tax exemption may be considered in such a case by waiving this time period (so-called teleological reduction).

In conclusion, it is worth mentioning that the BFH had already clarified on 22 November 2018 that a change in legal form (in this specific case from a sole trader to a one-man limited liability company (GmbH) is not exempt in the sense of § 6a GrEStG.

A change in legal form is already not taxable because there is no change of legal entity. In the event of a dispute, the "reorganisation" from a sole trader to a limited liability company does not constitute a reorganisation as defined by the Reorganisation Act (II B 8/18); the process is considered to be a contribution of the sole trader to the limited liability company, and is subject to real estate transfer tax in accordance with § 1 (1) No. 1 GrEStG. It is not tax-exempt in the sense of § 6a sentence 1 GrEStG.