German Growth Opportunities Act: Real Estate Sector faces higher tax burden due to tightening of interest barrier

First of all, the Growth Opportunities Act’ government draft lives up to its name in some areas. For example, it provides for the introduction of a declining-balance depreciation for buildings, which is intended to apply to residential buildings with construction starting on October 1, 2023 (limited to six years). The generation and delivery of renewable energy in the building sector is to be improved (raising the “dirt threshold” from 10 to 20 percent) and the loss carryback, which was extended to two years by the Fourth Corona Tax Relief Act, is to be extended by a further year to three years. This, too, will provide a benefit for real estate companies.

However, it is also planned to tighten Art. 4h of the German Income Tax Act (EStG), i.e., the section governing the deduction of operating expenses for interest expenses (interest barrier). The amendments proposed in the government bill serve, among other things, to implement the EU Anti-Tax Avoidance Directive (ATAD) and the prevention of abuse which is (supposed) to go beyond this. It should be emphasized that the proposed tightening does not only affect international cases, which might be expected with regard to ATAD (shifting of interest expenses), but also merely domestic cases.

Specifically, the government bill provides that a limitation of the interest expense deduction is excluded if “the net interest expenses of the business amount to less than three million euros. Similar businesses being managed by the same person or group of persons or over the management of which the same person or group of persons can directly or indirectly exercise a controlling influence qualify as one business for the purposes of sentence 1; the exemption limit pursuant to sentence 1 is to be allocated to these establishments in proportion to the net interest expenses”.

Please note that the originally envisaged tax-exempt amount has been dismissed and the exemption limit already in force will be retained.

However, sentence 2 of the proposed regulation is of particular importance. Under the current legal situation, for example, in group cases with several real estate subsidiaries, the exemption limit is granted in full for each individual subsidiary. This is due to the fact that each of the real estate subsidiaries is considered as individual business within the meaning of the regulation.

According to the government draft, the exemption limit can only be applied once in a group if the real estate subsidiaries are considered jointly as one “business” for the purposes of the exemption limit, which would be the case according to the wording if the management by the same person/group of persons or a controlling influence by the same person/group of persons is taken as a basis. A further prerequisite for the combination of several companies into one business is the “similarity” of the business operations. However, the law and the explanatory memorandum do not comment on such term in any detail. Important questions regarding the concrete interpretation remain unanswered:

• Is the letting of a single-tenant commercial property similar to the letting of residential property to many parties? 
• How many parties are required in order to no longer be considered similar?
• Does the rental activity of a project developer that holds its own real estate portfolio in the project company’s affiliates qualify as similar?

If the government draft should be implemented unchanged from the current version, this would have significant consequences for the real estate industry:

• Cases where the escape clause for group companies has been applied as well as the equity ratio comparison would have to be calculated (if necessary, for the first time),
• In the worst case, the financing structure would have to be completely restructured, or at least adjusted,
• Real estate subsidiaries could be subject to an income tax burden due to the restriction of the interest expense deduction, which would negatively impact their cash flow. In this respect, the Growth Opportunities Act’s government draft fails to achieve the objective promised by its name.

But that is not all. The government draft provides for further tightening. On the one hand, in relation to the stand-alone clause. Specifically, the application of this exemption from the restriction on interest deduction is to apply only if “the taxpayer is not related to a person within the meaning of Art. 1 (2) of the German Foreign Transaction Tax Act (AStG). Furthermore, an expansion of the definition of interest (“economically equivalent expenses and other expenses in connection with the borrowing of capital”) and a limitation on the use of interest carryforwards are planned.

The law also provides for the introduction of a completely new maximum rate for deductible interest expenses (“Zinshöhenschranke”), which is intended to apply to interest expenses arising from a business relationship between related parties. 

So far, no rumors have been leaked from the parliamentary procedure. At this time, the extent to which the schedule (adoption in the Bundestag is planned for November 10, 2023, approval in the Bundesrat for December 15, 2023; no date is yet known for promulgation) and the adjustments already expressed in various comments will still be implemented is subject to mere speculations.