United Kingdom
The general election held in May 2010 resulted in a coalition government and a new legislative agenda as well as a 2.5% hike in VAT to 20% from 4 January 2011. The new government’s drive to devolve legislative powers has produced the Localism Bill, giving local communities greater control over planning decisions.
One of the last Acts of the previous government, the Bribery Act 2010, comes into force later this year. It will apply to any entity carrying on business (or part of a business) in the UK and introduces strict liability for corporate entities unless they can show that they have “adequate procedures” in place. Both criminal and civil sanctions apply to non-compliance.
Competition law is also making its debut in the property industry. The UK law prohibiting anti-competitive agreements will apply in full to land agreements for the first time from 6 April 2011. It is unfortunate that the law applies retrospectively, so that existing land agreements will be caught. A breach of this law creates the risk of fines of up to 10% of worldwide turnover.
Although upwards-only open market rent reviews remain the norm in the UK, there is speculation that these, as well as the length of lease terms, may be in decline. New lease accounting rules proposed by the International Accounting Standards Board and the Financial Accounting Standards Board may also have an impact if – as is proposed – tenants are obliged to recognise some part of future contingent rent as additional liability on their balance sheets.
The UK property industry was hit hard by the financial crisis and lenders continue to reduce their exposure to real estate. There is general concern that the high level of maturing debt in the UK could lead to a funding “black hole” in the near future. This, coupled with a shortage of grade A stock, particularly in London and the South East, seems to point towards a widening two-tier UK property market. However, research by Hogan Lovells in September 2010 showed cautious optimism returning to the real estate market.
France
A company is thinly capitalised if it has large levels of debt in relation to its equity and this can result in interest deductions for tax purposes that tax authorities consider to be excessive. French tax law therefore limits the tax-deductibility of interest payments by thinly capitalised companies. In general, certain interest payments are only tax deductible in full if they do not exceed 1.5 times the borrower’s net equity.
Until recently, this limitation applied only to loans from related parties – parties which control the debtor, directly or indirectly, or are under the same common control. The provisions did not, therefore, apply to loans from unrelated lenders.
However, from 2011 the thin capitalisation rules have been extended to external financing deals where such loans are guaranteed by a related party. The aim is to prevent companies from circumventing the existing rules by substituting bank loans guaranteed by group companies, for intra-group loans.
The new rules complicate real estate finance and could necessitate a change in approach. Two main points emerge:
Bank debts guaranteed by a related party will need to be taken into account in determining the intra-group debt/equity ratio of 1.5:1.
All forms of security, whether real (for example, a pledge or mortgage) or personal (for example, a guarantee) will be caught.
Fortunately, the new rules carve out certain exceptions, several of which may apply to acquisition financing deals. Most notable of these are debts exclusively guaranteed by a pledge over the debtor’s shares. So, for example, bank loans granted for the acquisition of real estate are often secured (in addition to a mortgage over the asset) by a pledge granted over the shares of the company that acquired the asset. The pledge exception prevents such deals from falling within the thin capitalisation rules.
However, when a real estate portfolio is acquired, it is common for a special purpose vehicle to acquire each real estate asset. The holding company would then finance each SPV by granting security over the shares of all of the SPVs. In this scenario, the new rules relating to thin capitalisation could apply because the security given by the shareholder is not limited to the shares in the borrowing SPV. It is expected that the French tax authorities will take a flexible approach on this point, but it remains an area of theoretical concern.
Spain
For the past three years, the Spanish government and the Bank of Spain have relaxed the regulatory requirements to allow financial institutions to hold real estate assets acquired following breaches of financing covenants and insolvency proceedings. However, this looks likely to change because the Spanish government is about to embark upon a long-awaited reform of the Spanish banking system.
The reform will include an increase in the capital ratios of financial institutions and, to achieve this, such institutions could embark on a mass sale of assets to increase their liquidity. If the market is flooded with real estate assets, this will have a knock-on effect throughout the sector.
Another key element of the banking reform will be controversial changes to Spain’s unlisted cajas de ahorros or savings banks. To achieve a minimum level of capital adequacy, the government is encouraging the conversion of savings banks into listed banks and the merger of medium-sized savings banks. The closure of bank branches is a natural consequence of this process and it is likely that a number of branches will be marketed (either for sale or to let) at competitive prices.
From 3 December 2010 a new exemption has been in force in relation to capital tax/stamp duty, which makes contributions via equity to real estate companies more attractive. The exemption will apply to the incorporation of companies, increases in share capital and contributions carried out to offset losses. Previously, capital tax was payable at the rate of 1% on share capital. Capital tax still applies in cases of winding up and reductions of share capital.
Finally, a free amortisation regime has been introduced for new assets acquired for business purposes in the tax years between 2011 and 2015. This regime applies to the acquisition of fixed assets and real estate investments. It will also apply to developments completed during that time if they have started within the past two years, but it will apply only to performance since 2011. The new regime relaxes previous amortisation requirements, which have been in place since 2009.
Italy
From 1 January 2011, the indirect taxation rules which apply to Italian leasing have been restructured. Modifications have been made to the registration, mortgage and cadastral taxes imposed on all such leasing contracts. In order to adjust the tax burden in relation to leasing contracts which predate the restructuring, a substitutive tax on those contracts is due by 31 March 2011.
In the construction sector, there has been an increase in the time period available to construction firms to sell new or refurbished residential real estate with the sale being subject to VAT. The time period has increased from four years to five years and it is hoped that this change will support the revitalisation of this sector by allowing construction companies a longer period in which to recover VAT paid during the construction phase.
Italy has also been grappling with changes to the legislation that governs Italian REITs. Italian legislation grants a full tax exemption on profits realised by REITs and only a 20% withholding tax on the distribution of such profits to investors if the investor is not resident in certain “white list” countries. This favourable tax regime has been the subject of manipulation by wealthy families who created their own REITs with the sole aim of managing their real estate portfolios. In order to counteract this strategy, a capital levy of 1% on certain REIT’s net assets was introduced in 2008.
From 31 May 2010, new rules have introduced additional requirements for REITs. Broadly, there must be a plurality of investors and the fund manager’s decisions must be independent. REITs that do not meet the new requirements must be liquidated or their existing rules must be adapted.
Detailed guidance is awaited from the government in relation to the new requirements, particularly as to the meaning of “plurality” and whether the fund manager’s decisions will be independent if he has regard to the opinions of the investors.
Russia
A new law on the regulatory aspects of trade activities became effective on 1 February 2010. The law aims to create a more competitive and transparent retail market and to curb the growth of retail monopolies. The legislation introduced a number of mandatory rules and regulatory requirements in relation to the supply and trade of food.
In particular, special rules apply to retailers with a food-product market share in excess of 25% as at the end of the latest financial year within the municipal or administrative districts or regions of the Russian Federation, including the cities of Moscow and St Petersburg. Such retailers are prohibited from acquiring or leasing additional retail space within the relevant territory. Deals violating this rule can be rendered void by any interested party, including the Russian anti-monopoly authorities.
In July 2010 a new law was passed requiring obligatory civil liability insurance for individuals or legal entities that hold and operate “dangerous objects”. For the purpose of the new law, “dangerous objects” includes not only industrial objects and hydraulic structures, but also multi-family houses, shopping malls and administrative buildings if there are elevators or escalators within the structure.
The required limit of indemnity varies from Rb10m to Rb6.5bn, depending on the number of possible victims who could be injured as a result of an accident in connection with the dangerous object. The insurance must be taken out with a specially licensed insurance agent and must be effective for the duration of the operation of the dangerous object. The main provisions of the new law will come into force on 1 January 2012, but only in respect of elevators and escalators in multi-family houses on 1 January 2013.
In April 2010, Russian authorities approved a list of the construction activities that can be undertaken only by certified members of certain self-regulatory organisations. In particular, the performance of the functions of a general contractor requires such a certificate even if the relevant design or construction works are to be performed by sub-contractors.
Czech Republic
In July 2010, the complex calculation of late payment interest was simplified to provide a single late payment interest rate applied throughout the default period, calculated on the basis of the Czech National Bank repo rate plus 7% per year. This single rate applies in all cases where the parties did not previously agree a default interest rate.
The new regime should improve certainty for debtors, who will now know the interest rate for the entire period of default from the first day of default. The new regulations should also simplify the enforcement of debts, as creditors will no longer need to calculate late-payment interest rates for each half-year, which can become convoluted in the long term.
The 2006 Act on Collective Investment has introduced qualified investor funds (QIFs), which represent a tax-efficient solution for property investments in the Czech Republic. The main advantages of QIFs are tax benefits and a less onerous level of regulation. QIFs are subject to 5% income tax rather than the usual 19%, with zero taxation of dividends, and appear to be particularly attractive for high-volume, long-term investments.
An amendment to the Collective Investment Act that is expected to be adopted in mid-2011 will transpose the UCITS IV Directive into Czech law. This will expand the role of QIFs, for example, by allowing for the public offer and advertisement of securities issued by the QIFs, thus improving the access of QIFs to capital, and creating scope for securitisation and new structures including REITs.
Last year we reported on the 2009 transposition of the Second Company Law Directive. Since then, the directive has made financial assistance a viable corporate option and established new funding opportunities for real estate projects provided on an arm’s-length basis.
That said, the relatively strict conditions for providing such funding mean that financial assistance remains a complex matter for all parties involved, requiring very clear transactional documentation, co-operation from the target company’s relevant authorities and consistent legal compliance monitoring. Of particular concern to lenders is the need to mitigate the risk of a void loan security. Also, purchasers must manage potential liability risks to their directors and executives.
Hungary
At the end of 2010, the Hungarian Ministry for National Economy fostered optimism in the Hungarian real estate market by creating the legislative background for Real Estate Investment Trusts (REITs). The expectation of the ministry is that, by attracting funds from developing markets, primarily independent funds from China, India and the Middle East, Hungary will become “the Luxembourg of eastern Europe”.
Although they originated in the US many years ago, REITS have taken off in Europe only in the past few years. While the REIT concept has some common principles, different countries have adopted REITs with local variations. The Hungarian approach is expected to include the following: REITs would be stock exchange-listed public companies; accumulated financial assets would be invested in Hungarian domestic and commercial real estate for the purpose of investment and development; and 90% of profit would be returned to shareholders as dividends and would be subject to dividend tax and capital gains tax at the shareholders’ level.
Since REITs are considered to be stable, low-risk investments, these measures could result in a long-term capital inflow to the Hungarian real estate market. On the assumption that the introduction of REITs will stimulate the national real estate market, the Hungarian government has forecast that around 10,000 new jobs will be generated in the property industry and another 200 jobs will be generated in connected professional sectors.
REITs could also encourage a stable secondary market for Hungarian real estate developers and such a reliable environment could stimulate new investments and developments.
According to the Ministry, Hungarian REITs will generate a competitive holding structure, and as a result, other international – mainly Luxembourg and Cypriot – off-shore structures could become less prevalent. Another expected advantage of REITs is that they will be available to a wide range of investors rather than only national real estate funds.
The legislation process is expected to commence in the first half of 2011. However, some experts are sceptical citing the lack of detail in the published proposals.
