taxand pere 2012 global guide to tax

8/2/2019 Taxand PERE 2012 Global Guide to Tax

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OCT 2011 | perenews.com

FOR THE WORLDS PRIVATE REAL ESTATE MARKETS

ITS COMPLICATEDTaxanders see more joint ven-tures and club deals in Europe

TAx ASTCapital gains, benefcial owner-ship issues to cause anxiety

TOTAL TAx TAKETaxands T3 data evaluateseven more markets

THE 2012 LOAL IDE TO TAxA special supplement to PERE magazine


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Senior Editor, Real Estate

Erik Kolb +1 646 380 6194, [email protected]

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Robin Marriott +44 20 7566 54 52, [email protected]

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ISSN 1558-7177PEI Media 2011

No statement made in this magazine is to be construed as a recommendationto buy or sell securities. Neither this publication nor any part of it may bereproduced or transmitted in any form or by any means, electronic or me-chanical, including photocopying, recording, or by any information storageor retrieval system, without the prior permission of the publisher. While ev-ery effort has been made to ensure its accuracy, the publisher and contribu-tors accept no responsibility for the accuracy of the content in this magazine.Readers should also be aware that external contributors may represent firmsthat may have an interest in companies and/or their securities mentioned in

their contributions herein.

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TALE OF COTETS

18 Asias moving goalpostsAs Asias markets evolve, so do itstax implications. Taxanders fromthree of the regions biggest markets China, India and Korea tell ofwhat is happening in their particularjurisdictions

21 The word on the streetTaxands global real estate team oers aclient- and industry-based perspective onproperty markets around the globe andthe regulatory implications for them

24 Taand T3 researchTaxands proprietary research paints an easy-to-digest picture ofthe worlds tax-take for commercial and residential property

28 About Taand and global contact list

2 Force majeureKeith ODonnell, head of real estate at Taxand, explains howforces beyond Taxands control have been driving the nature ofits work

3 Ta window still openin distressedGovernments are raising rates andclosing loopholes, but opportunitiesremain for now

6 Leading the wayMost countries in Europe havent raised their real estate transfertax but Germany has, much to the chagrin of investors

7 A joint efortJoint venture deals and investmentclubs in Europe have risen to thefore, giving Taxanders the task ofstructuring these more complicatedvehicles

10 eyond ta issuesTaxands US real estate expert points out that due diligence inforeign investment is crucial for private equity real estate rms,but its really only half the battle

11 Land o opportunities andchallengesDespite strong investor condence inreal estate in Canada, Mexico and theUS, private equity real estate investorsstill need to be wary of potential pitfalls

17 An emerging market or emerging marketsWhen it comes to zero tax on capital gains from selling EasternEuropean real estate, Cyprus is king

14 Ta angstOver the coming months, changes

to capital gains tax treatment andbenecial ownership issues around theglobe are likely to cause anxiety forprivate equity real estate rms


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Eperts in your cornerWelcome to the 2012 Global Guide to ax, our third annual supplement ontax issues around the globe. Once again, we have combined our editorial re-sources with the expertise of Taxand to provide you with in-depth analysisfrom key markets around the globe and an overview of the biggest issues con-cerning private equity real estate and the tax man.

As you will discover from this years guide, it seems there are forces at work unstoppable ones, at that conspiring to make governments scrutinise al-most every real estate transaction. e ultimate aim, of course, is to derive asmuch revenue as possible and bolster national banks coers. Indeed, those

vaults are looking mighty empty in many jurisdictions, and they are not go-

ing to ll themselves!In this guide, however, you will nd indispensible intelligence on what is

happening on the ground in numerous jurisdictions around the globe. Notonly do we provide overviews of tax issues in select major markets, we alsobring you insight from regional leaders on issues across multiple jurisdic-tions. All that insight and analysis is capped o by Taxands proprietary T3research, an easy-to-digest comparison of the worlds tax-take for commer-cial and residential properties.

One of the key themes benecial interest can be found throughout ourcoverage. It is introduced by Keith ODonnell, Taxands global head of realestate, on p 2 and gures most prominently in our feature on capital gains,starting on p 14. In some cases, the hard-line approach of local tax authoritieshas dictated that the ultimate benecial interest in a company belongs to a

limited partner in a fund thousands of miles away from the actual asset. Inappropriate cases, unfair, illegal or just plain-wrong stances are being chal-lenged by Taxanders on behalf of clients.

Within this guide, there are various other issues of which the modern-dayprivate equity real estate rm needs be mindful, but lets be realistic: the rmsthat operate in this theatre do so because they rmly believe they can out-perform peers and deliver on promises made to investors. By nature, they arecondent, glass half-full people, and they wont let tax issues get in the way ofsuccessful investing. Still, more so than ever, they need to be cognisant of it.

We are condent this guide will help provide that extra edge over the com-petition and help fund managers to keep the tax man at bay.

Enjoy the guide,

Robin MarriottEditor, [email protected]

EDITORS LETTER

TE 2012 G GE T T |PERE 1


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Keith ODonnell, Taxands head of real estate, may beoverseeing a global team that is successfully ndingsolutions to minimising tax for real estate investors

and their fund managers, but there is one thing he can do littleabout: the force of the market.

Luxembourg-based ODonnell, who is in charge of a teamwhose global reach covers nearly 50 countries worldwide, saidmany regions around the globe are in nancial distress. Itis little wonder then that countries are working overtime tochallenge tax structures that may work within the law but aredesigned to get as close to zero percent tax as possible.

Another factor the team can do little about is the way fewer

classic blind-pool opportunistic real estate funds are beingcreated at the moment. Instead, Taxands global real estate taxteam has been presented with structuring vehicles that behavemore like individual mandates. Typically, these mightconcern a sovereign wealth fund enlisting the help ofa manager to manage a portfolio. Certain structuresmight involve a handful of large pension funds gluedtogether in a quasi-club vehicle.

ODonnell says: Four years back, we were design-ing fund structures that were made to appeal to thewidest range of people. You couldnt please everyone,though we found something that worked reason-ably well for most investors from a tax perspective.

ere were various standard models that developedin the market, from Luxembourg fund structures toUK limited partnerships. I think what has happenednow is that investors are saying, We cant have some-thing that is good on average; we want something thatworks for us.

As a result, Taxand has been involved in some fairlycomplex tax structures (the details of which can befound in the European feature, beginning on page7). For the uninitiated, here is a teaser: if you thoughtit would be easier to structure a tax-ecient club deal thana large closed-ended real estate fund with 20-plus investors,think again. Instead, such structures need the pilot to punch a

lot more buttons in the tax cockpit.Club deals (notwithstanding the possibility they might bea short-term trend) are something that Taxanders are havingto manage but can do little about in terms of the reasons whythey have become popular. Similarly, they cannot stop the waytax jurisdictions are going to some lengths to prevent tax-freeinvestments in some cases.

One example is the way some countries are dealing withbenecial ownership. Ordinarily, an investor in an underly-ing fund would be able to claim exemption from a withhold-ing tax on its dividend, assuming the existence of a treatyinvolving the country where an asset is located and the coun-

try where the fund is located. But in an ugly development forinvestors and therefore fund managers jurisdictions arerearing up on this issue if they perceive that the companyclaiming it is the benecial owner of the dividends isnt reallythe benecial owner at all. Instead, the tax jurisdictions mightargue the benecial owner would be the underlying investorfrom, say, a Middle Eastern country, which has no tax treatybenet with the country where the asset is located.

is is an area where Taxand is stretching the rubber band.Says ODonnell: Benecial interest is written into most trea-ties dealing with dividends and interest, and there has beenquite a bit of litigation concerning international structures.

Such issues make nonsense of 100 years of global capi-tal markets, but at least transactions are happening to invitesuch scrutiny. As transaction volumes begin to pick up, even

emerging markets are seeing some activity. Russia is perhapsthe clearest example, although Taxand also has advised on atransaction in Slovakia and is working on another in Hungary.

ere is evidence that people are prepared to go backto markets where the yields are attractive enough, saysODonnell. at said, a recent focus on government nancesaround the globe is shiing the perception of what is consid-ered a safe country to invest in. Combined with a healthierpipeline of deals in the more traditional markets of Asia, theUS and Western Europe, it means that fund managers andtheir investors are going to want to nd ways to squeeze everylast tax point out of a deal in these challenging times.

e key message is that there is a simple equation to master:cash-strapped governments + real estate = a need for early taxplanning.

Force majeureKeith onnell, head o real estate at Taxand, explains how orces beyond Taxands

control have been driving the nature o its work

There is a simpleequation to master:cash-strappedgovernments + real

estate = a need orearly ta planning.

Keith onnellTaxand

LOAL KEOTE

2 PERE| TE 2012 G GE T T


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W

ith governments around the globe undecided onhow best to cra tax policy for distressed real estate,many are moving to raise rates or close loopholes.

However, those eorts are just getting under way, and they areopposed by those who argue tax incentives could foster devel-opment and rehabilitation in many areas. While the debate ac-celerates, advisors are urging investors to sharpen their pencilsand nd the best opportunities while they can.

In the US, the problem is not that tax law and policy ham-per investment in distressed real estate, rather it is that law andpolicy have fallen badly behind the rapid advances in nancialmarkets. ere is no intention to discourage investment, buttax is denitely a limiting factor in that a lot of policy issuesrelated to troubled property have been on the books for a longtime, says Frank Walker of Taxand US. Much of it comesfrom the 1980 Bankruptcy Acts. Some of the provisions that

have to be interpreted never envisioned the nancial changesthat exist today.For example, Walker reports that there have been legislative

relief eorts in the area of treating cancellation of debt as in-come. Mostly, that has come as part of eorts to clear the hugeoverhang of foreclosed houses, but he says there could even besome benets to commercial real estate. e temporary work-out provisions expired last year, and neither lenders nor bor-rowers are as far along as they would like to be in the residentialside, he adds.

With Congress at loggerheads, Walker commends the staat the Treasury Department for doing what they can to keep

current with distressed property. e department and the In-ternal Revenue Service have made an eort to provide somelimited relief through notices and revenue procedures, he

says, because there is not much hope for a legislative solution.ere would be more regulatory relief, Walker adds, exceptthat ocials are always cautious about unintended conse-quences. Giving guidance in what might seem like a clear casecould give some unwanted benet somewhere else. It is a clas-sic case of the persistence of interim solutions.

In previous downturns, oshore buyers have oen come tothe rescue, but that has been less prevalent in this crisis in partbecause foreign investors in real property can nd long-termcapital gains taxed in the US even if they are not in their homecountry, Walker explains.

One other snag, Walker notes, is that the IRS is taking avery broad interpretation of what it considers public debt. In-

struments bought and sold among many types of entities arebeing included, even if the instruments are not traded on a reg-istered market.

ampered by harmonisationGermany is another nation with a large volume of distressedreal estate, but Ulrich Siegemund of Taxand Germany says taxburdens there are not as great as in other countries. ere maybe even more than is perceived because the banks have heldback on delinquency notices. Taxand Germany has been in-

volved in quite a few transactions.For many years, the German real estate market has been

Ta window still open in distressedGovernments are raising rates and closing loopholes, but opportunities remain

or now



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dominated by pension funds, especially on the commercialside, so the most common distressed properties are largeportfolios and, more recently, hotels. ere are eight to 10urban centres around the country with distressed proper-ties, says Siegemund.

Investors doing business in any member nation of the Eu-ropean Union benet from the harmonisation eorts of recentyears, but Siegemund notes that there have been some mis-steps. Germany had a provision where loss carry-forwardsfor corporations were retained in changes of ownership, butthe EU cal led that discrimination so the law was voided. Nowlosses are lost at transfer.

Another area of complication, Siegemund explains, is in ad-ditional equity or reduction of liabilities. If the benets comefrom a third party, that is clearly treatable as income. But insome cases, additional equity from shareholders or forgive-ness of liabilities is considered income for tax purposes.

ere is little initiative to change the current rules, Siege-

mund reports, even though there are rough patches like thetwo cited. Quite to the contrary, he adds that the recent trendhas been to increase tax rates, especially transfer taxes.

It used to be that there was a set federal rate of 3.5 percent,says Siegemund. at tax was shied to the states, and now

12 of the 16 have increased the rate. It now ranges from theold 3.5 percent up to 5 percent. He notes that 150 basis pointsmay not sound like much of a change, but it amounts to a 40percent increase and on multi-million dollar deals it certainlycan add up.

While distressed real estate in the US and EU has gottenextensive coverage, the economic crisis in Greece has gottenblaring headlines. ere are indeed opportunities in Greeceas values are very low, says Marina Allamani of TaxandGreece. And while there are distressed properties in everycity and region of the country and every category of real es-tate, the focus for the government at the moment is the priva-

tisation of public properties.Public buildings that are no longer in use are being oered

to investors from anywhere in the world, Allamani says,adding that the ta x laws neither discourage nor encourage in-

vestment in distressed properties.

ere are two impediments, however, to investors snap-ping up the dealsand bringing much-needed capital intothe struggling country. One is the reticence of banks to lend,even to well-capitalised borrowers. In 95% of cases, a bank isinvolved, and they have just stopped oering loans, Allamanisays. Some have begun to be more active, but not many.

e other problem is simply identifying properties and thennding the owners. ere are no central listings or clearing-houses even for real estate on the market. And even for buyerswilling to drive around to spot likely properties, it is a verycomplex legal practice to check on properties and get to thepoint of making a deal, Allamani says.

Seoul survivorsOn the other side of the world, the problems are the opposite.Korea has a well-ordered nancial and real estate market, so

nding suitable investments and getting to the ta-ble are not a problem. Its just that not many peo-ple, even in the country or across Asia, know thatthere is a pool of distressed properties in Korea.

Project nancing has gone sour and quite afew savings banks are in troublemostly becausethey invested in real estate projects, says StephanKim of Taxand Korea. e government has triedto li the whole real estate market, but it has notgotten specic in areas like tax treatment.

Overall, there is not much special treatmentone way or the other for distressed real estate,with one important exception. Historically thegovernment has discouraged individual invest-ment in real estate, says Kim. e maximumtax rate on most sources of income is 38 percent,but it was 40 percent to as high as 50 percent onindividuals who realise a capital gain on any-thing more than a second property. Just recently,that was changed to eliminate the tax penalty.

ere are other countries where the real estatemarkets are not in big trouble, but savvy investors always seekdiversication and can nd bargains almost anywhere. Most

markets in France are doing well, says Francois Lugand ofTaxand France. at said, Paris is grappling with steep decitsas are most other governments on the Continent, and that cre-ates pressure to increase tax collections; if not actual rates, atleast through enforcement and closing loopholes.

e main trend to solve government revenue problems is tocollect more tax overall, Lugand says. ere is a special com-mission on loopholes and tax incentives. It has been estimatedthat the government loses 1 billion per year through those.

In another case, the spectre of harmonisation strikes again:French tax law currently oers rather exible rules on operat-ing losses. Lugand reckons that new limitations on the use and

The main trend tosolve governmentrevenue problems isto collect more taoverall.

Francois ugand

Taxand France



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transferability of those losses are likely. Germany tightenedrules on use and transfer of operating losses several years ago,and France is likely to come into alignment.

In the commercial sector, the retail segment has over-per-formed, but there is some distressed property in a few areas.

Rates were very high before the recession, Lugand notes.Also, there are many new regulations on environmentallyfriendly buildings, which mean many oces are not in com-pliance.

Despite the lack of bargains, Lugand emphasises thatFrance has strong and concentrated markets that are verytransparent, a secure tax and legal regime and rules that allowinternational investors to minimise what seem to be heavyrates at rst glance.

e-ux accommodationsIf France oers a concentrated market, then Luxembourg isthe rened essence. Indeed, both French insurance compa-

nies and German pension funds consistently are major inves-tors. To be sure, there is not a lot of distressed property in theduchy, simply because there is not a great deal of geographyin the tiny nation.

e government is very aware of their in-ternational position and is quite careful, saysKeith ODonnell of Taxand Luxembourg. eydo not feel it is legitimate to impose a large taxburden on investors. Distressed real estate is

just another investment under the tax regime,whether for an income stream or capital gain.

Conservativeness has served the country well,but ODonnell notes that some questions are

arising, if only because nancial developmentsare happening so fast. ere are new vehicleswhere investors are paying 10 cents on the dol-lar and realising 60 or 80 cents. It is dicult togure a suitable way for the government to pickup a layer of gain without imposing what couldbe an arbitrary tax.

Furthermore, the mlange of international in-vestors makes for a nest of interlocking tax laws,ODonnell explains. We have US rules for can-cellation of indebtedness, UK rules for prudentinvestments by pensions and German insurance regulations.It can be tricky not to fall afoul of any rules.

ODonnell urges investors to exercise caution in designingan exit strategy from any investment in light of tax conse-quences. Do your best to be sure that what looks like a suit-able investment today is not going to have a government takea chunk on the way past later.

Mexico might jump to mind as a nation with a considerablepool of distressed assets, but Manuel Tamez of Taxand Mex-ico says that, despite the lurid headlines in US newspapers,the violence perpetrated by drug gangs has been a tragedy formany people but has not had a major impact on trade, com-merce and investment.

People are carrying on with their lives and their business,

Tamez says. In fact, the luxury real estate market is boom-ing. He cites development from Cancun down to Tulumalong the Mayan Riviera. ere are some smaller resort ar-eas where developers overextended, but not a lot of distressedproperties overall.

In an ironic switch, Mexican investors are act ively movingon distressed properties in the US, especial ly parts of Califor-nia, Texas and Florida that have been badly hit by the reces-sion. I have several clients involved in multiple properties,and I was oered opportunities in Miami, says Tamez.

Small countries, big ideasIn Belgium, where there is no current slant to tax policy ondistressed real estate. We have legislation to encourage reno-

vation and, on the other hand, legislation to punish own-ers that have empty or dilapidated real estate, says FredericKransfeld of Taxand Belgium.

Kransfeld notes that Belgium is struggling with budgetary

concerns, but chronic divisions in government between theFlemish north and the Walloon south make any major taxincentives unlikely in the near term.

Cyprus is another small country battling both budget bluesand sectional disputes, but Chris Damianou of Taxand Cy-

prus says tax policy on the island state is indirectly encour-aging investments in distressed real estate because this willgreatly facilitate maximisation of return on investment.

Damianou explains: A major advantage for the interna-tional investor wishing to acquire properties outside Cyprusis that Cyprus oers very low taxation. us, tax incentivesexist if a Cyprus company is used to acquire distressed realestate internationally.

In fact, that statement just may sum up the best piece ofadvice for anyone investing in distressed properties today:take advantage of current rules and loopholes before theydisappear.

We have legislationto encouragerenovation and,on the other hand,legislation topunish ownersthat have emptyor dilapidated realestate.

Frederic KranseldTaxand elgium



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If one wants to look at the way cash-strapped govern-ments and public authorities around Europe are makingdecisions that hit real estate investors in the pocket, one

should look at Germany.In other parts of the world, there have been some notewor-

thy changes. Hong Kong has increased transfer tax quite ag-gressively (as high as 15 percent) on speculative sales, whileChina generally is increasing taxes on property to reducespeculation. But apart from the Netherlands which recent-ly broadened its base, thereby capturing more share transac-tions, but reduced the rate on certain residential transactions it is Germany that is leading the way in Europe.

Ulrich Siegemund, Taxands real estate expert in Germa-ny, says real estate transfer tax is going up across all the re-gions, although power was delegated to each one as long agoas 2006. Given that Germany always has beenone of the biggest real estate markets in Europe,such a move is something global fund managersneed to be aware of.

is is especially the case since Germanyseconomy, which until just recently has beengrowing at a fast clip, has been a magnet for coreproperty investors. Perhaps the poster child ofthis real estate cycle was the December pur-chase of the landmark OpernTurm skyscraper

by JPMorgan and the Government of SingaporeInvestment Corporation for 500-600 millionfrom Tishman Speyer and UBS. It is even morepertinent given the number of German open-ended funds with property to sell.

With more deal ow, Siegemund says the ris-ing real estate transfer tax in Germany is a realissue that should be highlighted so as not to be-come a nasty surprise for those that have put thecountry on their investment destination map. Italso means that deals need to be structured ap-propriately from the outset.

Siegemund explains that transfer tax upon buying a prop-

erty in Germany is 3.5 percent, but it is increasing to 5 per-cent. It doesnt take much to work out that the tax bill ontransact ing a 100 million asset therefore will be signicant-ly higher.

In 2006, the German government made a decision to handover control of setting the real estate transfer tax to the re-gions that make up the country. States have scal needs, sothe trend to increase the tax began in the poorer states, suchas Berlin and those in eastern Germany, says Siegemund.is autonomous right to change the rate was taken up byBerlin and Hamburg in 2007 and 2009, respectively, whenthey raised the rate from 3.5 percent to 4.5 percent.

Aer the previous elections, however, one of the richest if not the richest states have begun evaluating it, Siege-mund continues. Among those states thinking of increasingor already having increased the tax to the maximum of 5 per-cent are Brandenburg, uringia, North Rhine-Westphalia,Schleswig-Holstein, Rhineland-Palatinate, Saarland, Bremenand Niedersachsen (Lower Saxony). In Baden-Wrttemberg,which includes Stuttgart, Mannheim and Karlsruhe, therealso has been an agreement between the parties of the newgovernment to increase the tax to 5 percent.

e issue, according to Siegemund, is that the transfer taxis applied to those buying property, so it creates pressure to

orchestrate the more time-consuming and complicated wayof buying an asset via share sales. en again, it seems thatthe government feels that real estate transfer tax avoidance

structures, such as share deals of a company up to 95 percentof the shares, are unfair. ose structures might be chal-

lenged going forward by the legislator or the tax oces,Siegemund says.Understandably, this tax increase is not going down well

among real estate folk looking at Germany. Aer al l, the lawprescribes that the transfer tax is payable on the transfer,which falls to both buyer and sel ler.

Siegemund speaks for a lot of people when he says: In away, it doesnt make a whole lot of sense. ough states havea scal need, it makes it more dicult to do transactions ifone wants to sell a property. I think this is now well knownin Germany, but perhaps less well known to potential foreigninvestors.

Leading the wayMost countries in Europe havent raised their real estate transer tax but Germany has,

much to the chagrin o investors

The rising realestate transer tain ermany is a realissue that should behighlighted so as notto become a nasty

surprise or those thathave put the countryon their investmentdestination map.

lrich SiegemundTaxand Germany

EROPEA KEOTE



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On Valentines Day this year, the UK property companyHammerson announced the acquisition of SQY Quest,a 31,000-square-metre shopping centre located south-

west of Paris. A run-of-the-mill investment you might say, but itwas close to hearts of Taxand because they advised on it.

According to Francois Lugand of Taxand France, the dealdemonstrates an important trend that Taxanders all over Eu-rope have been talking about the rise to the fore of joint ven-ture deals and club investment structures. Indeed, Hammersonpurchased the property through a 38 million joint venturewith French developer Codic France.

at isnt the only time Taxand France has structured a dealinvolving partners or investment clubs. Last year, it advisedHammerson on ensuring German insurance company Alli-anz could take a 75 percent stake in the Espace Saint Quentinshopping centre near Paris in a tax-ecient manner. In addi-tion, Hammerson sold a 51 percent stake in the OParinor shop-ping centre near Paris to the National Pension Service of Korea,

which acquired the asset through a separate account managedby Rockspring Property Investment Management.One would have thought that investment deals involving just

two parties or at the most a small club of investors would be alot easier to manage from a tax perspective compared to dealsby commingled investment pools containing several dozen in-

vestors. However, Lugand says that, recently, its actually theother way around. A greater concerted eort is needed to getthe investment structures right in order to please all the par-ticipants, he explains. Joint ventures involving a UK REIT, aGerman insurance company and a Korean pension fund bringextra tax complexity to the transaction.

Taxands projects are not limited to Hammerson, rather theyextend to plenty of other players seeking joint venture struc-tures. What is really dicult is to align the interest of the allthe dierent investors, Lugand says.

ow times have changedFour years ago, Keith ODonnell, head of global real estate atTaxand, and his team were busier setting up various standardmodels for commingled funds ranging from Luxembourg fundstructures to UK limited partnerships. Now, mandates revolvemore and more around investment funds, in which one, two ormaybe ve large investors such as pension funds invest along-side each other in conjunction with a fund manager to managethe investment.

Says ODonnell: I think what has happened now is that investors are saying, We cant have something that is good onaverage; we want something that works for us. One investormight have a particular tax prole, where if it invests directly

in a certain country it can get a substantive break on tax, so youneed to design for that investor a parallel structure so that itsinvestment enters into the deal in a dierent way to all the oth-ers. Four years ago, a fund manager would have said this wastoo complicated, but now they say, Okay, we will nd a way todo it somehow.

ODonnell explains how an investment vehicle might wish toinvest in multiple European countries: the vehicle might havethree investors, with one being a UK pension fund. If that fundnds a suitable investment in the UK, the UK pension fundwould say it wanted to invest directly to gain exemption fromtax on the rents and the gains (upon sale) from its investment.

A joint efortJoint venture deals and investment clubs in Europe have risen to the ore, givingTaxanders the task o structuring these more complicated vehicles



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However, the wider fund investment vehicle itself would beinvesting via some block or entity lets say it is a UK company.For the fund, the eective tax rate for the UK property, aerdeduction of depreciation of interest, might be 10 percent. eUK pension fund, though, gets a rate of zero.

Jonathan Hornby, Taxands UK expert based in London, saysjoint ventures are very straight forward for the most part in that

the structures exist to make sure these parties benet from theirown tax prole. A very common vehicle through the years,which still holds today, is the use of the UK limited partnershipas a co-ownership vehicle. One of the obvious benets is that theLP is tax transparent for income and gains purposes, he relays.

e problem is that the other investors might be upset aboutan approach where one investor out of a small number enjoys atax break. More to the point, it also might be unfair under Eu-ropes free movement of capital and anti-discrimination rules.

Taxand currently is doing a lot of work in this area, tryingto argue on behalf of clients that, in a structure like the one de-scribed above, a Dutch pension fund, for example, should enjoythe same tax break as the UK pension fund. e same argument

about a Dutch pension fund being exempt from UK tax on aUK deal could just as easily apply to a UK pension fund invest-ing in France. e UK pension fund could argue it should beentitled to the same break as the French pension fund.

ODonnell explains: We have been involved in tax litigationof a similar nature in France. e result suggests there may bescope to get something comparable in France. In essence, Tax-and has mobilised to lobby Europe lawmakers to arrive at some

sensible conclusions on this issue.

ocal policy shitsIn general, when it comes to direct investments by pensionfunds, European countries should allow tax exemption to EU-resident pension funds, although some countries are still yingin the face of anti-discrimination rules. France is being chal-lenged on its stance, but the Netherlands already has changedits approach to comply with the thrust of European policy.

Henk de Graaf, who works in Taxands Netherlands oce,says he is seeing local developers setting up strategic allianceswith investors to develop and/or redevelop properties. e

Dutch market suers from huge oce oversupply in unprovenlocations, which is one reason why they are looking at redevel-opment, he adds.

As an aside, de Graaf notes that VAT charges for conversionsor transformations of buildings that are no longer occupied arestiing activity. It has become a political hot potato in the Neth-erlands, he adds.

Taxand Belgiums Frdric Kransfeld is working togetherwith Henk De Graaf on one particular real estate investmentstructure involving a Dutch fund manager. e structure isbased in the Netherlands, but it is buying Belgian and Dutchreal estate. He notes that most investors at the start will beDutch individuals and/or companies, but participants alsomight be from Belgium.

It is very complex because you have to take into account allthe dierent parties and their specic needs and requirements,but this certainly also applies to the purely Belgian investmentfunds we have been working on, says Kransfeld. It is verycommon for several nationalities to come to the table and needthe ins and outs of Belgium explained several times because it

simply is not obvious at all, not even for tax lawyers.

ssues o complexityAssuming more than one investor can successfullymove out of a fund structure into a parallel struc-ture, this can certainly give rise to the challenge ofcomplexity. Taxanders says the result can be a verytailored for an individual investment, for which it isadvisable to perform a cost-benet analysis.

Such complex structures raise the question ofhow one allocates the costs of designing a morecomplex structure, as well as potential governanceissues. For example, does the new structure give the

UK pension fund a de facto veto right over futuredecisions to dispose of the property?Club structures indeed might be popular, but not

every country is geared up for them. Sometimes,club deals or joint ventures give opportunities to

save real estate transfer tax or advantages in the interest de-duction area, but normally this requires that each member ofthe club purchase separately and this is not what they usuallywant, says Ulrich Siegemund of Taxand Germany. Usually,they want one vehicle. Taxand Germany has advised on suchdeals, but more oen it has worked on structures involving acommon vehicle, normally located outside Germany.

While investing in German real estate generally is advanta-

geous because of its economy, Siegemund points out that the taxenvironment is unstable. Maybe it is the same in other coun-tries, but not in Luxembourg the typical location for such

vehicles where it very much considers the needs of investors,he says. In contrast, Germany has a battle between taxpayersand the government, which wants to close loopholes.

In neighbouring Poland, real estate also is keenly in de-mand given the way the economy didnt crumble like manyothers in Europe did during the global nancial crisis. LocalTaxander Pawel Toski points to the recent investment g-ures coming out of the country as evidence of that. Indeed, on4 August, property broker Savills said investment levels were

I a certainnumber o partnersare involved,a collectiveinvestment vehiclecan be set up to bemore ta ecientthan an ordinary

joint venture.

Stephan PenningerTaxand Switzerland



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on track to reach 2 billion by the end of 2011 areturn to 2007 levels.

Unsurprisingly, the country has witnessed joint venture deals as part of that volume. e Span-ish developer and manager Neinver, for example,struck up two joint venture structures in Polandlast year.

In one, Neinver teamed up with London invest-ment rm Meyer Bergman to develop a 200 mil-lion mixed-use project at Katowice railway station.Meyer Bergman, which has been raising its debutretail property fund, and Madrid-based Neinversaid they would hold a majority stake in the proj-ect, with a minor stake being held by Polskie KolejePanstwowe, the Polish National Railway company.In another instance, Neinver entered into a dealwith Heitman European Property Partners, theEuropean wing of the US investment rm, for a 75percent stake in Galeria Malta in the city of Poznan.

ere are even some new asset classes to get excited about in

Poland. For the rst time, condo hotels have been introducedin the country, which Toski points out has led to some confu-sion about how they should be taxed.

It is the same story in Russia, where Taxands Andrey Tere-schenko is seeing more deal activity, and in Switzerland, whereStephan Pfenninger has structured real estate joint ventures.Pfenninger says investors use joint venture partners in order tobetter manage and diversify their investment risks. But if a cer-tain number of partners are involved, a collective investment

vehicle can be set up to be more tax ecient than an ordinaryjoint venture, he adds.

Tereschenko says property investment funds usually try notto have a joint venture structure in Russia. If they do create a

JV, it oen would be with a Russian partner. However, the JVwould be structured to be governed by UK law, for example,since Russian corporate law is less developed.

Famine over eastOf course, not every Taxander has been lucky enough to seereal estate transactions go through. In Ireland, Taxand worked

tirelessly last year to organise a structure for New York privateequity real estate rm AREA Property Partners and partner

F&C REIT Asset Management to buy the 475,000-square-footLiey Valley shopping centre for a reported 350 million.

e deal kept falling through because of concern over Ire-lands bailed out economy and a threat by the last governmentto retrospectively tear up upward-only rent reviews, which bysome estimates would wipe 20 percent to 30 percent o realestate values immediately. It is no wonder then that Irelandhas seen not one commercial real estate investment deal thisyear as of press time. Nevertheless, Martin Phelan said Tax-and had structured something that was nearly good to go forAREA and F&C.

e idea, Phelan explains, was to put the shopping centreinto a qualied investment fund, which was a limited part-

nership established in Ireland. e benet of the structurewas that the rental income and gains upon future sale wouldhave been tax free, as would have the distributions out to theforeign private equity funds. e idea of forming a limitedpartnership, meanwhile, was to minimise the 6 percent stampduty cost on acquiring the building, as Ireland has quite a hightransfer tax at 6 percent, compared to the UK at 4 percent.

It was quite a good structure, but a dicultproject involving many steps, laments Phelan,who can only hope that the investment market forprivate equity real estate players will return. In themeantime, he has been working with retailers suchas Tesco and Disney to help them open up outlets

in Ireland. at, as well as advising on KennedyWilsons takeover of Bank of Ireland Real EstateInvestment Management, has been keeping TaxandIreland busy.

In the hotter investment markets such as France,Germany, Poland and the UK and to some extentBelgium, the Netherlands and Switzerland therecertainly is more work to be done on behalf of pri-

vate equity-style investors. With no sign that jointventures or club vehicle structures have run out ofsteam, Taxanders will be busy working on more ofthese complex structures for a while yet.

The benet o thestructure was thatthe rental incomeand gains uponuture sale would

have been ta ree,as would have thedistributions out tothe oreign privateequity unds.

Martin Phelan

Taxand reland

Propertyinvestment undsusually try not

to have a jointventure structurein Russia. I they docreate a JV, it otenwould be with aRussian partner.

ndrey TereschenkoTaxand Russia



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Investing in real estate in the US, Canada and Mexico hasbecome both increasingly attractive and increasingly wor-risome to foreign investors over the past three years. It is

attractive because of strong economies and lucrative opportu-nities and worrisome because of changing tax rules and regu-lations for each North American country. Not only that, someinvestors are still a bit gun shy about investing large chunksof capital overseas in the wake of the global economic crisis.

Foreign investors want to make sure that theyre minimisingthe amount of taxes theyre paying on income gained from realestate investments. However, Frank Walker of Taxand US saysthat, when it comes to investing in real estate in the Americas,

the taxes are only one factor.In fact, Walker points out that a big factor from an invest-

ment standpoint is governmental uncertainty both in termsof legislation and regulation. e reason for this isbecause governmental uncertainty directly impacts

job creation.ats what really drives the real estate market,

says Walker. Whether it is jobs for people buyingresidential property or shopping at retail centres orworking in oces, it drives so much of the economy.

Now, as opportunities seem to be picking up inthe years since the global economic crisis, capitalthat previously sat idle is looking for a place to go.

According to Walker, this means investors are goingto decide if they want to resume investing with rmsand people theyve worked with before or if theywant to start looking at alternatives. at can be afunction of previously committed funds remainingidle or human nature, including investor concernsabout prior investments not performing, he says.

As it stands now, each North American countrycurrently is experiencing its own issues, accordingto Walker. is means that each nation the US,Canada and Mexico has its own unique set of perks and chal-lenges to its real estate landscape. So its essential for foreigninvestors to nd out what makes each nation appealing and

what makes each problematic for the eort (see related featureon the Americas).For example, what makes the US attractive is the abundance

of commercial properties and nonperforming loans that canlead to both long-term revenues and high rates of return dueto the risk, according to Walker. One red ag, of course, is theincreased scrutiny the US Internal Revenue Service is placingon foreign investment, which is something foreign investorsarent used to. For Canada, the appeal is low tax rates and a

very stable government, while the challenge is high prices anda low amount of product. For Mexico, its the profusion of allsorts of property types, with the challenge of an extensive and

pricey tax system.In any type of real estate investment, people do a lot of tax

planning to try to maximise income treated as capital gains,Walker says. So if you have some place like Mexico that thatdoes not have favourable treatment for capital gains, you haveto determine what else makes it attractive versus another coun-try. Its pretty much a cost-benet analysis.

at said, Walker adds that its always a good idea to diver-sify, not just with the type of investments but with the geogra-phy as well.

Being consistent with the economic structure of the planfrom inception to exit also is more important than ever when

investing in the Americas, with the IRS demanding more trans-parency and Mexico seeing changing tax laws. Private equityrms, Walker says, need to make sure that the initial structure

of the deal makes economic sense and that it is not going to takeshort cuts that disregard that structure in the future.

In the long term, Walker says cost might be another big fac-

tor. While investors and private equity rms gure out hownew tax systems in the US, Canada and Mexico aect them,there may be a temporary chilling eect.

Although cost is a factor that could slow down investors andprivate equity rms seeking opportunities in the Americas,Walker thinks its unlikely that it will stop them. Aer all, hav-ing to pay taxes is the inevitable cost of doing any sort of busi-ness, anytime and anywhere.

e bottom line: if you want to make a small to large fortuneinvesting in real estate, you need to be ne with spending somemoney on domestic and foreign taxes. And if you cant, thenyou may be playing the wrong game.

eyond ta issuesTaxands S real estate expert points out that due diligence in oreign investment is

crucial or private equity real estate frms, but its really only hal the battle

In any type o realestate investment,people do a loto ta planning totry to maimise

income treated ascapital gains.

Frank WalkerTaxand S

AMERICAS KEOTE



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Despite recent stock market jitters surrounding the US

debt ceiling showdown and Americas subsequentcredit rating downgrade, economies throughoutNorth America have stabilised considerably since the globaleconomic crisis. is means that investor condence gener-ally is strong for markets in Canada, Mexico and the US.

Although the economic, tax and real estate landscapes forthe three North American countries are obviously as wellas markedly dierent, they each oer advantages to pri-

vate equity rms seeking real estate investment opportuni-ties. However, when investing in real estate in those markets,rms still should be aware of a number of red ags withineach countrys tax laws.

According to Taxand, there are a number of ever-changing

tax laws and pitfalls that private equity real estate investorsneed to be wary of within the three nations. Some of thesepotential risks include Internal Revenue Service scrutiny inthe US, high prices in Canada and the at tax in Mexico.

Still, Taxanders believe that these tax challenges are farfrom insurmountable. Investors exercising some caution, tol-erating some additional levels of transparency and creating acoherent exit strategy well in advance can help lead to prot-able investments.

Closer tabs, tighter leashAlthough real estate investment activity in the US hasnt

reached 2007 levels, it has grown slowly and steadily since

its precipitous drop in 2008. And although transactions foracquisitions are on the rise, there are sti ll some things inves-tors need to take note of about investing in real estate in thecountry, according to Frank Walker of Taxand US.

e climate is getting better and clearly the activity levelis picking up quite a bit, but there are still a lot of issues in theUS, says Walker of the US current economic environment.e biggest issue is perhaps the additional IRS scrutiny.

Indeed, the IRS has developed a managed fund approachto auditing private equity real estate rms and funds. In thepast, the IRS would select either a private equity rm or par-ticular fund to audit. Now, it is organising a coordinated ap-proach to managing related taxpayers in the private equity

space. In addition, the IRS is trying to work with other for-eign governments to oer a more coordinated audit on inter-national funds.

Currently, the IRS has made a deal with Australia and isin the middle of making deals with the UK and Netherlands.erefore, foreign real estate investors need to pay closer at-tention to the cross-border fee structures and whether charg-es are at appropriate arms length.

Regulatory compliance cost is the other major area ofconcern for investors seeking opportunities in the US, dueprimarily to the passing of the Foreign Account Tax Compli-ance Act (FATCA) in early 2010. FATCA came about due to

Land o opportunities and challengesespite strong investor confdence in real estate in Canada, Mexico and the S,

private equity real estate investors still need to be wary o potential pitalls



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concerns about US investors having funds hidden in overseasaccounts. e IRS announced that enforcement would be de-layed in order to provide additional guidance to aected busi-nesses, which should enable investors to understand howmuch this regulation is going to cost.

Because of FATCA, certain foreign nancial institutionsmust enter an agreement with the IRS by June 2013, statingthat the rms are in compliance with these reporting require-ments. Otherwise, theyre going to have to start withholdingpayments they make to investors beginning in 2014. e IRShas not nalised guidance on which foreign nancial institu-tions may not need to comply with these rules.

is increased scrutiny from the IRS and increased regula-tion in the US also could lead to cold feet from investors orintermediaries, as some may be unsure whether to continueseeking real estate opportunities in the US or wait for morespecic guidance. So, although the US has plenty of invest-ment opportunities, the country may see some change in the

sourcing of capital for these investments in the near future,Walker pointed out, adding that it may be too early to tell atthis stage in the game.

ere also are a number of private equity rms looking topurchase nonperforming loans something of which the UShas an overabundance. Youre seeing a lot of movement to

clean up some of that, but theres still a long way to go, saysWalker. Some strategies for these nonperforming or bad loanscould involve restructuring of debt or consensual agreementsinstead of foreclosure. But theres still a lot that has to hap-pen, he added.

Ultimately, Walker asserts that foreign real estate invest-ment in the US requires considerably more planning of late inorder to make the deals as consistent and tax ecient as pos-sible. You need to know the procedures, he says. e IRS isfocusing hard on whether theres real substance to the struc-ture of an investment and determining whether the fund op-erates in accordance with that structure on an ongoing basis.

ower rates, higher pricesIn contrast, Canada has a dierent set of rules, perks andproblems for potential investors. For one thing, the countryis substantially more stable, economically, than the US. Inaddition, it has comparatively low tax rates.

Vince Imerti of Taxand Canada says: In terms of taxrates, the US and Canada are going in dierent directions.In fact, the two countries are a lmost polar opposites, accord-ing to the Canadian tax lawyer. Canada currently is drivingdown tax rates, while I suspect there will be pressure in theUS to squeeze [as many] tax dollars out of these private eq-uity funds [as possible], he adds.

In addition, there arent huge capital gains issues for inves-tors seeking Canadian properties, as foreign investments aretaxed at half rates. e new conservative government wantsto keep taxes down, Imerti notes.

Canada is not really seeing many benecial ownership ordebt restructuring issues. is does not mean, however, that

Canada is the land of consequence-free milkand honey for the would-be real estate investor.

In fact, Imerti says all these low tax and in-terest rates within Canada have caused a fairlypredictable consequence namely, higher pric-es. Prices havent really come down in Canada,so purchasers are a little reluctant to pay topdollar, he adds. Interest rates are low enoughthat vendors feel they can continue asking thoseprices.

Another problem private equity real estateinvestors are facing in Canada is quite simply,as Imerti put it, a lack of product in the mar-

ket. He points out that, despite seeing a stableeconomy and strong investor condence, themarket is very tight.

As a result, whereas the US is seeing a greatdeal of investment activity in distressed andforeclosed properties, Canada is seeing a greatdeal of foreign investment activity in real estate

development. Imerti also notes that nancial stability andlow tax rates in Canada lead to low-risk investments. How-ever, that also may mean low rewards.

Canadas very stable, Imerti says. e US is very un-stable, which means that theres a lot of foreign interest in theUS markets because people are buying debt and foreclosing

on properties.is doesnt mean there arent opportunities for lucra-tive real estate investment deals in Canada or that theresno product. As PERE recently reported, New York-basedprivate equity and real estate giant e Blackstone Grouprecently sold a portfolio 29 refurbished oce buildings lo-cated throughout Canada to Dundee Real Estate InvestmentTrust for C$831.8 million ($881 mill ion). ese types of dealsarent common in Canada, but they do exist.

Ultimately, Canadas tax laws make rea l estate investmentan enticing low-risk endeavour for private equity rms andinstitutional investors alike. Canadian pension funds and

The IRS is ocusinghard on whethertheres realsubstance to thestructure o aninvestment anddetermining whetherthe und operatesin accordance withthat structure on anongoing basis.

Frank WalkerTaxand S



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sovereign wealth funds are ush with cash Imtalking billions of dollars and need to deployit, Imerti says.

ong arm o the (tax) law

On the ip side, whereas Canada may have alack of product, there currently are several eyeson Mexico for real estate investment opportu-nities. Mexico has seen a great deal of appetitefor real estate from foreign investors of late, asevidenced by the meteoric rise in residential,commercial and industrial construction takingplace in the nation.

Manuel Tamez of Taxand Mexico points outthat perhaps the biggest hurdle for investorsseeking opportunities in Mexico is the coun-trys long-reaching tax system.

Mexico considers revenue from a foreign rm

taxable if the majority of its investments are inthe country. For example, if a US investor wereto sell shares of a Japanese rm that does the majority of itsreal estate investment deals in Mexico, that investor wouldbe hit with a Mexican capital gains tax.

Because of this, it would be wise for rms looking forshort- or medium-term investments in Mexico to have anexit strategy placed well in advance of any and all projects.is is a very signicant issue in tax planning, Tamez says.Because of the Mexican tax system, you need to consider apotential exit.

One solution to this situation is doing business with a Bel-gium- or Luxembourg-based rm, as these nations have dou-

ble-taxation treaties with Mexico and therefore have beengranted exceptions. However, this obviously isnt a solutionfor all rms and investors.

e at tax is another issue of concern for investors inMexico. When real estate is purchased in the country, the

owner is given a deduction. is deduction, however, will beused against income gained on that property. If the owningentity decides to sell the property, all the income obtainedfrom the sale is taxable because it used the deduction upfrontinstead of sheltering capital gains.

Considering that the rate for the at tax is quite high 17.5 percent this can turn into a serious issue if the privateequity rm doesnt execute thorough due diligence on theinvestment plan.

eres no shelter for this tax, says Tamez. If you takethe deduction in advance when you purchase the invest-

ment, then thats going to be used against current rental in-come going forward.To avoid the at tax, in some extreme cases, some rms

owning Mexican real estate that want to sell o assets havemigrated to other countries to avoid the at tax, as it is only

paid by Mexican residents. is isnt very com-mon, Tamez notes. Its not illegal, but its stilla bit aggressive.

At the end of the day, Tamez points out that agreat number of the tax issues that can besiegeforeign investors can be mitigated and possiblyeven outright avoided by thorough preparationand having a good exit plan. In other words, its

all about planning ahead.You want to structure the deal in a way thatthe exit optimises ta xes in Mexico, Tamez says.In fact, this advice could apply to just about anyinvestment plan for any nation.

Despite the pitfalls, Taxand believes theNorth American markets are ush with realestate investment opportunities. Taxes need tobe taken into account, but they are not the onlyconsideration. Taxes are only one factor, saysWalker. If theres an opportunity to make aprot, you can aord to pay some taxes.

ecause o theMeican ta system,you need to considera potential eit.

Manuel TamezTaxand Mexico

There arent hugecapital gainsissues or investors

seeking Canadianproperties, as oreigninvestments aretaed at hal rates.

Vince mertiTaxand Canada



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W

hile tax treatments remain favourable to privateequity real estate GPs in some jurisdictions, a

number of recent changes in tax law could impactinvestment strategies.Changes to capital gains tax treatment and benecial own-

ership issues are likely to remain two of the key areas of tax forprivate equity real estate rms to grapple with in the comingmonths. When combined with governments looking to chal-lenge tax structures and possibly introducing new rules, taxadvisors face the possibility of having their hands tied in re-ducing the tax burden of investing.

Many jurisdictions treat capital gains on equity investmentsfavourably, applying some form of participation exemptionto dividends and or gains on signicant shareholdings. etheory is that the underlying prots already have been taxed at

the level of the company.is means a lot of grey matter is going into constructing theright platform to invest in assets in order to escape being taxedtoo highly on the expected pick-up in values. ough hugeprots have been made in the past, the additional challenge ofreal estate investing is that domestic tax laws and regulatoryframeworks have been changed, and in some cases delayed.

Carrying one US has been faced with much back and forth regarding atax hike on carried interest. However, the conversation cameto a grinding halt aer contentious debt ceiling negotiations

failed to include carried interest tax changes, a victory for pri-vate fund managers.

Debate over carried interest tax designation has raged overthe past few years with Republicans defending the capitalgains rate and Democrats arguing a carried interest tax hikecould help address the decit. In 2009, the government esti-mated that taxing carry as ordinary income would raise nearly$26 billion in tax revenue. While that would be a drop in thebucket in terms of paying down the $14 trillion national debt,Congress remains under intense pressure to increase revenueby all means necessary.

In April, Obama unveiled his budget proposal, which di-rected Congress to require executives of private equity rmsto pay ordinary income tax rates as high as 35 percent (39.6percent aer 2012) on the prots they receive as compensa-

tion. Carried interest currently qualies for lower capital gainstax rates of 15 percent (20 percent aer 2012).Many industry players were sure the momentum in the US

for a carried interest tax increase picked up as Republicanswere being forced to make dicult decisions during ongo-ing debt ceiling negotiations. Indeed, Congress and PresidentBarack Obama were locked in a bitter battle, with various taxincreases expected to be part of the nal agreement. Aer sev-eral attempts to put carried interest tax on the table, however,the debt ceiling negotiations closed with capital gains rmlyo the table.

e discussion around capital gains has indeed been part

Ta angstver the coming months, changes to capital gains tax treatment and benefcial

ownership issues around the globe are likely to cause anxiety or private equity real

estate frms



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of the larger tax debate, says Frank Walker of Taxand US.However, an observer might say that Congress has bigger is-sues to deal with now.

As a result, private equity real estate managers have nothingto fear until the next round of discussions in the fall.

Reworking the system

Proposals underway in India to rework the nations domestictax system could lead to a 30 percent tax on carried interest.India is about to change its domestic tax code, replacing thecurrent law with a new direct taxes code, which will go intoeect in April 2012.

What does this mean for the private equity real estate man-agers? Unlike most other countries, India taxes even non-residents on the sale of Indian shares, therefore this changecould impact all oshore funds whether investing directly intoIndia or through an onshore fund. e apprehension has beenthat once this new tax code comes into eect, all the structuresset up in low-tax jurisdictions such as Cyprus andMauritius, where the primary motive is to avail a

favourable tax treaty with India, could come underdetailed scrutiny.

At present, the ordinary income tax rate is 40percent for foreign companies and 30 percent forothers, whereas the capital gains tax is 20 percent,so there is a 10 percent dierential. Under the newtax code, there will be a uniform 30 percent ratefor all taxpayer on all income, as per the currentproposal.

ere will be certain deductions, however, forcapital gains. For example, if one were to sell listedcompany shares on the oor of the stock exchangeaer holding them for one year, then there will be

100 percent deduction from the capital gains tax.So essentially, there will be zero tax.e impact on real estate has been swi. Fund

managers are now exploring alternative jurisdic-tions where they have a better chance of meeting the substancetest. Many fund managers are exploring Singapore because In-dia also has a favourable treaty with the Asian city-state, thedierence being that the Singapore treaty already has someanti-treaty shopping provision built into it. So, somewherethere is an expectation that it might sustain even aer the newtax code comes in.

Secondly, Indian fund managers are more concerned if theyare controlling the fund from India. In such cases, the proto-

cols that are put in place for the investment decisions are likelyto face more scrutiny. Many fund managers also have startedexploring structures where they can pass on the tax credit totheir investors.

K exemptionMeanwhile, UK tax authorities made it easier in May for o-shore private equity real estate investors to preserve returnsas capital gains aer once fearing an income tax rate treat-ment. Indeed, realisations made by funds in investmentsstructured oshore will be treated as capital gains and not asoshore income.

Without the exemption, UK-based private equity real estateinvestors and GPs potentially faced an income tax rate as highas 50 percent on their returns generated from investments heldthrough oshore entities. e UK capital gains tax rate for highearners currently is 28 percent.

To gain the exemption, at least 90 percent of the assets ofthe oshore special purpose vehicle (SPV) must be in unlisted

trading companies. e exemption originally stated the SPVhad to maintain the 90 percent threshold right up to the dateof disposal, but UK tax authorities have since relaxed the stan-dard to allow assets to be realised before then, even if doing sowould mean the SPV dipped below the 90 percent oor.

e issue arose in late 2009, aer the UK government de- vised new rules to clamp down on investors avoiding taxthrough the use of oshore investment vehicles. e revisionspotentially could have captured private equity funds usingoshore SPVs to structure their investments, which the newoshore funds tax regime will cover.

utch exemption upheldPositive developments continued in the Netherlands, as capitalgains are mostly 100 percent exempt under the Dutch partici-pation exemption. e participation exemption, which existsin a handful of European countries, relates to the exemptionfrom taxation for a shareholder on dividends received and po-tential capital gains arising from the sale of shares. A DutchSupreme Court case rearmed that exemption.

An interesting development in this respect is that, as a result

of a Dutch Supreme Court decision, capital gains on certainderivatives on shares (convertibles, option rights and warrants)under certain circumstances also are covered by the participa-tion exemption, says Henk de Graaf of Taxand Netherlands.

Other capital gains that are taxable at the statutory rate havebeen consistent as well. An important way of deferring tax-able gains is contributing the gain to a so-called reinvestmentreserve, says de Graaf. In broad terms, if a property held forinvestment is sold and one intends to replace this property by anew investment, the capital gain may be deferred by reducingthe tax basis of the new property.

Over the last few years, tax authorities have challenged the

Realisationsmade by undsin investmentsstructured ofshorewill be treated ascapital gains andnot as ofshoreincome.

Jonathan ornby

Taxand K



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use of the reinvestment reserve by taxpayers,stating that all relevant criteria are not met. isposition was taken in respect of the requirementthat the replacing property would not have thesame economic purpose, says de Graaf. How-ever, the Dutch Supreme Court ruled in manycases in favour of the taxpayer stating that the

reinvestment reserve should be applied broadly.

Clariying benefcial ownershipe term benecial owner has given rise to dif-ferent interpretations by courts and tax adminis-trations. Given the risks of double taxation andnon-taxation arising from these dierent inter-pretations, several governments have developedproposals aimed at clarifying the interpretation.

For example, the Netherlands historically hasapplied a very legal interpretation to the termbenecial owner. In fact, the owner of the legaltitle is in principle also considered the benecial owner.

However, the new Organisation for Economic Cooperationand Development (OECD) discussion dra on benecial own-ership may change this view since the Netherlands refers tothe OECD commentary for the interpretation of its tax trea-ties. Since the Netherlands applies a dynamic interpretationof their tax treaties, new commentaries may have an eect onhow treaties are interpreted, explains de Graaf.

e three key points in the discussion dra are as follows:First, a treaty-based approach to interpreting the term is

used, although it recognises that a domestic law interpreta-tion may be applicable if consistent with the general guidanceof the commentary. A narrow technical interpretation of theterm based on domestic law is not appropriate.

Second, the recipient of a payment is the benecial owner ifhe has the full right to use and enjoy the income unconstrainedby a contractual or legal obligation to pass the payment to an-other person. Such an obligation will normally derive from rel-evant legal documents, but it also may be based on facts andcircumstances that show that the recipient does not have the

full right to use and enjoy the payment. e use and enjoyment

of a payment must be distinguished from the legal ownership.Finally, the fact that the recipient qualies as the benecial

owner does not guarantee reduced withholding tax rate basedon the treaty. Other anti-abuse rules can be included in a trea-ty that may restrict the use of the treaty.

Taking the issue to courtIn the benecial ownership debate, Denmarks court systemhas taken centre stage. In January, a ruling from the DanishTax Tribunal considering the concept of benecial ownershipwas published. at ruling is the third from the tax tribunalregarding benecial ownership rules, which initially were is-sued last year.

ere is a very aggressive stand on benecial ownership inDenmark, says Anders Oreby Hansen of Taxand Denmark.ere are a number of court cases running, and it will be aerce battle for the next six to eight years.

A recent tax case in Denmark considered the meaning ofbenecial ownership of interest and dividends paid by Danish

companies to Swedish holding companies, whichthen paid the interest to a Jersey holding company.

Danish tax law levies withholding tax on in-terest at a rate of 25 percent to payments madeto non-resident holding companies unless thetaxpayer can benet from a reduced rate under atax treaty, the EU parent subsidiary or the inter-

est and royalty directives. To benet from the taxtreaty, the taxpayer generally must be the bene-cial owner of the interest income.

Clients are concerned about investing in Den-mark, says Hansen. ey are worried about be-ing caught in the crosshairs.

In the meantime, many wil l be keen to gaugethe reaction of the large global rms, for whichthese tax rulings are intended. Whether theirinterest levels in certain markets will remain thesame in the face of such uncertainty remains tobe seen.

An important wayo deerring taablegains is contributingthe gain to a so-called reinvestmentreserve.

enk de GraaTaxand Netherlands

enecial interestis written into mosttreaties dealingwith dividends and

interest, and therehas been quitea bit o litigationconcerninginternational tastructures.

Keith onnellTaxand uxembourg



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For more venturous fund managers and investors, thecountries of Eastern Europe (which roughly pass foremerging markets) has held greater allure in recent

months thanks to economic stability.Even the smallest markets, such as Estonia in the Baltics,

have seen some action of late. In July, the Norwegian-basedrm BPT Asset Management bought an oce complex in Tal-lin for a new property fund.

Against that background, Chris Damianou of Taxand Cy-prus says the Mediterranean island nation is still the leadingplace to structure holding companies that make investmentsin the region. at is because of the double taxat ion trea-

ties that Cyprus has with many of those Eastern Europeancountries.

Reecting the ndings of a Market Update report by Cush-man & Wakeeld in July, which highlightedRussia as a country seeing good demand fromrisk-taking oce buyers, Damianou says Rus-sia tops the list in terms of the markets his cli-ents are active in. Russia is then followed by theUkraine, India, Romania and other Common-wealth of Independent States countries as in-

vestment destinations.e most important event to plan for is the sale

of the investment, and real estate fund manag-

ers typically will be able to pay practically zero incapital gains tax if the asset is sold via shares in aspecially created company. ese sales are most-ly tax free where the real estate is located and taxfree in Cyprus as well, Damianou says. Realestate funds can utilise the double taxation ad-

vantages that Cyprus has with other countries.If the fund manager ultimately is from the US,

there certainly is still scope to keep the tax closeto zero.e proceeds from a property sale struc-tured through Cyprus will attract no taxation in the countrywhere the investment has taken place or in Cyprus. Further-more, when repatriated to the US, the prots will not be sub-

ject to any withholding taxes either. It is a powerful tool inthe hands of a US corporation, adds DamianouTaxand Cyprus currently is working on a plentiful supply

of deals in Russia, almost as many as it was working on priorto the global nancial crisis. It has three full-time advisersthat work on Russia/Cyprus aairs and 99 percent of the workis real estate-related.

Even though Russia has renogiated its tax treaty with Cy-prus, Damianou says the real estate element of the new treatywill only come into eect in 2016. Even then, the organisationis experienced enough to provided proper advice on how tomitigate the eect of this change in the taxation of real estate.

Underlining that point, Taxand currently is in the midst ofadvising on the sale of an asset in Russia, on which it per-formed tax planning advice several years ago.

Despite the activity in Russia, the largest transaction Tax-and Cyprus has been involved with so far has been the sale ofreal estate in Poland and Romania.

Around two years ago, Taxand Cyprus began tax planningfor a US real estate conglomerate that owned a substantialportfolio of shopping malls in various countries in the EU

via other European subsidiaries. In deciding how best to exitthose investments, it worked with ve Taxand colleaguesfrom other countries to restructure the property holdings. By

using the EU Merger Directive, which is designed to aect taxfree mergers in Europe and is valid in Cyprus, the organisa-tion was able to transfer the property to a Cyprus company.

When the Cyprus company itself was sold to another inves-tor, the US manager of property paid no tax.

e EU Merger Directive al lows companies to restructure

their holdings without paying tax anywhere, not even stampduty or transfer fees. In this case, it was really a structure tolimit the tax upon a sale rather than a straight-forward merg-er and acquisition, yet the directive still allows this.

It was really challenging and complicated because we hadsix countries involved, explains Damianou. We needed a

very well-organised, step-by-step approach leading to courtdecisions from each country. e deal nally was completedthis February when the Cypriot company was liquidated.

It is good example of how Cyprus seems to be the placeto be when investing in Eastern Europe and other emergingmarkets.

An emerging market or emerging marketsWhen it comes to zero tax on capital gains rom selling Eastern European real estate,

Cyprus is king

Real estate undscan utilise thedouble taationadvantages thatCyprus has withother countries.

Chris amianouTaxand Cyprus

EMERI MARKETS KEOTE



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Forward planning ones capital gains tax exposures is a tallorder at the best of times. For those international privateequity real estate rms engaged in unlocking as much

value from Asian real estate as humanly possible, the challengebecomes much more complicated when the tax authorities movethe goalposts.

Take India for example. In 2009, PERE reported that the

countrys Dra Direct Taxes Code (DDTC), part of Indiasplans to overhaul its entire tax system for corporations and lay-men alike, would come into eect this year. Of high relevanceto private equity real estate rms, the DDTC is expected to laydown a blueprint from which tax-cognisant investment strate-gies can be better executed. Unfortunately for those waiting,that wait is going to continue, with a revised date for imple-mentation of 1 April 2012.

Rumours suggest even this date will be missed, says Ab-hishek Goenka of Taxand India. Currently, the DDTC is in thesecond dra stage and with a parliamentary committee (theirrecommendations pre-empt when it can be considered ready forenactment). Although implementation of this more watered

down version remains uncertain, rms must keep tabs on howits content is evolving, he notes.Of particular concern within the DDTC are the proposed

anti-avoidance provisions, which give Indian tax authoritiessweeping powers, including the ability to deny treaty benets incases of alleged tax avoidance. ese anti-avoidance provisionsare particularly likely to impact the eligibility of investors to takeshelter under the provisions of Indias tax treaty with Mauritius,for many years a favoured domicile for investors seeking to re-lease prots from Indian investments while circumventing thecountrys standard 20 percent capital gains tax.

According to a report by Te imes of India, more than 40

percent of total foreign direct investments into India come fromMauritius entities. erefore, Goenka says it was little wonderwhen news surfaced earlier this summer that the India-Mauri-tius treaty could be de-negotiated, that Indias stock markettanked by a few percentage points. Still, he counters by say-ing: Our take is that the negotiation is more about introducing alimitation of benets clause, which essentially means only genu-

ine structures operating out of Mauritius are entitled to benetfrom the treaty.Exasperated by an ongoing legal feud between telecommu-

nications giant Vodafone and Indias tax authority, the latter ofwhich is pursuing the former for failure to withhold tax on itsacquisition of Indian peer Hutchinson Essar in 2007 via a Cay-man Island-domiciled entity, scrutiny on what constitutes sub-stance for a Mauritius company has never been higher. With noconcrete guidelines available, Goenka suggests rms setting upentities on the island could avoid them being labelled paper orshell companies by ensuring they are responsible for mean-ingful activities, such as the pooling of capital in the case of afund manager. In addition, he recommends having local resi-

dent directors with adequate nancial backgrounds and sug-gests carrying out fund administration and accounting workthrough local employees.

Goenka also notes that Singapore is fast becoming a compet-itive alternative treaty destination for rms investing in India.As with Mauritius entities investing in India, there are no capi-tal gains taxes under the treaty between the two jurisdictions,and rms increasingly are coming around to the belief that thecity-state also benets from better stang potential. Aer all,Singapore is recognised as a nancial hub in its own right.

Predictably, however, Goenka warns that setting up in Sin-gapore comes with potentially more onerous hurdles than do-

Asias moving goalpostss sias markets evolve, so do its tax implications. Taxanders rom three o the

regions biggest markets China, ndia and Korea tell o what is happening in their

particular jurisdictions



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ing so in Mauritius. ere are challenges in theSingapore jurisdiction in terms of determiningsubstance, registration tests and so on, he pointsout. e place works for some funds, like closed-ended ones, but it doesnt work for other kinds.

Classifcation o 2012

Under the current treaty, private equity real estaterms are enjoying no capital gains taxation on thetransfer of securities or shares in an Indian compa-ny to a Mauritius company. Firms have long estab-lished Mauritian entities to acquire shares in Indiancompanies that own underlying real estate. Indeed,ownership of the real estate comes with buying theshares of the owning company.

However, Goenka says an emerging paradigmshi in respect to the scope of capital gains taxa-tion, as classied in the latest incarnation of the forthcomingDDTC, could have signicant ramications on taxation of in-come from the sale of shares. at is because the denition of

what constitutes a capital asset is changing.Essentially, any assets used for or in conjunction with the

business of a company are no longer a capital asset, Goenkasays. It is treated as a business asset with an exemption onlyin the case of securities held by foreign institutional investors,which would continue to be treated as a capital asset. As such,the question of how tax is calculated on the income of such as-sets has surfaced.

Goenka demonstrates using a hypothetical situation: An o-shore investment company based in a tax haven owns a particu-lar project through a special-purpose vehicle, holding 100 per-cent of the shares. e question that arises is whether the incomefrom the sale of those shares is taxable as business income or as

capital gains under the domestic law. It seems, under the reviseddenition, it is going to be business income.Such a situation would give rise to several complications re-

garding the eligibility of the onshore company to rely on capitalgains tax relief under various tax treaties, and that could de-pend on the specic language used in the individual tax treaty,Goenka says. However, he also suggests such an interpretationcould oer some advantages. For instance, as business income

for international rms operating through a treaty country isnot taxed by the country unless such income is linked to a per-manent establishment, income earned by international rms

from the sale of shares may not be taxable and the need to routetheir investments from jurisdictions such as Mauritius may nolonger be necessary.

Goenka says: If the income from the sale of shares by aprivate equity real estate fund is indeed treated as businessincome, a US entity could very well invest directly into Indiaand still not suer any taxes on the income from the sale of itsshares, even without routing the income through jurisdictionssuch as Mauritius.

Exit blockingAnother jurisdiction to see its taxation goalposts shi is Korea.Of indirect concern to international investors is how the Korean

tax authorities recently have moved to block exits en-masse bycorporations holding non-commercial land or residential prop-erties situated within its three designated speculative regions inSeoul Gangnam, Seocho and Songpa. Koreas National TaxService (NTS) stipulated that, from March 2009, an additional10 percent tax on capital gains made on sales of properties inthese regions be added to Koreas standard 22 percent (24.2 per-cent with resident surtax) corporate tax rate. Previously having

extended the hike to December 2010, the additionallevy has been further extended to December 2012.

From its oces in Star Tower, which sit in one ofthe designated speculative regions that would besubject to this sa les deterrent, Stephan Kim of Tax-

and Korea explains that international private equityreal estate rms have not been popular with Koreastaxman since the Asian nancial crisis, when rmslike Morgan Stanley Real Estate Investing and LoneStar Funds were able to take advantage of distressedmarket conditions and subsequently distressedsellers to extract huge prots. For him, it is theshi in how tax obligations are interpreted stem-ming from those instances where the more mean-ingful goalpost movements could come.

Recalling the late 1990s, when many US rmsmade their Korean entries, Kim says: Once the In-

The [Korean ta

authorities] arequite aggressive,particularly whenit comes to oreigninvestors.

Stephan KimTaxand Korea

Essentially, anyassets used or orin conjunction withthe business o a

company are nolonger a capitalasset.

bhishek GoenkaTaxand ndia



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ternational Monetary Fund lent to Korea, it eectively dictatedscal policy, namely that many of Koreas banks had to be re-structured. Many debt-ridden corporations with trophy com-mercial buildings also had to be restructured, and thats when alot of foreign buyers came in.

Indeed, the Star Tower itself was one such example of that.When Lone Star eventually sold the property to the Govern-

ment of Singapore Investment Corporation (GIC) for $350 mil-lion in 2004, the Dallas-based rm recorded a capital gain ofapproximately $250 million.

In addition to the extension of the extra tax on capital gainsin Seouls designated speculative regions, Kim suggests atten-tion should be paid to the ongoing dispute between the NTSand Lone Star over which jurisdiction ultimately had the au-thority to tax the gain in the Star Tower sale Korea or Bel-gium, which has a double taxation treaty with Korea. at isbecause Belgium was where Lone Star had incorporated theentity that it used in the acquisition of the Star Tower. It wasthat Belgian holding company that subsequently sold the asset

to GIC by transferring the shares of the Korean company andtook the position that the gain from the sale of the shares wasnot taxable in Korea under the Korea-Belgium tax treaty.

e NTS, however, argued that the Korean-Belgium taxtreaty was inapplicable because the Belgium holding companywas merely a conduit for Lone Star entities in the US and Ber-muda ,which were

taxand pere 2012 global guide to tax

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