EU-based Real Estate Funds Investing in Norwegian Real Estate – Tax & Corporate Law Developments
By Oyvind Hovland
Posted: 1st November 2013 09:10There has recently been certain changes in Norwegian international tax and corporate law that are positive and potentially negative to EU established real estate funds investing in Norwegian real estate.
In this article this will be illustrated by looking at foreign investors that via Luxembourg established real estate funds invest in Norwegian real estate owned by Norwegian private limited liability companies (PropCos). There are different types of investment vehicles/structures that may be used depending on the profile of the investors, like e.g., private equity real estate fund using regular Luxembourg private limited liability companies (Sarls), real estate SICAV fund, real estate SICAR fund etc.
It is imperative that surplus cash from rental activities and net sales proceeds from partial sale of real property can be distributed tax efficiently on a regular basis from Norwegian companies to the ultimate investors of the fund.
Under Norwegian domestic tax law, gains on sale by a Luxembourg real estate fund, or by an intermediate Norwegian holding company, of shares in Norwegian PropCos are tax-free. Furthermore, transfers of shares in Norwegian PropCos are not subject to real estate transfer tax, while a direct sale of property is subject to 2.5% real estate transfer tax (stamp duty).
So far, so good. Dividends, however, from Norwegian companies to a foreign investor are generally subject to 25% withholding tax, which is reduced under relevant tax treaties. Under the tax treaty between Norway and Luxembourg, the withholding tax is reduced to 5% provided the fund owns 25% of the capital of the Norwegian company. A Luxembourg real estate SICAV fund, however, will not be able to invoke the treaty as it is not subject to Luxembourg corporate income tax. The Norwegian domestic withholding tax exemption on dividends may however come to rescue.
The Norwegian Domestic Withholding Tax Exemption on Dividends
According to the Norwegian domestic withholding tax exemption, dividends to a Luxembourg real estate SICAV fund will be exempt from Norwegian withholding tax provided the fund is equivalent to a Norwegian private limited company and it qualifies as a genuine establishment as opposed to a wholly artificial arrangement. It should be noted that the withholding tax exemption will only apply to dividends that have been distributed in compliance with Norwegian corporate and accounting law.
The fact that Norwegian law does not recognise a vehicle with a legal form identical to that of a Luxembourg SIVAC and that a SICAV is not subject to Luxembourg corporate income tax, should not be a hinder for such funds to invoke the withholding tax exemption on dividends. This is supported by the recent Norwegian Supreme Court decision in the Statoil KG-case, which involved the classification of a German limited partnership in which the general partner had no economic interest while the limited partner owned 100% of the economic interests in the partnership. The Supreme Court concluded that the partnership under Norwegian tax law was equivalent to a Norwegian private limited liability company as opposed to a Norwegian limited partnership which is transparent for Norwegian tax purposes. In reaching this conclusion, the Court also disregarded the fact that there were important differences between the Norwegian governance rules for Norwegian private limited liability companies and the German governance rules for German limited partnerships. The Supreme Court referred to and adopted the reasoning by the European Court of Justice (ECJ) in the case C-303/07 Aberdeen.
This case concerned a Finnish real estate private limited liability company that was a wholly owned subsidiary of a Luxembourg SICAV. The SICAV was not subject to corporate income tax in Luxembourg, and the profits it on distributed to the investors was not subject to Luxembourg withholding tax. Under its domestic tax law, Finland could levy withholding tax on dividends to the SICAV. However, the ECJ concluded that the Finnish withholding tax rules represented a restriction on the freedom of establishment, and it did not accept the justifications put forward by the Finnish Government to justify the restrictive Finnish withholding tax rules. This was the case even if profits of the Finnish real estate company could be distributed free of Finnish and Luxembourg taxes to the ultimate investors of the fund, which primarily were German insurance companies and pension funds.
According to the ECJ, Finland could only levy withholding tax in the exceptional situation where dividends were distributed to a wholly/purely artificial SICAV which does not reflect economic reality and is set up solely to escape the Finnish tax due on the profits of the Finnish real estate company.
This leads over to the second requirement under the Norwegian withholding tax exemption which requires that a Luxembourg real estate SICAV fund must qualify as a genuine establishment as opposed to a wholly artificial arrangement. This substance requirement will apply to any type of Luxembourg real estate fund irrespective of how it is structured, like e.g., private equity real estate funds, real estate SICAV funds and real estate SICAV funds.
The Substance Test under the Domestic Withholding Tax Exemption
The Norwegian tax authorities have during the last years issued several tax rulings/unofficial position statements concluding that an EU established investment fund will qualify as genuinely established if the fund and its active portfolio management operations are carried out within the same EU country. In this respect, it is irrelevant whether the fund is self-managed or has an external portfolio manager. However, in a recent 2013 binding tax ruling, the Norwegian tax authorities concluded that a Luxembourg investment fund that had a Norwegian manager qualified as a wholly artificial arrangement. It should be noted however that the fund in this case primarily was owned by Norwegian investors, that escaped Norwegian taxation by moving the fund from Norway to Luxembourg, and may thus be viewed as a disloyal circular tax arrangement.
In a recent 2012 statement, the Norwegian tax authorities stated that the activities at board level of an EU established company in general cannot be considered when determining whether or not a company is genuinely established. In my opinion, this cannot be correct as the functions of a board of directors is an integral part of the carrying out of any company’s business.
On the other hand, if the real top level management on board level of a Luxembourg real estate fund in fact were to be carried out within Norway and the board proved to be nothing more but “a mere tool of execution”, and the manager of the fund also were to be based in Norway, this could potentially qualify as a wholly artificial arrangement.
It is thus important to make sure that the board of the Luxembourg real estate fund carries out its overall supervisory duties and be entrusted with the appropriate top level decision-making responsibilities, and that the board meetings generally are conducted within Luxembourg. In such a situation, the fact that the Luxembourg real estate fund has a Norwegian manager should not imply that the fund should qualify as a wholly artificial arrangement.
Corporate law changes
In 2013, the following important changes were made to the Norwegian Limited Companies Act for private limited liability companies that will facilitate more efficient upstreaming of cash from Norwegian PropCos:
The share premium fund is no longer considered restricted equity but is included in the company’s distributable equity that can be distributed under the dividend rules.
Repeal of the prohibition against distribution of dividends (without using the procedure for reduction of share capital or share premium fund) when the equity is less than 10 percent of the total balance sheet.
The book value of deferred tax assets in the statutory account is no longer automatically excluded in the basis for determining distributable equity.
It is possible to distribute interim dividends during the financial year based on an audited interim balance sheet that has been approved by the general meeting. This implies in general that current year earnings, including net sale proceeds from partial sale of real estate, can be distributed as interim dividends.
Expansion of a company’s ability to acquire its own shares.
As a result of the above changes, increased emphasis will be put on the board of directors to consider whether a company has sufficient equity and liquidity to make distributions.
Proposed Restrictions on Deductibility of Interest on Shareholders Loan
Interests on any and all types of external and intra-group debt are generally deductible, including interest on external and intragroup debt incurred in connection with the purchase or improvement of real estate. In respect of intra-group debt, however, a Norwegian company may be said to be thinly capitalised when it has excessive intra-group debt in relation to its arm’s length borrowing capacity. If the debt capacity is fully utilised to support the funding from a third party bank - and it can be assumed that no third-party bank would provide the loan on the terms provided by the real estate fund - then the interest would not be allowed to be deducted.
The Labour Party-led government has in connection with the 2014 National Budget released on 14 October, proposed a strict limit to the effect that net interest expenses paid to a related party could be deducted only to the extent they do not exceed 30% of the taxable business profit after adding back net internal and external interest expenses, and tax depreciations (a taxable EBITDA approach). Interest payments on third party debt (without parent guarantee) will not be affected.
The change is proposed to enter into force on 1 January 2014. The rules will also apply to debt drawn before 1 January 2014. If enacted, this proposal will prevent highly leveraged transactions.
The Labour Party-led government lost the election this fall and will on 18 October concede power to the new Two-party Conservative Coalition government. This new government will present a revised National Budget mid-November, and it remains to be seen if it will support the law proposal.