The interest barrier receives further barriers
The government draft of the Act to Strengthen Growth Opportunities, Investment and Innovation as well as Tax Simplification and Tax Fairness (Growth Opportunities Act, Wachstumschancengesetz) provides for considerable tightening of the current legal situation, in particular in the area of the interest barrier (Zinsschranke), in addition to many tax simplifications and concessions. The real estate sector is particularly affected and, according to the explanatory memorandum, also the target of the tightening.
The interest barrier (sec. 4h of the German Income Tax Act, EStG, 8a of the German Corporate Income Tax Act, KStG) has so far provided that a business can deduct interest expenses to the extent that they exceed interest income (so-called net-interest-expenses) only up to a maximum of 30% of the EBITDA adjusted for tax purposes. According to the current legal situation, the interest barrier is not applicable if the net interest expenses of a business amount to less than EUR 3 million. This limit is an exemption limit (Freigrenze), i.e. if it is reached or exceeded, the 30% limit described above applies to the entire amount of the net-interest-expenses.
A common structure in the real estate sector is that under uniform management, often a holding company, several real estate owning corporations (PropCos) each hold one or more properties. This is not primarily for tax reasons, but rather for liability reasons. In addition, the separation of individual pieces of real estate in separate companies also makes sense with regard to a later sale. Under the current interest barrier regime, the exemption limit of EUR 3 million described above can be claimed by each of these PropCos. The reason for this is that, under the current interest barrier regime, corporations always have their own business and (outside of a fiscal unity for income and trade tax purposes) are also not combined with other corporations to form one business. This corresponds to the overall system of German corporate income tax law, according to which corporations form separate entities from their shareholders and affiliated companies and represent independent tax subjects (so-called separation principle, Trennungsprinzip). This is precisely what is to be softened under the draft Growth Opportunities Act.
The government draft of the Growth Opportunities Act now provides that similar businesses that are under uniform management or control are deemed to be one business for the purposes of the interest barrier. This is also to apply to corporations with similar (gleichartig) businesses under the same management. The consequence would be that the exemption limit of EUR 3 million would only be applied once to such a combined business. The use of the exemption limit is to be divided among the individual "sub-operations", i.e. the individual real estate companies, according to the ratio of their net-interest-expenses.
The term "similarity" is not legally defined. The explanatory memorandum to the law leaves it with a reference to sec. 4 para. No. 1 of the German Corporate Income Tax Act (Körperschaftsteuergesetz), which also uses the term "similar", thereby expressing that it is to be interpreted quite broadly. However, real estate companies that exclusively hold and manage real estate would probably be understood as similar.
Accordingly, several PorpCos under a holding company would have to be combined as one business within the meaning of the interest barrier in the form of the Growth Opportunities Act. The exemption limit of EUR 3 million would only be applied once to the entire structure, which would probably considerably restrict the interest deduction for income tax purposes in many cases. The corresponding non-deductible part of the interest expenses is carried forward and can be used, if necessary, upon exit, provided that this takes place by way of an asset deal and the amount of the capital gain is sufficient to fully utilise the interest expenses carried forward. The interest carried forward, however, is to be carried out as before for each individual PropCo. The combination of several similar businesses into one business is only to apply to the application of the exemption limit and not to the general regulation of the interest barrier. A corresponding flexible use of interest carry-forwards within a group would therefore not be possible.
It is apparently planned to conclude the legislative process this year, so that the application of the new provisions can be expected in the coming year. The new provisions, if passed, would also apply to existing structures.
