All questions
Transactions
i Legal frameworks and deal structuresSubject of the deal
The majority of real estate transactions (office, retail, healthcare, residential or warehouse) relate to existing and completed buildings. However, real estate developments can be acquired in future state of completion no matter the investment sector. This kind of transaction can be structured either as a forward purchase or a forward funding. Their names are similar; their operations, however, are different.
In a forward purchase structure, the parties agree to sign a sale and purchase agreement, either for the shares of the company owning real estate under development or for the real estate itself (see below), under the condition precedent of the completion of the works (being in most cases the provisional acceptance). Transfer of ownership therefore occurs only after provisional acceptance, meaning that the investor-buyer will neither bear the construction risk nor the risk of insolvency of the developer-seller. This could also ease the financing of the transaction, such financing being most of the time negotiated before signing but with a draw-down only on completion.
In a forward funding structure, the parties agree to sign a sale and purchase agreement, either for the shares of the company owning real estate under development or for the real estate itself, without a condition precedent of completion of the works. To mitigate the risk for the investor-buyer, parties usually agree on a condition precedent of definitive permits. Contrary to the forward purchase, the sale – and thus the transfer of ownership – occurs prior to the completion of the construction works and the price is paid upfront, most of the time in instalments over the construction process. It also means that, except for the regulated forward funding under the law, the parties have to contractually agree on the process and allocation of risks during the entire construction process.
Structure of the deal
A real estate transaction is structured either through an asset deal or a share deal.
In the case of an asset deal, the subject of the transaction is the asset itself. In the case of a share deal, the transaction concerns the acquisition by the purchaser of the shares issued by a company holding the asset.
Both structures are observed in Luxembourg. However, the majority of the transactions in Luxembourg are structured as a share deal mainly because share deals are not subject to real estate transfer taxes.
ii Acquisition agreement termsLetter of intent
Real estate transactions usually start with the negotiation and the execution of a letter of intent containing the most important commercial and financial parameters of the transaction, referring to the envisaged steps until closing of the transaction and granting to the candidate purchaser an exclusivity period.
Sale agreement
The sale agreement usually contains conditions precedent, representations and warranties, indemnification clauses and covenants. The content of the sale agreement also reflects the outcome of the due diligence exercises performed by the purchaser’s advisers for the technical, legal and tax aspects.
Imported from the UK market, an upward trend is warranty and indemnity (W&I) insurance, which covers undisclosed risks for the period prior to closing. Parties usually negotiate their terms of acquisition and then provide the purchase agreement to an insurance broker. The insurance company usually reviews the agreed representations and warranties to, as the case may be, exclude some from the insurance coverage. Usual exclusions concern the condition of the properties, certain environmental matters and transfer pricing.
The market is currently experiencing the development of tax insurance to guarantee identified risks – most of the time at the exclusion of transfer pricing. In such process, (at least) the purchaser must provide the insurance with a robust defence memorandum stating the arguments in favour of the taxpayer and the likelihood of success in the case of litigation.
Asset deal
A real estate transaction is often completed in two phases.
The parties enter into a private sale agreement. The content of such agreement is freely determined by the parties. Once completed, the agreement is valid and enforceable between the parties. However, the sale contemplated on the private sale agreement is not enforceable towards third parties.
For this reason, the transfer of ownership contemplated in the private sale agreement needs to be recorded to the Mortgage Register. To do so, the sale must be enacted in a deed to be signed before a notary public.
Share deal
Share deal real estate transactions are subject to only one document: a share purchase agreement (that does not need to be recorded or enacted in a notarial deed).
iii Financing considerations
Financing real estate depends on the structure chosen, the development stage of the real estate or the type of acquisition (shares versus asset deal).
Either the fund is directly financed by a master facility agreement or the financing is directly granted to a special purpose vehicle (being a director or indirect subsidiary of the fund). The latter is usually used for development financing or direct asset financing.
In the event of a share deal, the holding company will usually be the borrower under the relevant financing to acquire the shares of the target entity and the debt will be then pushed down to the target.
The security package typically implemented is mortgage over the real estate, pledge over the bank accounts (rent account, etc.), pledge over receivables (intra-group or third-party debtors) or assignment of insurance for the benefit of the lender and pledge over the shares of the company holding the estate. Intercreditor or subordination agreement are also contracted to subordinate any intragroup loans.
Luxembourg is also a prime location for international real estate financing. Luxembourg vehicles are usually used in the financing structure, not only for corporate or tax reasons, but also to strengthen the lender’s position, especially when a double LuxCo structure is implemented. The efficiency of the enforcement of security (notably enforcement of share pledge) is greatly appreciated by the lenders.
iv Tax considerations
As a matter of general principle, real estate income (be it current income or capital gains) is taxed in the country in which the real estate is situated.
Real estate situated in Luxembourg
The tax treatment of income from real estate situated in Luxembourg depends on the investor.
Assuming the real estate is owned by a Luxembourg company, any real estate income is subject to ordinary Luxembourg corporate income taxation at an aggregate rate of 24.94 per cent (for companies having their registered office in Luxembourg City, for the tax year 2023). On top of that, the unitary value of the real estate is subject to an incremental net wealth tax charge at a rate of 0.5 per cent for a company having a net wealth below €500 million and at a rate of 0.05 per cent applied to any excess. It should be noted that such unitary value is currently (still) determined based on a rate card dating back to 1941, because of which these values are significantly lower than the current fair market values of the buildings concerned. Luxembourg property companies can, subject to certain limits and exceptions, deduct general operating expenses and interest expenses as well as depreciation charges from their taxable basis.
Transfers of real estate situated in Luxembourg by way of an asset deal can be subject to registration and transcription duties at a maximum rate of 10 per cent. Share deals are not subject to registration and transcription duties.
Real estate situated outside Luxembourg
Investors can invest into real estate situated outside of Luxembourg. Based on its extensive double tax treaty network, Luxembourg should generally not have the right to levy tax over the income derived from or the net wealth allocable to such real estate.
Luxembourg as an investment jurisdiction
Luxembourg has become the default jurisdiction for real estate investments and investment funds. Fund managers frequently set up Luxembourg pooling vehicles, such as SIFs, RAIFs, UCITs or unregulated partnerships, as investor-facing entities. If properly structured, no material tax leakage should occur at the level of these pooling vehicles. Luxembourg fund vehicles are generally not subject to withholding taxation in Luxembourg.
Since 2021, Luxembourg has levied a 20 per cent tax on certain types of income realised by certain tax-opaque investment entities that invest into real estate situated in Luxembourg. This levy does not apply for investments into real estate located abroad.
Luxembourg is also frequently used as a jurisdiction of choice for the establishment of intermediate holding, joint venture or acquisition vehicles. In general, these entities are organised as private limited liability companies and are regular taxpayers in Luxembourg. When properly structured, they should not be subject to a material tax burden in Luxembourg. Different from investment funds, Luxembourg holding companies are subject to withholding taxation in Luxembourg. However, a wide range of exemptions or rate reductions are available. In addition, at arm’s-length interest payments, loan principal repayments or liquidation distributions are not subject to Luxembourg withholding taxation.
It should be noted that Luxembourg does currently not offer a specific tax regime applicable to REITs.
Finally, even though Pillar II and ATAD 3 are not yet in force, their implementation in Luxembourg should be closely monitored as both pieces of legislation are expected to have an impact on the tax treatment of typical real estate investment structures.
v Cross-border complications and solutions
Besides EU AML requirements and EU sanctions, on 16 September 2021, the Luxembourg legislator announced a bill of law to implement foreign direct investment (FDI) measures and to introduce a screening mechanism for FDI that may adversely affect national security or public order in Luxembourg. As per the bill of law, the prior approval mechanism will apply to FDI in a Luxembourg entity carrying out critical activities in Luxembourg that may adversely affect national security or public order.
