The recent amendment of the Luxembourg - Hungary double tax treaty will result in a sharp decrease of Luxembourg-based schemes for Hungarian real estate transactions. Those groups which currently use such schemes for holding their Hungarian real estates will need to react fast.
Foreign investment groups often structure acquisitions of Hungarian real estate through Luxembourg-based holding companies. In such schemes each Hungarian real property is owned by a separate Hungarian company which is, in turn, held by the ultimate shareholder through a foreign holding company, often established in Luxembourg. From a tax point of view, this scheme provides an optimal solution not only for the continuous income flow from the real estates, but also for an eventual sale of the real estate.
The tax advantages of such Luxembourg schemes will, however, cease from next year. In 2010 the Hungarian Corporate Tax Act was amended in a way that Hungary can levy a withholding tax on capital gains resulting from the sale of companies the assets of which consist mainly of Hungarian real estates. Until now, similar to tax treaties with many other countries, the Luxembourg – Hungary treaty precluded the application of such withholding tax. Nonetheless, an amendment of the Luxembourg - Hungary treaty has recently been adopted which is now waiting for ratification in Luxembourg. As soon as the new treaty enters into force, capital gains arising from the sale of Hungarian companies by the Luxembourg owner will be charged to tax in Hungary - provided that most of the assets of such companies consist of Hungarian real estates. This will, all of a sudden, deprive Luxembourg-based holding schemes of one of their key tax advantages.
What to do with the existing schemes?
As a predictable consequence of the amendment of the tax treaty, Luxembourg will no longer be an option for tax advisors when picking the location of holding companies for investing in Hungarian real estates. The automatic question also arises: what will happen to currently existing real estate investments made through Luxembourg companies?
As soon as the treaty amendment enters into force, the current Luxembourg schemes will no longer be efficient from tax perspective. Consequently, these schemes will need redesigning and restructuring. Moreover, there is not much time left to take actions. From 2016, the Hungarian source tax will be levied even in cases where the Hungarian company owning the real estate is transferred in the course of a group reorganization. Therefore, in order to ensure a future tax-efficient exit opportunity, the group should reorganize the holding of its Hungarian investment before the new treaty enters into force. Two months are left for this if Luxembourg timely ratifies the new tax treaty.
Planning for tomorrow
Fortunately, there are still several countries that may take over Luxembourg’s place in the above schemes. The new holding country candidate needs to have, first of all, a double taxation treaty with Hungary that excludes Hungary’s right to levy tax on capital gains realized on real estate share deals. Further, the new holding company country will need to ensure the tax-optimal flow of the Hungarian source income to the ultimate shareholder. At present, several countries meet these criteria, including the Netherlands, Singapore and Malta. These countries are anticipated to play a leading role in the course of the restructuring of the Luxembourg schemes.
One lesson to learn from Luxembourg’s example is that constant attention needs to be paid to changes in international taxation. Further, the new holding company locations for Hungarian property deals will not stay safe harbours forever. Similar to the Luxembourg treaty, existing tax treaties with the above countries can also be amended in the future which can lead to the need to restructure these schemes again.