How to invest in local real estate
Until the country joins up with the European Union in 2007, European citizens cannot buy local land directly, but options are still available
Real estate transactions in Romania are now becoming a hot issue not only for Romanians but also for foreign investors who have realised this country offers plenty of opportunities to invest and has excellent potential for future growth.
But how is the investment going to be done? Can foreigners buy real estate properties in Romania? How are their profits going to be taxed and what are the ways to maximise the investor's return on investment? Do any transfers taxes and local taxes on land and buildings need to be paid? All these questions need to be answered before taking the decision to invest not only in Romania, but also in any other jurisdiction. Otherwise the investor's expectations may just not be fulfilled.
Like any other investment, the business plan is very important. This should be known from the beginning and the legal structure should be designed accordingly.
Because land can only be owned by Romanian legal entities or by Romanian citizens, establishing a local company becomes a must if land is purchased. After Romania joins the European Union, EU citizens will also be allowed to buy land in Romania. If the investment involves only buildings and not land, creating a branch in Romania may also be considered. Branches withholding tax on dividends is not an issue.
Structuring the investment is also very important because of taxation issues. The Romanian Fiscal Code states that incomes obtained from real estate - either rent or capital gain from selling the real estate - are taxed in Romania. The standard corporate tax rate applicable is 16 per cent, but the capital gain obtained from selling real estate may be taxed by ten per cent if the property is owned for at least two years. The same provision is contained in the double taxation treaties concluded by Romania.
A frequently used tax optimisation solution is to use special purpose companies, meaning that one company is only used for one project. When the investment is sold, the investor has two alternatives: to sell the property or to sell the shares of the company that owns the property. Normally, the capital gain from selling the shares is subject to the same capital gains tax as if the property was sold (16 per cent or ten per cent if the shares are owned for at least two years). However, if the investor is resident of a country with which Romania has a double taxation treaty, the capital gain is usually not taxed in Romania, but in the country in which the shareholder is resident. However, the provisions of the double taxation treaty should be carefully analysed because in some cases (i.e. Germany) the capital gain obtained from selling shares of a company, which has the majority of its assets in real estate property, is taxed in Romania.
If the purpose of investment is not to develop and sell, but to rent and keep for a longer period of time, two other issues are important to consider: thin capitalisation rules and withholding taxes on interest and dividend.
Thin capitalization rules are important when the investment is financed with loans obtained from shareholders and not from banks. In this situation, the interest is not deductible if the debt/equity ration is higher than three, i.e. less than 25 per cent equity. It must also be taken into consideration that interest exceeding nine per cent paid for loans that are not obtained from banks is not deductible, irrespective of the debt/equity ratio.
Withholding taxes on interest and dividend are normally of 15 per cent and therefore these taxes may add an important burden on the investor. Because of this, tax optimisation schemes must always be considered. Romania has concluded over 80 double taxation treaties and most of them concern reduced withholding tax rates for both interest and dividends.
The most popular jurisdictions to invest in Romania are currently Cyprus, Luxembourg and the Netherlands. Each has its advantages or disadvantages and sometimes a combination of holding structures may be the most efficient solution. But, like in any other business, there are no tailored solutions.