Real Estate Investment in Romania: Tax Aspects

Investing in Properties
Foreign investments in real estate in Romania are typically made either by setting up a local company (legal entity) which then purchases properties, or by acquiring a local corporate vehicle owning real estate.

Sale and purchase of real estate located in Romania are subject to stamp duty and notary fees. Stamp duty is charged as a percentage of the value of the transaction (the marginal rate is approximately 0.5%) to which a similar amount in notary fee is generally added. In case such value is significantly different from the market value, the respective assets would be subject to a valuation and the stamp duty will be computed on the certified market value. The value of stamp duty may be reduced by 50% in case of land without any building on it located outside urban limits (extravilan in Romanian).

As a rule, transfer of immovable property in Romania is subject to VAT charged at the standard 19%. However, special VAT simplification measures apply in case of acquisition of land and buildings (or parts of buildings), provided both the seller and the buyer are registered in Romania for VAT purposes. Specifically, the measures imply application of VAT through the reverse-charge mechanism, under which the seller and the buyer account for both input and output VAT without any VAT cashflow.

Financing of Real Estate Acquisitions
A local company acquiring and operating real estate may be financed either by equity or debt financing. Equity financing would normally be tax neutral, while for loan financing the following tax implications should be considered. From a profits tax perspective, under the existing thin capitalisation rules, there are certain restrictions on the deductibility of interest expenses and related foreign exchange losses.

Usually, interest expenses incurred by companies are subject to the following limitations:
Debt-equity ratio – interest expenses are deductible if the debt-equity ratio is equal to or less than 3:1. In case such ratio is higher than the aforementioned limit, interest expenses are non-deductible for profits tax purposes and can be carried forward until they are fully deductible under the same conditions. Also, the difference between foreign exchange losses and foreign exchange revenues relating to long-term loans is treated as interest expense and is subject to the debt-equity ratio limitation.
Interest rate (for loans granted by companies other than financial institutions) – interest rate is deductible within the following limits:
the reference interest rate of the National Bank of Romania in the last month of the quarter, for loans denominated in RON (currently in the range of 8%);
the annual interest rate of 7% for loans denominated in foreign currencies.

The non-deductible portion of the interest cannot be carried forward. Separately, interest expenses as well as the foreign exchange differences related to loans obtained from domestic or foreign banks and other legal entities which may grant credits according to the law are not subject to the thin capitalisation rules.

In intra-group financing transactions, the transfer pricing regulations should be observed with regard to the interest rate level.

In case of financing obtained from abroad, the withholding tax of 16% will apply to the interest income derived by the non-resident. Such tax may be reduced (even to zero) under the provisions of some of the double tax treaties with other countries to which Romania is a party, in case a tax residency certificate of the beneficiary is available to the Romanian payer of interest.

Loans received by Romanian legal entities (either from related parties or other financial institutions) and related interest are not subject to VAT.

Operational Phase
From a profits tax perspective, local entities will tax the rental income related to the immovable property at the standard profits tax rate of 16% and will be allowed to claim tax depreciation charges of the real estate based on the acquisition price. Land, however, is a non-depreciable asset. Depreciation for tax purposes may be different from accounting depreciation and any revaluation of real estate performed after 2003 is not taken into account for tax depreciation purposes. The typical depreciation period for buildings is 40 years.

Although rental of immovable property is normally VAT exempt without credit, legislation allows the landlord to opt for charging VAT on rentals. It is important to note that rentals exempt from VAT may negatively affect the input VAT incurred by the landlord on acquisition or construction of the real estate due to retroactive pro-rata computation.

Separately, owners of buildings should pay an annual building tax to the local authorities. For companies, such building tax would range between 0.5% and 1% of the book value of the building. The building tax may increase to up to 10% if the building has not been valued in over 3 years. Land owners are liable to pay the tax on land, which is established as a fixed amount per square meter, depending on the location.

Dividends paid abroad by a local company from its profits are subject to a 16% withholding tax in Romania. However, this tax may be reduced (even to zero) under the provisions of some of the double tax treaties signed between Romania and other countries.

Dividends paid by a local company to a person residing in a EU member state would be exempt from withholding tax after Romania’s accession to the EU, provided certain conditions are met (the non-resident holds at least 25% of the Romanian company’s shares and the shares are held for at least 2 years).

Exit Scenarios
To dispose of a real estate investment in Romania, a foreign investor can typically sell its Romanian subsidiary, or the Romanian subsidiary can sell the real estate directly.
Based on the existing provisions of the Fiscal Code, non-resident legal entities are taxable in Romania at the standard profits tax rate of 16% for the capital gains realised from selling ownership right over a local company.

The legislation puts particular emphasis on application of the above taxation rule to the profits or gains obtained from transfer of shares/participation titles in companies, where 50% or more of the assets’ value represents, directly or indirectly, immovable property located in Romania.

Separately, profits derived from direct sale of real estate in Romania are also subject to the standard 16% tax.

Starting 1 January 2006, capital gains derived by individuals from disposal of shares in local companies are subject to 16% tax. However, this rate is reduced to 1% for shares held for over 365 days (the reduced tax rate is expected to be cancelled in 2006).

Generally, capital gains derived by individuals from sale of buildings with land sold within 3 years from acquisition as well as from sale of land without construction acquired after 1990 are subject to 16% tax.

However, under most of the double tax treaties signed by Romania with other countries, income from sale of shares in a Romanian company is generally subject to tax only in the state where the seller is resident even if most of company’s assets are represented by real estate. Income from direct sale of real estate does not normally benefit from treaty protection.

Direct sale of real estate is subject to stamp duty and notary fees as described above, while transfer of shares in a Romanian entity is not.

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By: Venkatesh Srinivasan
Partner
Head of Tax Division

Alexander Milcev
Tax Senior Manager