The impact on real estate transfer tax of Dutch lenders enforcing security rights

Avoiding unexpected liabilities: in a distressed market in the Netherlands, the enforcement of security rights by lenders may have consequences for real estate transfer tax (RETT).

The lockdowns imposed around the world as a result of the coronavirus pandemic have led to significant revenue losses for businesses and an inability to pay their obligations in a timely way. Currently, most Dutch lenders are discussing their options and the market is still characterized by leniency, with little enforcement taking place. Overall market prices are not substantially decreasing and rental prices for residential and office space do not appear to be materially impacted. However, if the pandemic continues to have such a negative effect on the economy, it is inevitable that prices and rents for real estate will start decreasing. Many borrowers will end up in a default situation, with no other outcome than to restructure the collateral or loan.

In most EU Member States, lenders require their borrowers to provide collateral in the form of rights of mortgage and/or a pledge. In case of a default, the lender is entitled to enforce its rights under the mortgage or pledge as agreed with the borrower in the loan documentation. The execution of security rights often brings the underlying collateral under the control or supervision of the lender to preserve the value or to initiate the sale of the real estate. Such enforcement may trigger unforeseen RETT consequences for the lender.

Dutch RETT and beneficial ownership

RETT of 6% (7% as of January 1, 2021) is levied in respect of the acquisition of the legal and/or beneficial ownership of real estate located in the Netherlands or certain rights concerning such Dutch Real Estate e.g. ground lease. (For the acquisition of residential properties, a reduced RETT rate of 2% applies.)

In addition, acquiring shares in entities that qualify as a real estate entity may under certain circumstances constitute as a RETT taxable event (together referred to as Dutch Real Estate). RETT is payable by the purchaser of the Dutch Real Estate. A party acquiring Dutch Real Estate is liable to pay RETT irrespective of whether such party is a private individual or a legal entity and regardless of whether the party is a resident or non-resident of the Netherlands.

As mentioned, the acquisition of beneficial ownership in Dutch Real Estate is subject to RETT. Beneficial ownership is defined in the Dutch RETT Act as a set of rights and obligations relating to real estate that represents an interest in those assets or rights. The following two conditions must be met:

• A combination of rights and obligations representing an interest related to Dutch real estate (Allocable Interest Test).
• Said interest includes at least a risk of a change in value of the Dutch real estate (Risk Test).

Both tests are broad and may be met if the capital of someone other than the legal owner is impacted by changes in value of the real estate (positive and/or negative).

The Dutch RETT Act provides that the security rights of pledge (pandrecht) and mortgage are excluded from RETT. As such, RETT should not be levied upon the sole acquisition or vesting of such surety rights. In this respect, the Dutch Secretary of Finance has indicated that the sole execution of surety rights does not constitute the transfer of beneficial ownership to the person who executes such security rights. However, this may be different if underlying collateral is brought under control of a lender in the execution of security rights.

Execution of security rights and beneficial ownership

With distressed real estate, a lender will often start enforcing its security rights. This may have implications for Dutch RETT if part of the underlying collateral consists of real estate located in the Netherlands. In the event of a default, there are various options for lenders to enforce security rights vis-à-vis the borrower. Most notably, the lender may decide to: exercise additional powers of control over the distressed real estate i.e. the collateral; sell pledged shares in the borrower’s legal entity; and sell the non-performing loan (NPL) to another party.

In some jurisdictions it may take some time for the lender to sell the distressed real estate. In these instances, a lender may feel obliged to increase its powers of control over the real estate to preserve its value. Following the economic crisis of 2008-09, we encountered a number of cases where the Dutch tax authorities (DTA) took the position that beneficial ownership transfers to the lender upon the execution and/or enforcement of its security rights. This transfer may, according to the DTA, take place if a combination of the so-called trigger events occurs:

• the fair market value of the real estate is significantly lower than the value of the receivable: LTV of more than 100%
• agreed and/or enforced management clause
• agreed and/or enforced pledge on rental and/or sales income
• profit participating incentives (PPL)
• existence of and/or enforcement of other agreements with receiver/debtor that the creditor or a party appointed on their behalf manages the real estate (or the entity holding the estate
• existence of and/or enforcement of other agreements with receiver/debtor that the creditor is entitled to rent/sales income and/or carries (part of the) costs of the real estate
• additional provisions in the credit agreements that give creditor more control
• bankruptcy

It should be noted that, in our experience, there is no clear guidance or policy as to when or whether transfer of beneficial ownership actually occurs.

In addition, different views seem to exist within the DTA. As such, the trigger events as described above are in essence a sliding scale. The mere fact that the value of a loan exceeds the value of the collateral should in itself not result in a transfer of beneficial ownership. However, where additional powers or controls are established by a lender - even where such powers do not lead to changes in financial interest - the DTA may take a different view and consider that beneficial ownership is transferred.

As previously stated, the Dutch RETT Act explicitly excludes the vesting and acquisition of rights of pledge and mortgage from RETT. Generally, the transfer of beneficial ownership requires transfer of a financial interest that is directly related to the real estate and not indirectly through a loan. However, based on the above, all security rights and obligations and any controlling and management powers must be taken into account when assessing the RETT risk.

Sale of pledged shares in Dutch legal entities

The sale of pledged shares in legal entities previously owned by the borrower may constitute a RETT taxable event insofar as the legal entity qualifies as a real estate rich entity (Real Estate Entity). A legal entity owning real estate will only qualify as a Real Estate Entity if its asset consists for more than 50% of real estate (of which 30% is located in the Netherlands) and the assets are not actively used in the course of a business.

It should be noted that the lender should not incur any RETT liabilities as generally only the purchaser of the pledged shares will be liable. However, often a higher purchase price can be negotiated if no RETT would be due. Further, in certain cases the borrower may also be held liable for the RETT upon transfer. As a result, lenders that enforce their borrowers to sell the shares into a Real Estate Entity may want to closely review the RETT consequences of a sale.

Furthermore, if the parent company on a consolidated level would stay under the Real Estate Entity thresholds described above, it may be efficient to transfer the shares in the parent as this transaction should not result in RETT - whereas a sale of shares in a subsidiary only holding Dutch Real Estate would result in RETT due.

Sale of underlying loan

The sale of a loan granted to a borrower that relates to real estate should generally not constitute a RETT taxable event. The purchaser of the loan will typically not be considered to have beneficial ownership of the underlying collateral, as it is not directly affected by an increase or decrease in value of the underlying collateral. This would only be different if, based on the trigger events, the beneficial ownership has already been transferred to the lender and this beneficial ownership will subsequently by way of the sale of the loan be transferred to the acquirer.

This analysis may of course be different if it concerns the sale of a profit-participating loan of which the value depends on the underlying value of Dutch Real Estate.

In conclusion, the COVID-19 pandemic will most likely have a significant impact on businesses and therefore the (in)ability of borrowers to comply with their obligations under the loan documentation. In the case of a default, lenders may enforce their security rights, which could trigger unforeseen Dutch RETT liabilities. Since potential RETT liabilities amount to 6% of the fair market value of Dutch real estate, 7% in 2021, lenders are recommended to closely monitor and evaluate the enforcement of their security rights to avoid unexpected RETT liabilities.

The RETT rate in the Netherlands will increase from 6% to 8% as of 2021, if the current budget proposals from the Dutch government are adopted by Dutch parliament. For more information, please contact the authors of this article.