Usually, an individual, when buying a real estate intended for personal use, for example, an apartment, a flat, or a private house, will register himself/herself as owner of the property. Indeed, the mere purchase of the real estate as such does not create any immediate tax consequences. However, if the buyer has an intention (or at least allows) to sell this property sometime in the future, it is probable that he/she will be liable to pay tax for the sale of the real estate in Latvia and /or in the country where the owner has his/her tax residence.
If an individual or legal entity intends to purchase the real estate in Latvia, for the purpose of carrying out the business activity or to hold it as a passive investment for resale, then the tax consequences should be assessed in advance. The purchase of the real estate via legal entity could be considered also in the situations, if the individual does not wish to be seen as a registered owner, for example, because of pending or probable litigation that may expose it to the property loss risk. In such situations, the real estate could be acquired, using the company shares in which belongs to a trust or similar foundation, against which no legal claims associated with the individual could be raised.
The purpose of this article is to provide an insight in Latvia taxes that should be considered before purchasing the real estate in Latvia if the real estate is intended for commercial exploitation and/or is intended for the resale in the nearest future.
Before buying the real estate in Latvia the following decisions should be made:
- Purchase the real estate directly or use the separate company which owns such property?
- If the real estate is purchased using a real estate company – where this real estate company should be established: in Latvia or abroad?
Should I purchase the Latvian real estate myself or use a special company for such purposes?
The seller of the property often may be interested to sell not the real estate itself, but the company that owns such real estate. There are a number of reasons for doing that:
- If the real estate is sold by a Latvian company, the profit from the transaction results in the corporate income tax at a rate of 20%. If, however, the shares of the company (Latvian or foreign) are sold, the profit of the transaction may not be subject to tax.
- The sale of real estate results in stamp duty of the buyer amounting to 2% of the transaction value for registering the ownership rights with the State Land Registry (maximum is capped at 42,486 EUR). If, however, the shares in the Latvian real estate company are sold, then only stamp duties apply for re-registering the ownership of shares with the Enterprise Registry.
- If the property is sold by the company that has purchased it as “unused real estate” (meaning that it has paid value-added tax within the last 10 years) and the purchaser is not a Latvian value-added taxpayer, then the seller might have a liability to repay at least a part of the input VAT recovered previously. If, however, the shares in the real estate company are sold, there is no such duty for the seller of the shares. But such duty may arise for the purchaser if the property is used for the purposes which are exempt from the value-added tax (for example, for rented out for residential purposes).
- If the property is sold by a company, the seller still has a right to pay real estate tax for the period until the end of the taxation year. If, however, the real estate company is sold, the tax obligation is retained by the company which is being sold and therefore undertakes such costs.
However, it should be noted that the following factors benefit the seller (with the exception of only 2% of the stamp duty for the re-registration of ownership, in practice normally covered by the buyer). Does the buyer have any benefit in buying shares of the real estate company rather than the real estate itself? As a general rule, the answer will be no, for the following reasons:
- When purchasing shares in the company, the buyer will normally acquire not just a blank company but also all the contractual rights and obligations that the company has assumed over time. There is a risk that not all of the liabilities are disclosed and therefore unplanned expenditure or legal proceedings may arise when dealing with the undertaking taken by the buyer.
- The buyer will not be able to calculate the tax depreciation on the purchased building from the full purchase amount, as it would be if the real estate itself were purchased. Instead, the purchased company will continue to calculate tax depreciation from residual value for tax purposes, which typically will be less than the acquisition value. The difference between the amount of the purchase of this property and the residual value for tax purposes in the company will normally result in additional corporate tax costs of 15% over the long term period.
- If a buyer further sells real estate rather than the shares in the company, it will have to pay a 15% corporate income tax on the difference between the sale price of the property and its residual value for corporate tax purposes. Thus, if the residual value of the real estate in the accounts of the acquired company is significantly lower than the value of the property itself, the buyer will incur an additional corporate tax of 15% on that difference.
- If, on the other hand, the buyer resells the shares in the company rather than real estate, it should be assumed that the next buyer would want to reduce the purchase price by the factors already mentioned.
- As a general rule, the acquisition of an enterprise entails additional costs than the purchase of own real estate related to the enterprise’s legal, financial, and tax research (due diligence).
- Purchase financing is more complicated because, firstly, the buyer takes over already existing liabilities (if any), secondly, there may be additional restrictions on the deduction of interest on the share purchase business, and thirdly, additional restructuring costs will arise, if the loan interest is to be deducted and transferred to the acquired company.
In view of the aspects described, if the buyer nevertheless decides to participate in the transaction by purchasing parts of the company, it may certainly consider asking the seller to reduce the price, taking into account the above-mentioned savings that will arise for the seller and additional costs that will arise for the buyer.
Purchase of property through a company registered in Latvia or another country?
The answer to this question will largely depend on the intended use of the real estate, ie whether it is actively used in the course of business or not.
If the property is used actively in economic activity (for example, a hotel in equipment, starts production, is managed for further leasing).
If such an object is purchased by the Latvian company, which continues to carry out this activity, it will have to pay a 15% corporate income tax on the taxable income generated. On the other hand, the net profit will be able to be distributed in dividends by paying it without withholding tax, unless the beneficiary has:
- Individual when the paying agent is required to withhold a 10% personal income tax, or
- The person who is or has been established in a low-tax or tax-free country or territory when the paying agent is required to deduct 15% corporate tax.
If such an object is acquired by a foreign company, it is likely to create such activity in Latvia, the so-called “permanent establishment”. That is, it will have to register as a separate taxpayer in Latvia and pay corporate income tax of 15% on taxable income. Profits remaining after-tax will, in turn, be transferred to a foreign company without any additional tax being imposed. However, it should be noted that the activities of Latvia’s “permanent establishment” are likely to be subject to corporate income tax while allowing for a reduction of the tax on corporate income tax already paid in Latvia. Therefore, if the tax rate in this foreign state is higher than in Latvia (above 15%), it will be necessary to pay an additional tax on this difference. Therefore, such a body, when the property is acquired by a foreign company for active use, will not incur additional tax costs only if:
- this foreign jurisdiction has a lower corporate tax rate than in Latvia, or
- if, under foreign jurisdiction, such income from a foreign “permanent establishment” is exempted from tax (for example, Lithuania will be exempt from tax, but in Cyprus or Malta the effective tax rate will be lower).
In conclusion, it can be said that the acquisition of real estate for active use will generally be more convenient through a company established in Latvia. If an existing or established company is used, such a company may incur additional tax costs in a foreign country, as well as additional administrative costs to ensure accounting and reporting in two countries.
Where immovable property is used for passive income
If the purchased property is intended for passive use (for example, it would not be used there until resale) and the owner is a Latvian company, the difference between the sale price of the property and the acquisition value of the property will apply with the 15% corporate income tax at the time of resale.
If, in turn, the owner of such property is a foreign company that does not constitute a so-called “permanent establishment” in Latvia, the foreign company in Latvia will not be obliged to pay corporate income tax on the sale of the property, that is, the foreign company will be obliged to pay tax in its country of residence when selling the property. It has one exception. If the buyer of such real estate is a Latvian company, it will deduct a 2% corporate income tax from the total amount of the purchase. In such a situation, a foreign company has the right to submit a subsequent calculation of the corporate tax on the tax payable in Latvia, paying a 15% tax on the profits of the transaction, and to recover the overpaid tax (thus the tax liability will not be higher than in a similar situation for the Latvian company). In addition, a foreign company may evaluate the right to reduce the corporate income tax due in its country of residence for the tax paid in Latvia (for example, if it is provided for by local state legislation or the tax convention concluded with Latvia).
Therefore, if a foreign company acquires real estate without creating a permanent establishment in Latvia, it is important that it is established in a country where the corporate tax rate is as low as possible (e.g. Malta) or where such a transaction is not taxed (e.g. Cyprus or the Netherlands). This option to exempt profits from the transaction (or to be taxed in part by applying a 2% tax on the purchase amount) may also be used in other situations, such as:
- An investor buys developable real estate through a foreign company that performs project development outside Latvia and after the project is developed, the property is already sold to a foreign or Latvian company (related or unrelated) for the implementation of construction works. Thus, part of the profits of this transaction can be shifted to that foreign jurisdiction. If a foreign jurisdiction does not tax such income, it is thus possible to ensure that part of the profits of the transaction is not taxed in any of the countries.
When planning such a transaction structure, it is important to make sure that the presence of a foreign company does not create a permanent establishment, so that there is no risk that Latvian tax authorities consider that the profit of the transaction is taxable in Latvia. When assessing the occurrence of a permanent establishment, it is necessary to take into account not only the regulatory enactments of Latvia, but also the provisions of the tax convention concluded between Latvia and this foreign state, which are generally more favorable. If such a tax convention has not been concluded or has not yet entered into force, this means that the Latvian rules have to be applied and therefore the creation of a foreign company in such a country might not be the best solution.
In any case, in addition to the tax aspects already described, consideration should also be given to non-tax aspects, such as whether Latvia already has an investor’s (group) home country, where a holding company is already established, which will be a funder and how the financing will be structured.