The Czech government has approved the scrapping of a 4% tax on real estate buyers as part of efforts to breathe life into the country’s residential market, effectively closed by the Coronavirus pandemic. What will this mean for residential and commercial property deals?
Finance Minister Alena Schillerová said on 30th April that the proposal, which still needs parliamentary approval, will abolish the Real Estate Transfer Tax (RETT) that buyers currently pay on purchases of existing properties, not on new builds. Its abolition would, therefore, only affect the “aftermarket”, i.e. that for pre-owned existing stock. As part of this proposal, the possibility for the buyer to deduct the interest paid on home mortgages or bank financing of property purchases will also be revoked.
Residential
In the short term, the announcement by the finance minister confirming the government’s decision should give the market a boost, because speculation about repealing the tax has meant that potential buyers of residential property were holding off in expectation of saving the money needed for the tax payment. Immediately after the tax’s abolition, demand for homes could increase, as buyers now have effectively 4% more to spend and total transaction costs can be argued to have decreased.
In the medium term, although the dynamics of the Prague market are not expected to change, with demand continuing to outstrip a poor supply, the step will improve liquidity but not result in increased pricing. This is because borrowers are having to deal with higher costs of finance and tighter loan conditions from banks post Covid-19, not to mention general ‘consumer’ confidence and uncertainty, as unemployment rates look set to rise and salaries fall.
Commercial
RETT is only one of several reasons that commercial transactions are overwhelmingly carried out as share deals rather than asset deals. Sellers prefer share deals because they don’t have to pay corporate income tax on gains from the trade, whereas in the case of asset deals corporate income tax must be paid on disposals when the asset has been held for less than five years (which is set to be extended to 10 years). The seller’s position, however, remains the same after the scrapping of RETT. On the other hand, asset deals will look more appealing to buyers.
It is difficult to estimate the magnitude of the impact that the repeal of the tax will have on the current transaction model where virtually all transactions are share deals, since corporate income tax (alternatively, capital gains tax) is the main differentiator between the two approaches.
As for the tax deductibility of interest, the benefits from abolishing RETT would be mitigated by an inability to lower the tax base each year by the interest amount, but the amount is relatively negligible compared to the saving on RETT. Moreover, tax deductibility of interest against the tax base is often not applicable even under current conditions: for example, if the investor uses non-bank financing from a related company (e.g. fund financing, shareholder loans or quasi-equity funding), accounting rules don’t allow for the deduction of interest when the debt-to-equity ratio is too high.
In conclusion, the decision-making and interactions of investors on the commercial real estate market are complex. It should be assumed that the abolition of RETT would only be reflected in a limited amount of cases, since the corporate income tax is a proportionally bigger differentiator between the two transaction models.
