These days, an increasing number of buyers of Swiss companies require that the real estate of the target is taken out of the deal and that the company enters into a lease agreement for its facilities. There are good reasons for that, but also legal considerations to consider.
The buyer’s reasons are several. First, an operational buyer will want to buy an income stream at a multiple. With a lease instead of ownership of the facilities, the EBITDA is easier to calculate and project in the long term.
Second, with a lease, the buyer has more flexibility to move to larger or smaller spaces and thus adapt to business developments.
Third, real estate is almost always a time bomb in terms of deferred taxes, as Swiss companies often purchase real estate and depreciate it entirely (a method allowed by Swiss accounting standards) to reduce taxes, at the same time creating considerable hidden reserves that will be taxed upon a resale of the property.
From the seller’s point of view, removing real estate can also make sense. Private sellers will often keep it as their retirement’s recurring income stream. Corporate sellers will try to maximise the return on their real estate by selling it independently.
Indeed, there are many funds and investors that acquire Swiss commercial real estate aggressively and at high prices. Its appeal is as a hard asset, in a low-tax country. One should also note that foreigners can only buy commercial and industrial real estate in Switzerland (apart from specific and limited holiday residences in tourist resorts) making commercial and industrial real estate even more attractive.
There are numerous legal issues to be dealt with when stripping out the real estate of an acquired business.
First, for industrial sites particularly, environmental issues will remain with the operating company. According to the Contaminated Sites Ordinance, the required measures (investigation, monitoring, remediation, follow-up) required in relation to contaminated sites will in principle be carried out by the owner of the polluted site. However, the authority may also require the party responsible for the pollution to carry out the preliminary investigation, the monitoring measures or the detailed investigation. The same applies to the preparation of the remediation project and the implementation of the remediation measures. As a result, the purchased operating company may remain liable for the pollution even if it no longer owns the property. Environmental due diligence may thus remain necessary.
Second, refinancing issues will often arise for the target. Swiss banks generally grant operating loans with a mortgage on real estate as security. Taking out the real estate will then cause the operating loans to be terminated and additional security may have to be provided by the buyer, often in the form of a pledge on the target’s shares.
If the buyer cannot pledge the target’s shares (because they are already pledged to finance the acquisition), the buyer will often want to finance the target to reimburse the target’s debts and request that assets of the target be pledged in its favour to secure its own financing. This will however generally be considered an illegal upstream guarantee and alternatives will have to be examined.
Third, the stripping of the real estate may trigger transfer taxes. Since the landmark Supreme Court decision obtained by the Python law firm in 2009 (ATF 2C_641/2009, see link), the tax authorities cannot levy transfer taxes on the sale of a company owning real estate, even if such real estate is very substantial. As a result, if a purchaser acquires a company and transfers its assets (but not the real estate) in an asset deal in a second stage, no transfer taxes should be levied.
In a second case (ATF2C_199/2012), the Supreme Court declared that a transfer of all the real estate within a group, even if it was owned by a foundation or an entity abroad, could qualify as a merger and should also be exonerated from transfer taxes. However, if the transfer is made directly to an individual, transfer taxes (around 3% of the real estate value, without deduction of related debts) will be levied. As it appears from the foregoing, there are various ways to separate real estate from operations, but not all of them have the same tax results.
Fourth, income taxes may be triggered on the difference between the actual value and the book value of the real estate in the accounts of the target and the seller may be held liable for such income taxes. Considering that the seller is a related party to the target, if the transfer of the real estate is made at book value the tax authorities will not treat such a transfer as being at arm’s length. An independent expert opinion on the fair market value of the real estate will thus be necessary and this valuation will depend largely on the lease agreement concluded between the target and the seller as the new owner of the real estate.
In the same manner, a split of the company between an operating company and a real estate company will trigger taxes if the real estate company cannot show an independent activity. A residual commercial activity for the real estate company would avoid all profit taxes, whereas should the sole activity of the real estate company be to lease the properties, a profit tax will be levied.