I INTRODUCTION TO THE LEGAL FRAMEWORK
i Ownership of real estate
Real estate is most commonly held by way of freehold, which is an unrestricted ownership (in terms of the right to occupy and dispose of real estate) manifested by registration in the Swedish Land Register. Certain restrictions are applicable to freeholds with regard to the right to develop land and construction of or materially changing the look, function or use of buildings. The government guarantees the accuracy of the Land Register, which is kept by the Mapping, Cadastral and Land Registration Authority.
A common form of tenure is the site leasehold, which is a usufruct whereby investors may hold government- or municipality-owned real estate against an annual fee. Site leaseholds are generally treated as freeholds when it comes to the right to occupy, develop and dispose of the leasehold as well as using the leasehold as collateral by registering mortgages in it. A site leasehold is usually granted for long periods of time, up to 60 years, unless longer periods are agreed between the parties. Shorter periods are allowed when it comes to non-residential real estate. However, the fee may be reviewed every 10 years unless otherwise agreed in the leasehold agreement.
ii System of registration
A new owner of real estate (whether in the form of a freehold or a site leasehold) is required by law to submit an application to attain a title deed with the Mapping, Cadastral and Land Registration Authority. The application shall be submitted within three months of completion of the acquisition of the real estate. It is required to provide the Land Registration Authority with the original deed of transfer together with the application. The physical or legal person registered as owner with the Land Registration Authority has the right and ability to take action involving the property, apply for mortgages, decide rights of use, etc. Failure to apply for a title deed within the three-month time limit does not affect the validity of the acquisition; however, the Land Registration Authority has the right to order an application under a penalty of a fine. Corresponding requirements apply to acquisitions of site leaseholds.
The Swedish government guarantees the accuracy of the Land Register and is liable to compensate any loss or damage caused by faulty information in the register. For this reason, there has to date not been any need for nor, to our knowledge, any availability of title insurance in Sweden.
iii Choice of law
Sweden is a member of the European Union (EU), and is, therefore, bound by the Rome I Regulation (Regulation (EC) No. 593/2009 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations). The general rule is that a contract is governed by the law chosen by the parties. If the parties to a contract have not made a choice of law, contracts regarding the right in rem to or the tenancy of real estate shall be governed by the law of the country in which the real estate is situated (lex rei sitae). However, if the contract has a manifestly closer connection with another country, the law of that country shall govern the contract.
II OVERVIEW OF REAL ESTATE ACTIVITY
i Real estate activity
In terms of transaction volume in the Swedish market, 2019 was a record year. The total volume was around €22 billion (compared to around €20.1 billion in the previous record year of 2016) with 42 transactions with a transaction value over the €100 million mark. The trend in the market is fewer transactions at a higher value. The outlook for 2020 is said to be positive.
Interest from foreign investors in the Swedish market continues to be high, with foreign investors acquiring real estate assets for over €7.5 billion in 2019 (representing around 35 per cent of the total transaction volume). The weak Swedish currency combined with continued economic growth and low interest rates are said to play a key role in this trend. Other factors that make Sweden an interesting market for foreign investors, however, are (1) the fact that the Swedish market is considered safe compared to other markets, (2) it is characterised by a robust and transparent system and simplicity in terms of transaction processes and agreements, and (3) it has for a long time proven to provide liquidity for investors. In terms of asset classes, the residential market stands out as particularly hot. Logistics is another strong market with record volumes in 2019.
ii Legal factors
The regulation regarding investment aid for student housing and housing for rent has been reintroduced and will take effect in February 2020 since being halted back in 2018. The terms for granting aid in relation to new developments have been updated and the effects of it remains to be seen.
In the second half of 2019 the prohibition on trading with residential lease contracts was further tightened and both buying and selling residential leases is now a criminal offence.
The Swedish government issued an official report in March 2017 that contained a proposal stating that if a real estate holding company was subject to a change of control because of a tax-exempt sales of shares, the company itself would be taxed as if it had sold and purchased the actual real estate at fair market value. The proposal came under very heavy criticism and was not been enacted. There are currently no indications that the proposal will ever be enacted, but it still may serve as an indication of political will to increase the tax burden for the real estate sector.
See Section VIII for further discussion regarding anticipated legislation and proposals for reform.
iii Social factors
In spite of significant development projects in recent years, the general consensus is that there is a shortage of particularly low-cost housing in and near Sweden's main cities, especially Stockholm. Politicians have been promising significant increases in development of residential real estate; however, the reality is that current rent control legislation, permission processes for development projects, the cost of meeting current requirements on residential buildings and the shortage of resources in the construction industry will make these targets hard to meet in practice.
III FOREIGN INVESTMENT
There are no restrictions on foreign investors owning or registering title to real estate in Sweden. However, it is still common practice for foreign entities to establish limited liability companies in Sweden through which real estate will be held.
IV STRUCTURING THE INVESTMENT
Investments in commercial real estate are generally made as indirect investments through special purpose holding companies. This is, in part, to avoid real estate transfer tax when divesting the property (see Section V.iii), but the main reason for an indirect holding is to ensure that capital gains upon a transfer of the real estate (indirectly through the transfer of the shares in the holding company) are tax exempt for the seller (see below).
The special purpose holding companies most commonly used today are Swedish limited liability companies. Such companies are formed through registration with the Swedish Companies Registration Office. A limited liability company is represented by a board of directors and in some cases a managing director. At least half of the board of directors and the managing director must be residents within the European Economic Area (EEA). If none of the representatives is resident in Sweden, the company must authorise a person resident in Sweden to receive service of process on behalf of the company. The liability of the shareholders in a limited liability company is by default limited to the company's share capital and it is very rare for the corporate veil to be pierced in Sweden (whereby the shareholders would be directly liable for a limited liability company's debt and obligations).
Another form of legal entity that is sometimes used for owning real estate is a limited partnership. However, limited partnerships are currently not as commonly used anymore due to a less favourable tax regime.
i Acquisition vehicles and acquisition financing
Local Swedish acquisition vehicles are usually established as limited companies. The acquiring company is normally financed through a combination of equity, external loans and shareholder loans. Sweden does not have thin capitalisation rules, so generally equity is kept fairly low. Interest deduction limitations rules may, however, limit the tax deduction of interest paid to affiliated companies. Sweden has also, as of 1 January 2019, introduced earnings stripping rules that may limit interest deductions (see below).
The acquisition vehicles and the target company are often merged post-completion of an acquisition to get the acquisition financing into the target company holding the real estate and thereby making it possible to, inter alia, use the real estate as collateral for the financing. Should the initial structure be left intact, however, the financing costs may still be set off against taxable income in the target or real estate holding company in subsequent years, using group contributions with fiscal effects.
ii Interest deductions
As mentioned, there are currently no formal thin capitalisation, formal debt-to-equity rules in the Swedish tax system, save for the recently introduced earnings stripping rules. Shareholder loans and debt-to-equity ratio may thus to a degree be used to provide for tax optimisation through interest deductions and flexibility in moving cash upstream.
Compulsory liquidation will, however, be triggered under the Swedish Companies Act should the equity of a company fall below 50 per cent of the registered share capital, unless the equity is restored to an amount corresponding to at least the entire registered share capital. Hence, it is often recommended to keep the registered share capital limited compared to the market value of the company containing real estate or to the free equity of the company.
Interest accrued on third-party loans is generally tax deductible provided the interest is not related to profits or distribution of profits. Interest between affiliated parties must be at arm's length to be deductible. Interest paid between affiliated companies that are in excess of an arm's-length interest rate is not tax deductible to the extent it exceeds the arms'-length interest rate. Provided the interest on intercompany loans is properly benchmarked and documented, interest costs are normally deductible.
There are interest deduction limitation rules in Sweden covering intercompany loans between affiliated companies and interest costs on such loans. Put simply, expenses related to these loans will only be tax-deductible if the beneficial owner of the interest is taxed at a level of at least 10 per cent, and provided that the loan was not exclusively, or as good as exclusively (at least to 90 per cent), put in place for tax reasons; or the beneficial owner of the interest is an EEA resident, and the loan was predominantly put in place for business reasons. The scope of the interest deduction limitation rules covers all loans from affiliated companies regardless of the purpose of the loan. Companies are considered to be affiliated if they could be seen as predominantly jointly managed, or if one of the companies, directly or indirectly, has significant influence over the other company. A company is defined as a legal entity or as a Swedish partnership. Foreign equivalents also fall under the definition in the Swedish Income Tax Act of a company if the association has the ability to acquire rights and undertake obligations; the ability to institute legal obligations before a court and other authorities; and separate partners cannot freely dispose over the association's assets.
As of 1 January 2019 Sweden has introduced earning stripping rules. The rules are based upon the EU Anti-Tax Avoidance Directive (ATAD), which in turn is based upon BEPS Action 4. The new rules limit interest expense deductions to – much simplified – net interest expenses of up to 30 per cent of earnings before interest, tax, depreciation and amortisation (EBITDA). This limitation only applies – also much simplified – to net interest expense exceeding 5 million kronor (in a group). Equalisation of interest deduction capacity within a group is possible, provided the companies qualify for Swedish tax consolidation. Negative net interest not possible to deduct in one year may be carried forward for up to six years, but is forfeited in the event of a change of control.
Furthermore, as of 1 January 2020 the scope of the anti-hybrid rules has been broadened to also cover tax effects of, for example, disregarded entities and permanent establishments, certain hybrid financial instruments and 'double dips' (i.e., costs being deductible in more than one jurisdiction).
iii Pre-exit restructuring
Put simply, a real estate holding company may transfer real estate to a subsidiary (including a newly formed company or acquired shelf company) at a price equalling the lower of the tax assessment value and the tax base value, without any adverse income tax consequences. Such a transfer will, however, trigger a real estate transfer tax (see Section V.iii). The subsidiary can subsequently be divested without any tax consequences.
A divestment of real estate is subject to capital gains taxation. For corporate entities the tax rate is generally 21.4 per cent.
There is a capital gains tax exemption for Swedish corporate entities on gains related to the disposal of shares 'held for business purposes'. Shares in Swedish corporations and participations in partnerships (as well as in foreign companies) can qualify as shares held for business purposes, and thus be divested tax exempt. The rules are applicable also for real estate owning companies, but not for construction companies or companies holding estate as current assets.
V REAL ESTATE OWNERSHIP
Planning control is mainly the responsibility of the municipalities in Sweden. The municipalities draw up comprehensive plans and local plans. A comprehensive plan covers the entire municipality and stipulates the long-term development of the land but is not legally binding. A local plan is a legally binding document and regulates more specifically how a particular land within the municipality shall be used. A local plan is, for example, required for new densely built areas and new buildings that may have a greater impact on their surroundings. A local plan is of significant importance for the ability to grant permits.
Most developments and change of use of real estate require a permit. The responsibility for granting permits lies with the local building committee in each municipality. A building permit is, among other things, required for new buildings, extension of existing buildings and change of use of existing buildings. Furthermore, a demolition permit is required for demolition of whole or parts of a building and a ground permit is required for excavation and filling that affects the ground level.
The liability for contaminated land is primarily based on the 'polluter pays' principle, which essentially means that the operator who caused or contributed to the contamination is responsible for investigating and remedying the damage caused by the contamination.
A real estate owner may be liable in a subsidiary manner for damage caused by contamination if the liable operator cannot be found or is unable to remedy the damage. However, such liability is only imposed if the real estate owner knew of, or should have discovered, the contamination at the time of the acquisition of the real estate (and only applicable on acquisitions effective after 1 January 1999).
Sweden levies a real estate transfer tax (stamp duty) on most transfers of real estate. Most legal persons pay 4.25 per cent; natural persons and tenant owner associations pay 1.5 per cent tax on a base that consists of the higher of the consideration paid and the tax assessment value of the real estate. Real estate transfer tax on an intragroup transfer of real estate may usually be deferred provided the real estate, the buyer and the seller remain in the same group. Real estate transferred through a merger, a demerger or real estate re-allotments are currently not subject to real estate transfer tax.
In respect of real estate, deductions for depreciation of buildings are allowed at various rates between 2 and 5 per cent annually, depending on the type of building. Furthermore, as of 1 January 2019, a 'primary deduction' was introduced, which means that an additional annual depreciation of 2 per cent is allowed during the first six years from the completion of a new apartment building. Land is a non-depreciable asset.
iv Finance and security
The most common form of security granted over real estate is the pledge of mortgage certificates taken out in real estate. The registered owner of real estate has the right to take out mortgages on the real estate. An application to take out mortgages is made with the Land Registration Authority. Taking out a mortgage is subject to 2 per cent stamp duty based on the face value of the mortgage. When the application is approved, a mortgage certificate in electronic or physical form is issued that evidences the mortgage. To perfect a pledge over a mortgage in real estate, the pledgee must be registered as the holder of the electronic mortgage certificate in a register with the Land Registration Authority, or in the case of a paper mortgage certificate, take physical possession of the certificate.
It is furthermore common to pledge the shares in a special purpose real estate holding company. These pledges are perfected by the transfer of share certificates to the pledgee, or, in the event that no share certificates have been issued, through noting the pledge in the company's share ledger. Examples of other forms of security are business mortgages, pledges of intellectual property rights such as trade names and pledges of balances in bank accounts.
VI LEASES OF BUSINESS PREMISES
The term of a lease is, in general, freely negotiable between the parties and may be indeterminate or determinate. The maximum lease term is 50 years for premises located in non-planned areas and 25 years in planned areas. If the lease term is indeterminate, there is a legal requirement to ensure a minimum notice period for termination of nine months. If the lease term is determinate, the law requires the parties to ensure certain minimum notice periods as well; for example, if a lease term is longer than nine months, the minimum notice period is nine months.
The grounds for forfeiture are fixed by law. The landlord has, for example, the right to terminate the lease early if the tenant:
- does not pay rent;
- subleases the premises or transfers the lease without necessary approval; or
- materially neglects the premises.
Furthermore, the tenant under a commercial lease has an indirect right of tenure (see below), while a tenant under a residential lease has a direct right of tenure.
As a general rule, the rent must be fixed in the lease agreement if the lease term is less than three years. If the lease is longer than three years, another basis for calculation of rent is allowed, for example tying the rent to an index such as the Consumer Price Index. If the lease is longer than three years, another basis for calculation of rent is allowed, for example tying the rent to an index such as the Consumer Price Index. For heating, cooling, warm water, electricity, water and sewage do not need to be included in the fixed rent. The rent may also be based on the tenant's turnover (which is common in retail and for hotels) or on a written agreement concluded between the landlord and an organisation of tenants (which is common in residential).
iii Tenant liability
A tenant's main responsibilities under the Tenancy Act are as follows:
- A tenant is responsible for paying rent.
- A tenant may only use the leased premises as intended and as stated in the lease agreement unless the landlord gives its approval for a change of use. If the landlord does not give its approval, the regional rent and tenancies tribunal may grant the tenant permission to use the premises for another purpose if the tenant has leased the premises for more than two years and has considerable reasons for change of use, and the landlord does not have reasonable grounds for opposing the change.
- A tenant is responsible for taking care of and maintaining the premises and is liable for compensating the landlord for any damage caused by the tenant. The parties may agree on more extensive responsibilities for the tenant, with respect to maintenance.
- A tenant is not allowed to use the premises in a way that may disturb or damage the health and living environment of people living in surrounding areas. A tenant is furthermore responsible for preserving order and soundness within the premises and keeping the premises in a good condition.
- A tenant is generally not allowed to transfer a lease or sublease without the landlord's approval. However, transfers may be permitted if the business operation that has been conducted in the premises is also transferred and the regional rent and tenancies tribunal gives its approval to the transfer. With regard to subleasing, the tenant may, if the landlord has denied the tenant permission to sublet the premises, apply to the regional rent and tenancies tribunal to get the denial overruled provided that the tenant can show that the landlord has unreasonably withheld its approval.
- A tenant is generally responsible for reinstating the premises to an acceptable condition at the expiry of the lease term (however, this is not explicitly regulated by law).
As stated above, most of these liabilities may constitute grounds for forfeiture if they are neglected by the tenant.
iv Security of tenure
Tenants to commercial leases have an indirect right of tenure, which secures a right to compensation for the loss of the lease if the landlord terminates and refuses to renew the lease, or if the landlord as a condition for renewal requires lease terms that are not in accordance with the market standard and the tenant cannot accept such terms and therefore decides to leave the premises. The compensation shall cover a minimum of 12 months' rent.
However, the tenant does not have the right to such compensation:
- if the tenant has neglected its responsibilities under the lease agreement;
- if the premises shall be demolished and the landlord provides other acceptable premises;
- if the premises shall undergo essential reconstruction and the landlord provides other acceptable premises;
- if the landlord has reasonable ground for refusing renewal; or
- if the landlord's terms for renewal are reasonable.
The tenant may waive its right to compensation. Such a waiver requires a separate written agreement between the parties, and, if the lease has been in force for less than nine months when the waiver is provided, the parties need approval from the regional rent and tenancies tribunal.
VII DEVELOPMENTS IN PRACTICE
i Coming tax reforms
The debate around whether the real estate sector in general is 'undertaxed' or not has been ongoing for quite a while now, but has somewhat subsided after the above described earning striping rules were introduced. There are, however, unknowns related to coming tax reforms as several political parties have highlighted the need for a major tax reform. However, the fact that the election to the parliament in September 2018 failed to create a clear winner, and Sweden is currently ruled by a minority coalition that needs support from the opposition to enact any changes, indicates that it is not likely that any major reforms will be enacted or even proposed during the current term. The next general election is to be held in September 2022.
In general, the real estate sector has been quite protected from any major disruption, with the exception of the hotel industry with the entrance of the likes of Airbnb. Looking forward, the office market may be facing similar disruption owing to increasing demand for flexibility from tenants looking for possibilities to quickly increase as well as decrease leased space. New business models based on co-working spaces and spaces as a service are coming, but are held back to some extent by traditional business models and ultimately tenancy laws and VAT-laws that are not designed to accommodate these changes. In effect, this means that the era of long and stable cash-flows in the office segment may be over, which in turn will have implications for traditional valuation models.
The consistent growth of e-commerce is likely to continue to negatively affect the market for retail real estate, at the same time as having positive effects for logistics real estate.
Finally, we see a lot of new technology (proptech) coming into the real estate industry, and considerable sums being invested in companies looking to disrupt the industry in various ways such as solutions for management of buildings and tenants, smart buildings, energy efficiency and platforms for add-on services that may be offered to tenants.
VIII OUTLOOK AND CONCLUSIONS
Anticipated legislation and proposals for reform
As discussed above in Section VII, it is currently exceedingly difficult to foresee any general direction and there are currently no known tax initiatives concerning the real estate and construction industry as such. It is, however, expected that the corporate tax rate will be lowered to 20.6 per cent as of 1 January 2021.
1 Jan Berg and Carl-Magnus Uggla are partners at Bird & Bird.