The Real Estate Law Review: Luxembourg
Introduction to the legal framework
Under Luxembourg law, there are several types of in rem rights pertaining to real estate assets.
The most comprehensive right of real estate ownership is the full ownership right, which includes the right to use the real estate asset, the right to perceive the fruits (e.g., rent) of the asset and the right to dispose of the property of the asset and is defined in Article 544 of the Luxembourg Civil code as 'the right to enjoy and dispose of things, provided that they are not used in a manner prohibited by law or regulations'.
Besides the full ownership right, there exist several other in rem rights attached to real property, which as opposed to the right of full ownership, are generally only granted for a limited period of time. Over the past decade, an increasing number of real estate development projects have been structured in the form of an emphyteosis or surface rights. Both the emphyteosis and the surface rights are in rem rights which are commonly granted by the public authorities to private property developers and which entail the right for the developer to use the property and to erect buildings on the land plot. At the end of the contractual term (usually between 27 and 99 years), the grantor of the emphyteosis respectively the surface right may become the owner of the constructions.
Aside from the individual ownership rights, ownership rights can be split up between several co-owners in the form of indivision (joint ownership rights), which are characterised by the fact that two or several co-owners share their ownership rights over the same property. Whereas the indivision is considered to be temporary form of joint-ownership which usually arises as a result of an inheritance, another form of deliberate co-ownership is very commonly used to structure the cohabitation of several co-owners within a condominium project, the so-called co-ownership rights governed by the law of 16 May 1975, as amended.
A sale of real estate (asset deal) must be registered and recorded in the mortgage registry held by the Land Registration and VAT Authorities in order to be enforceable vis-à-vis third parties (which triggers the payment of registration taxes, as further detailed in Section V.iii).
In addition to the right of ownership, all the remaining in rem rights pertaining to real estate assets as well as any mortgage inscriptions or easements (with the exception of legal easements) must be registered with the mortgage registry. This also holds true for lease agreement with a duration of over nine years.
Due to the fact that only duly certified deeds may be entered in the mortgage registry, the respective transaction must be recorded in a deed, received by a Luxembourg public notary.
The public notary will register the transfer or inscription deed with the Land Registration and VAT Authorities. The administration will then record the transfer or inscription with the mortgage registry, making it opposable to third parties.
Aside from the mortgage registry, there is another land register kept by the Land Registry and Topography Administration, which is managing both the land documentation and the official maps in Luxembourg.
Asset deals involving real property in Luxembourg are governed by the laws of Luxembourg, being the law of the country where the property is located (lex rei sitae).
Overview of real estate activity
The Luxembourg real estate market has been booming over the past several years, driven by very low interest rates on the financing site and a steep incline in the overall business activity.
The Luxembourg real estate sector is largely driven by the office sector. The major development areas in the office sector are currently located around the city belt of Luxembourg city, for example the Kirchberg area and the Ban de Gasperich area. Vacancy rates in the office market are continuously declining in central districts as well as in the city belt and the periphery, with an overall office vacancy rate of around 3 per cent. This has led to a shortage situation where rental values of up to €50 per m² of office space per month have been registered for prime locations in the city centre.2
The boom in the office sector also has a significant impact on the residential sector, where the offer of new housing projects is consistently lacking behind the demand. According to a study published in 2011 by the STATEC (the National Institute of Statistics and Economic Studies of the Grand Duchy of Luxembourg),3 there would be a need for 6,500 dwellings per year given the actual growth of the population in Luxembourg. This leads to significant mismatch between the offer and the demand on the housing market and ultimately to a sharp increase of the housing prices, especially in the city centre of Luxembourg.
Under Luxembourg law, there are no restrictions on ownership or occupation of real estate by foreign investors. A lot of large real estate complexes in Luxembourg are ultimately held by foreign (institutional) investors, often acting through a Luxembourg SPV.
As to the Luxembourg security package with regard to financing transaction, there are generally no restrictions applicable to foreign investors. Moreover, the Luxembourg legal framework in the matter of collateralisation is generally regarded by business professionals and practitioners as one of the most valuable systems within the EU.
Because of its combination of a number of different features, namely the contractual flexibility allowing tailor-made structuring, a non-formalistic approach, full protection against insolvency risk, an efficient and safe enforcement process and investor friendly case law, the Luxembourg Law of 5 August 2005 on financial collateral arrangements is very popular amongst local and foreign investors who are looking to secure their real estate deals.
By transposing into national law the European directive of 6 June 2002 (Directive 2002/47/EC), the Luxembourg legislator decidedly exceeded the guidelines of the directive by providing a protection regime that is very attractive to (foreign) holders of collateral, whether under the form of pledges, transfer of title for security purposes, repos or netting arrangements.
Structuring the investment
Real estate transactions can be structured either as a direct purchase (or 'asset deal'), where the property is directly transferred from one individual (or company) to another individual (or company) or as a share deal, where the shares of the target company owning the real property are transferred to the purchaser without directly transferring the ownership of the property from one entity to another (after the completion of the share deal, the target company will remain the owner of the property).
The asset deal is a very common transaction form amongst private individuals who are selling their (residential) real estate, although from a tax perceptive it is not very advantageous for the purchase due to the transfer taxes (i.e., 7 per cent of the property value for direct transfers of properties; office and commercial properties located in the city of Luxembourg are taxed at 10 per cent of the property value). Moreover, the capital gains realised by the seller will normally be taxed upon transfer of the property.
For the above reasons, the vast majority of large real estate transactions are structured through a share deal, whereby the purchaser acquires the shares of the target company owning the real estate asset. Due to the fact that the registered owner of the property (namely the target company) will remain unchanged, no transfer tax will be due. At the moment of the share sale, the then-realised capital gains (difference between the book value of the property and the sales price) will not be taxed as the property is not considered to have changed hands in the eyes of the tax authorities. This tax burden will be transferred to the new shareholder of the target company, as the taxable gain is only realised when the property is ultimately sold in an asset deal. Thus, the selling price is usually diminished by a provision for latent capital gains.
Due to the corporate veil and the flexible legal framework, the private limited liability company and the public limited liability company are the most commonly used special purpose vehicles (SPVs) for the holding of real estate. The private limited liability company would require a minimum share capital of €12,000, whereas the minimum share capital of a public limited liability company is set at €30,000.
As a general principle, any capital gain realised upon the transfer of an asset should be subject to corporate income taxes at a rate of 24.94. per cent (including municipal tax) for companies having their registered office in the city of Luxembourg. If the tax returns of the company demonstrate that there have been losses, these losses may be offset against any capital gains realised by the company which will ultimately lead to a decrease of the taxable base for the company.
By structuring the deal through tax-transparent entities (e.g., partnerships), the municipal tax (6.75 per cent for the city of Luxembourg) may be saved, depending on the place of residency of the ultimate shareholders. Whether or not it is worth structuring the transaction through a tax-transparent structure has to be assessed on an individual basis, taking into account the individual exit strategy of the investor.
In addition, investment fund regimes are becoming increasingly popular within real estate investors in Luxembourg. Due to the high setup costs and ongoing expenses, the setup of such a fund structure is only worth considering for large volume real estate portfolios.
The specialised investment fund (or SIF), a collective investment structure governed by the Luxembourg Law of 13 February 2007 and reserved to well-informed investors, is an investment structure that can be structured in a very tax-efficient way to the extent that realised capital gains may be totally tax-exempt (if certain criteria are met).
Real estate ownership
In Luxembourg, urban planning is subject to both national and municipal laws and regulations.
At the national level, the Luxembourg government seeks to further intervene in the urban planning process by setting up four new urban master plans in 2018. The idea behind these master plans is to centralise the broad outlines of urban planning by selecting certain areas that are prioritised development areas.
At a local level, each municipality has its own general town planning scheme (PAG), which is considered to be a set of regulatory requirements in graphic and written form, applicable across the respective municipality and dividing the municipal territory into various zones, stating for each zone:
- how the land is to be used, namely which types of use can be made of each plot of land (e.g., dwellings, economic activity, forest, etc.); and
- the degree of land use, namely the development potential associated with each plot (e.g., the gross built-up surface area, number of houses, etc.).
General development plans are approved by the communal council, the Minister for Home Affairs and, as the case may by, by the Ministry of the Environment.
Specific town planning schemes execute and specify the mode and degree of land use of each zone or part of a zone in a municipality's general town planning scheme (PAG).
The environmental administration manages contaminated and potentially polluted sites through a register of former landfills and contaminated sites.
This register has the following objectives:
- detect pollution issues where urgent intervention is needed;
- develop medium- and long-term analyses and decontamination programmes, taking into account priority intervention needs;
- have a planning tool to take into account the possible presence of contamination when carrying out projects or developing town planning schemes (e.g., PAG); and
- monitor the evolution of the state of the various sites listed.
Approximately 10,000 sites are currently listed on this register. Upon request, anyone can obtain information about a specific site.
As a general rule, the liability for any decontamination of polluted land has to be assumed by the last operator of the site. If the operator of a classified establishment decides to close down its activity, he has to file a declaration of cessation with the competent authorities, who will then decide on potential obligations to restore the site.
Such a decontamination obligation may also be triggered due to a change in the activity carried out on a plot of land on which a potentially polluting activity has taken place, or at the request of the Ministry of the Environment, when there are serious indications of pollution on the site
The direct sale of real estate through an asset deal is subject to a transfer tax of 7 per cent (6 per cent registration duty and 1 per cent transcription fee) while for office and commercial properties located in the city of Luxembourg the transfer tax is fixed at 10 per cent.
The transfer tax is calculated on the purchase price, as indicated in the notarial deed of transfer and it may be adjusted by the competent authority (the Land Registration and VAT Authorities) if the sales prices does not correspond to the fair market value of the property. The transfer tax is usually paid by the purchaser.
Acquisition of real estate are generally exempt from VAT, except in the case where both parties are subject to VAT and explicitly choose to opt in for the VAT regime by filing a VAT option form. In such a case, the applicable VAT rate (currently 17 per cent) is added on top of the sales prices, and the transfer tax will be calculated based on this cumulative amount.
For a property sale before the completion of the works, the remaining works that have to be performed by the developer after the transfer of the property will be subject to VAT, although the buyer can opt for a reduced VAT rate of 3 per cent if he or she acquires the property for his or her personal use.
iv Finance and security
Real estate transactions are generally secured by a first-ranking mortgage granted in favour of the third-party lender. In rare cases, the debtor will also grant an irrevocable mortgage mandate in favour of the lender whereby the debtor irrevocably authorises the lender to register a mortgage on his or her behalf.
The mortgage deed has to be signed in front of a notary public (subject to a few minor exceptions) and the inscription fees for the mortgage will amount of 0.29 per cent of the principal amount of the underlying receivable (0.24 per cent registration duty and 0.05 per cent inscription fees).
Conventional mortgages have to be renewed every 10 years in order to remain enforceable.
For more complex transactions, which are generally structured through a share deal, lenders do often require a more extended security package, including pledges over the shares of SPV owning the property, pledges over bank accounts and other receivables such as rent incomes or insurance policies.
Financial assistance issues may arise.
Leases of business premises
Under Luxembourg law, commercial lease agreements are defined as any lease of a building intended for the exercise of a commercial, industrial or artisanal activity and are governed by the law of 3 February 2018, which has modified or added certain articles to the Luxembourg Civil Code.
The parliamentary works do clearly state that this new regime is not applicable to liberal professions and premises intended for administrative use (i.e., office space). Hence, office lease agreements are only governed by the general provisions of the Luxembourg Civil Code, which do not provide a lot of protection for the tenant.
Commercial lease agreements may be concluded for a fixed term or for an undetermined duration. As there is no mandatory rental period, the fixation of the term of the lease is subject to contractual freedom. Nevertheless, the provisions of the law of 3 February 2018 are not applicable to lease agreements with a term of up to one year (e.g., pop-up stores).
ii Rent and rent increases
The rent amount as such can be freely determined between parties. A main objective of the legislature was to abolish the practice of the 'key-money' for commercial lease agreement. The revised Article 1762-5 of the Civil Code states that neither the landlord nor any third person can demand any surcharge from a potential tenant in order to conclude a lease agreement, and any such provision would be void.
The new regime also tries to prevent the tenant profiting from its lease agreement by sub-renting the premises with a top-up to the rent of the main lease agreement. Save where the tenant has made significant investments related to the activity of the subtenant, the rent that the tenant is allowed to the demand from the subtenant cannot be higher than the rent he or she pays to his or her own landlord.
The rent for commercial lease agreements is usually linked to the consumer prices index, published by the STATEC and will be adjusted upon variation of the index, usually on a yearly basis.
Payment of rent is generally exempt from VAT, but the parties can declare to opt in for the VAT regime if more than 51 per cent of the activities performed out of the leased premises are subject to VAT. In such a case, the current VAT rate (currently 17 per cent) will be applied on top of the rent.
iii Renewal or termination
For commercial lease agreements, the notice period has to be at least six months and the termination notice has to be notified to the other party by registered letter with acknowledgment of receipt.
In contrast to office lease agreements, where the tenant has no legal right to renew the lease agreement after the expiry of the contractual term, the new commercial lease agreement regime does foresee a right of renewal of the tenant, which has to be notified by registered letter with acknowledgment of receipt at least six months before the expiry of the lease's term.
During the first nine years of a commercial lease agreement, the landlord can only terminate a lease agreement or refuse its renewal if one of the following three criteria is met:
- the landlord wants to occupy the premises himself or herself (or by his or her first-generation descendants);
- surrender of all leasing activities for comparable activities by the landlord; or
- reconstruction or transformation of the premises.
Furthermore, after nine years, the landlord can terminate the lease agreement or refuse its renewal, without having to provide a justification, if the landlord or a third person pays an eviction indemnity to the tenant. The impact and the modalities of the fixation of this eviction indemnity will be further discussed in Section VII.
Developments in practice
i New regulations concerning constructions in the 'green zone' and introduction of compensatory measures relating to the destruction of biotopes
The new environmental act dated 18 July 2018 has refined the regulations with regard to the requalification and the constructability of land plots located in the 'green zone' and has introduced a new compensation system defining compensatory measures triggered by the reduction, destruction or deterioration of existing ecosystems or habitats of species.
The new digital system assigns to each biotope, habitat or other land use a numerical value per unit area (the 'eco-points'), depending in particular on the rarity and restoration potential of different types of land use.
If a new development project will reduce, destroy or deteriorate such an existing biotope, the initiator of this project must take compensatory measures corresponding to the number of eco-points attributed to the biotope or habitat in order to rebalance the ecological impact of the project.
Hence, it is becoming increasingly burdensome for property developers to exploit new constructions areas.
Further to the above, each modification of the general town planning scheme shall be subject to a strategic environmental assessment (SUP), specifying the environmental impact of the proposed development project.
In addition, certain projects of a certain size may be subject to an environmental impact assessment.
ii Introduction of an eviction indemnity for commercial lease agreements
As already pointed out in Section VI relating to leases for business premises, the Luxembourg Law of 3 February 2018 has introduced the possibility of the landlord terminating a commercial lease agreement or refusing its renewal after an initial rental period of nine years by paying an eviction indemnity to the tenant.
Unfortunately the legislature has missed the opportunity to further define the determination modalities for this eviction indemnity, which can be freely determined by the parties to the lease agreement.
In the absence of any clause in the lease agreement relating to the eviction indemnity, Article 1762-12, Section 2 of the Luxembourg Civil Code states that the parties to the lease agreement may request the judge to determine the amount of the eviction indemnity (based upon the market value of the business capital).
Currently there is no Luxembourg case law on the determination modalities of this eviction indemnity, which leads to a certain uncertainty with regard to the valuation criteria of the business capital. In the absence of any clear court ruling in this regard, it is recommendable to determine the amount of the eviction indemnity contractually.
iii Growing number of sale and leaseback transaction on the Luxembourg market
Over the past several years, sale and leaseback operations have become more popular for owners of office or retail premises in Luxembourg who are looking to sell their real estate assets while continuing to occupy them as tenants, by entering in a (long-term) lease agreement for the premises.
For the seller, this has the advantage that the sale of its current premises will generate a surplus of working capital which can be used to repay existing debts and thus improve the debt-to-equity ratio of the company.
A sale and leaseback operation can be very useful for transitional phases, whereby the seller is looking for a new property or has already commissioned the development of a new building which is not yet finished. This operation will enable the seller to stay in the premises until his relocation to the new premises and at the same time receive the required liquidities to finance its new acquisition or any new business ventures.
The purchaser, on the other hand, can be reassured that he or she will acquire a (fully) let building with a constant cash flow and that will be occupied by a tenant who is well acquainted with the premises.
iv Luxembourg as a hub for real estate investment funds
As already pointed out in the real estate structuring section of this chapter, the Luxembourg funds platform is becoming increasingly popular amongst fund initiators who are looking to market their funds to EU investors.
Whereas the vast majority of Luxembourg domiciled funds do invest in foreign real estate, there are is also an increasing number of domestic real estate developers and investors who structure their investments through fund structures.
With the implementation of the AIFM directive (AIFMD) in 2013, a single marketplace within the EU has been created for the marketing of AIFs, known as the EU 'marketing passport'. Thus, Luxembourg-issued funds can benefit from large access to the EU internal market.
Amid the different structuring possibilities offered by the Luxembourg fund toolbox, two regimes are particularly suitable for real estate funds: the specialised investment fund (SIF) and the reserved alternative investment fund (RAIF) regime.
As already stated, the specialised investment fund was introduced by the Luxembourg Law of 13 February 2007 (the SIF Law). The Law of 12 July 2013, which implemented the AIFMD into national law, further amended the SIF Law.
Funds regulated by the SIF regime are not subject to general investment restrictions, which makes them particularly suitable for real estate funds. This flexibility is one of the key reasons for the popularity of the SIF regime amongst real estate funds. According to a recent survey performed by the Association of the Luxembourg Fund Industry (ALFI), a majority of direct real estate funds (54 per cent) falls under the SIF Law regime.4
Besides the SIF Law, the Luxembourg legal landscape was completed in 2016 by an additional alternative investment fund regime which is similar to the SIF regime: the reserved alternative investment fund (RAIF).
With the adoption of the Law of 23 July 2016 (the RAIF Law), Luxembourg introduced a completely new AIF product that is managed and authorised by an AIFM. The main novelty of this new fund structure is that the RAIF is not subject to any product approval by the supervisory authority of the Luxembourg financial sector (CSSF). The number of newly launched RAIF funds has significantly increased in 2019. According to a recent survey performed by the ALFI, 18 per cent of the fund launches during the surveyed period (in 2019) do fall under the RAIF regime.5
As the CSSF will not be involved in the approval of the fund documentation and will not be in charge of the on-going supervision of the fund anymore (the supervision by the CSSF will be performed at the management company level), a RAIF fund can be set up simply by notarial deed (Article 34 RAIF Law), which gives it a notable time-to-market advantage in comparison to the SIF regime.
On the other hand, a fund structured through the SIF regime can apply directly for an AIFM licence without having to appoint an external AIFM (Article 80(2) SIF Law), whereas the RAIF regime is not available for internally-managed AIFs, due to the lack of authorisation by the CSSF.
Both RAIF and SIF structures offer the possibility of setting up umbrella funds. This leads to an increased flexibility for the fund initiator, who is able to offer different products (e.g., different real estate asset classes) and target different clients within one fund vehicle.
Real estate funds governed by the SIF Law and the RAIF Law may be set up either in a corporate form (e.g., SICAV-SCA or SICAF-SA), in a contractual form (FCP) or as a limited partnership (SCS or SCSp). A key determining factor in the selection of one of these structures is the tax regime applicable to investors: FCPs and limited partnerships are tax transparent, whereas SOPARFIs, SICAVs and SICAFs are opaque for tax purposes.
v Tax measures – Luxembourg government's budget bill for fiscal year 2021
Several new tax measures have been included in the Luxembourg government's budget bill for fiscal year 2021, which was submitted to Parliament on 14 October 2020.
A certain number of these new tax measures directly affect real estate investments in Luxembourg.
For example, an annual real estate tax at the fixed rate of 20 per cent will be due as from 1 January 2021 by certain Luxembourg investment funds that hold real estate assets located in Luxembourg.
The aim of this measure is to close existing loopholes, in particular in the real estate area by introducing a new real estate tax (the prélèvement immobilier) due by certain investment funds holding Luxembourg real estate.
The Luxembourg entities covered by the new measure are the following investment funds having legal personality (SCS being, however, expressly excluded from the scope):
- undertakings for collective investment (UCIs) subject to Part II of the Luxembourg Law of 17 December 2010;
- specialised investment funds (SIFs) subject to the Luxembourg Law of 13 February 2007; and
- reserved alternative investment funds (RAIFs) subject to the Luxembourg Law of 23 July 2016.
Finally, the government intends to reduce the attractiveness of share deals by increasing the registration duties applicable for contributions of Luxembourg-based real estate properties made to civil and commercial companies in exchange for shares from 1.1 per cent to 3.4 per cent (including transcription tax).
Outlook and conclusions
Due to the current boom in the Luxembourg real estate market and the ongoing attractiveness of the different Luxembourg real estate fund regimes to foreign investors, it is expected that the activity of the Luxembourg real estate market will remain at a high level, both in relation to the domestic market and the activity of Luxembourg as a structuring hub.
Aside from the recent reforms of the commercial lease agreement regime and of the environmental law, the newly introduced tax bill will probably affect the structuring of real estate investments in Luxembourg and require some local development funds to modify their existing legal structures.
With regards to the domestic market, the development pipeline for the next 12 months looks quite promising with a large set of (office) properties currently under construction and scheduled for completion in the near future, mainly in or around the city of Luxembourg (Ban de Gasperich, Kirchberg and airport/Hamm area) and in the southern area of Belval near the French border.
On the structuring side, the Luxembourg fund toolbox continues to remain very attractive for European fund initiators; where the newly introduced RAIF regime is becoming a noteworthy alternative to the more established SIF regime, especially for initiators who are looking to market their newly established funds on a relatively short note.
1 Serge Hoffmann is a counsel and Philippe Eicher is an associate at Allen & Overy SCS.
2 JLL Luxembourg Property Market Overview H1 2020: https://www.jll.lu/content/dam/jll-com/documents/pdf/research/emea/luxembourg/en/research/Lux%20Market%20REsearch%20Report%20H1%202020_DEF_3.pdf.
3 https://statistiques.public.lu/catalogue-publications/economie-statistiques/2011/55-2011.pdf, published in September 2011.
4 ALFI REIF Survey 2019: https://www.alfi.lu/getattachment/72e65a60-1fec-46ca-be6e-2260c9f3e291/alfi-alfi-real-estate-investmet-funds-survey-2019.pdf, published in November 2019.