Newsletter Real Estate & Tax - 1/2014 EN

Introduction

Law Decree No. 133 of 12 September 2014 (the “Decree”), published in the
Italian Official Gazette of 12 September 2014 and entered into force on 13
September 2014, has introduced several provisions that affect the real estate
sector; these provisions are included in Chapter 5 “Measures to revamp the
building industry”.
Article 20 of the Decree, titled “Measures to revamp the building industry” has
introduced several amendments to the SIIQ regime, specifically affecting both
the requirements to access the said regime and the tax treatment, in order to
encourage the use of this type of investment vehicle (which was introduced by
Law No. 296/2006, but so far rarely used).
In addition Article 18 (“Liberalization of the market for large leases for non-residential
use”), Article 19 (“Exemption from any taxation of rent reduction agreements”), Article
21 (“Measures to encourage investments in leased residential properties”) and Article 23
(“Rules for lease agreements entered into for the future sale of real estate properties”) have
made significant amendments to Italian Laws on leases and rents.
The decree must be converted into law within 60 days after publication in the
Official Gazette. The conversion law may make changes to the provisions
contained in the Decree.

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1. AMENDMENTS TO THE SIIQ REGIME



1.1 Amendments to the SIIQ requirements



1.1.1 Exclusion from AIFMD

First of all, it is worth pointing out that, pursuant to Article 20 of the Decree, SIIQs are by law considered out of the scope of Directive 2011/61/EU regarding alternative investment fund managers (AIFMD), implemented in Italy by Legislative Decree No. 44 of 4 March 2014.

Article 1, par. 119-ter, of Law No. 296/2006, as amended by Article 20 of the Decree, in fact states that SIIQs are not included in the definition of undertakings for collective investments provided for by Legislative Decree No. 58 of 24 February 1998 ("Consolidated Law on Finance").

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1.1.2 Ownership requirements (Art. 1, par. 119, 119-bis of Law No. 296/2006)

Article 20 of the Decree introduces several amendments to the ownership requirements that SIIQs must meet in order to benefit from the regime provided for by Law No. 296/2006. In particular, the holding threshold allowed to one single shareholder has been increased from the current 51% to 60% (of voting rights or profit participation rights).
Therefore the maximum holding threshold is now aligned to comparable investment structures of other EU countries (e.g. France, Germany).

Moreover, Article 20 of the Decree reduces the free floating threshold from 35% to 25%, consistently with the ordinary rules provided for listed companies. Accordingly, under the new rules, the SIIQ regime requires that at least 25% of the SIIQ shares be held by shareholders that do not own more than 2% of the voting rights or of the profits participation rights.

In terms of timing the new legislation introduces a “pre-SIIQ” regime.

Indeed, the first requirement (i.e. 60% threshold) must be satisfied within the 2 fiscal years following the one in which the option for the SIIQ regime has been exercised. If the requirement is satisfied, the SIIQ rules are applicable since the first day of the fiscal year in which such requirement has been met.

The second requirement (i.e. 25% threshold) must be satisfied within the end of the fiscal year in which the SIIQ option has been exercised. In this case, the SIIQ regime has effect from the first day of the same fiscal year.

The SIIQ tax regime applies temporarily until the requirements are satisfied. If the requirements are not satisfied in due time then ordinary taxes become due while the taxes applied according to the SIIQ regime (i.e. “Entry tax”, 20% substitute tax on capital gains and 2% mortgage and cadastral taxes) become a tax credit.

According to the new legislation, ownership requirements may be exceeded in case of corporate transactions (e.g. increase of share capital, mergers).

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1.1.3 Asset test (Art. 1, par. 121, 122 of Law No. 296/2006)

Under the current SIIQ regime, at least 80% of total assets must be:
?real estate properties held for lease purposes;
?shareholdings in other SIIQs or not listed SIIQs (hereinafter “SIINQ”).
Such asset test is aimed at demonstrating that the main activity of the SIIQs is the lease of real estate properties, carried out directly or indirectly.

According to Article 20 of the Decree, the asset test may be satisfied also considering investments held by the SIIQ in certain qualifying REIFs.
Pursuant to the Decree, a qualifying REIF is an Italian real estate investment fund in which at least 80% of the assets is represented by real estate properties held for lease purposes and investments in real estate entities (i.e. real estate investment funds, SIIQs, SIINQs).

It is worth pointing out that the grace period within which the asset test must be satisfied has been extended from the current 2 years to 3 years. Therefore, under the new rules, the non-compliance with the asset test for 3 consecutive years will trigger the termination of the SIIQ regime starting from the second year on which the asset test is not met.

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1.1.4 Profit test (Art. 1, par. 121, 122 of Law No. 296/2006)

The second test to be satisfied by SIIQs regards the prevalence of income deriving from the lease activity. Currently, at least 80% of income must be:
?proceeds from lease activity;
?dividends from lease activity carried out by the investees SIIQs / SIINQs.
Consistently with the amendments regarding the asset test, pursuant to Article 20 of the Decree the profit test also includes income from the investments held in the above mentioned qualifying REIFs.

Moreover, pursuant to the new rules, the profit test may be satisfied also considering capital gains realized on the sales of real estate properties held for lease. Prior to such amendments, only lease income and dividends were relevant for the purposes of the profit test (Art. 6, par. 3 of Ministerial Decree No. 174 of 7 September 2007).

Similarly to the asset test, Article 20 of the Decree extends the grace period within which the test must be satisfied. Accordingly, non-compliance with the profit test for 3 consecutive years will trigger the termination of the SIIQ regime starting from the second year on which the profit test is not met.

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1.1.5 Distribution requirements (Art. 1, par. 123, 123-bis of Law No. 296/2006)

Under the SIIQ regime, the entity must distribute a fixed statutory percentage of net profits deriving from the lease activity to its investors.

Article 20 of the Decree reduces the amount of profits to be distributed in order to take into account that, in the calculation of net profits, Italian SIIQs are not allowed to deduct depreciation costs on leased real estate properties according to IFRS accounting principles. On the contrary, comparable investment structures in other EU countries, that do not use IFRS accounting principles, may deduct high amounts of depreciation costs thus reducing the amount to be compulsorily distributed.

Accordingly, under the new rules, each year the SIIQ must distribute 70% (in lieu of the previous 85%) of the lower of:
?net profits from lease activity and/or from investments in other SIIQs / SIINQs / qualifying REIFs; and
?total profits.
Moreover, in order to harmonize the Italian SIIQ regime with the French SIIC regime, Article 20 of the Decree introduces the obligation to also distribute a percentage of any capital gain deriving from the disposal of leased real estate properties.

In particular, SIIQs must distribute 50% of net capital gains realized on the disposal of real estate properties held for leasing or on the disposal of investments in SIIQs / SIINQs / qualifying REIFs, in the 2 years subsequent to the disposal.

It must be noted that, on the contrary, capital losses attributable to the real estate lease activity decrease net profits thus reducing the amount to be distributed.

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1.2. Taxation



1.2.1 Exemption at the entity level (Art. 1, par. 131 of Law No. 296/2006)

The SIIQ regime provides that corporate profits from the lease activity and from dividends distributed by the investee SIIQs / SIINQs are exempt from corporate income tax (IRES) and regional business tax (IRAP). On the contrary, profits from activities other than lease activity are subject to ordinary IRES and IRAP taxation (total tax rate approximately 31%).

In order to harmonize Italian rules with those of other EU countries (e.g. Netherlands, Germany, UK, France) and with the amendments regarding the SIIQ requirements, Article 20 of the Decree provides that capital gains on the disposal of leased real estate properties and of investments in SIIQs /SIINQs / qualifying REIFs are also exempted. In particular, the exemption is granted in order to facilitate the real estate portfolio rotation, which is the main self-financing source for SIIQs given the distribution requirements.

Moreover, as regards the tax regime at the level of the SIIQ, Article 20 of the Decree provides for an exemption from the withholding tax on profits distributed by REIFs to the SIIQ.

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1.2.2 International aspects (Art. 1, par. 134, 141- bis of Law No. 296/2006)

For non-resident investors, the SIIQ regime provides for the application of a 26% final withholding tax on dividends. The withholding tax is reduced to 15% in case of dividends deriving from the lease of residential properties.

In this perspective, Article 20 of the Decree expressly states the applicability of Double Taxation Conventions to profits distributed by the SIIQ to foreign investors. Accordingly, the withholding tax rate may be reduced pursuant to the Tax Treaty between Italy and the State of residence of the foreign investor.
It is worth noting that, prior to such clarification, the applicability of Double Taxation Conventions to the SIIQ was doubtful, under the interpretation of Tax Treaty provisions.

Moreover, as regards foreign investors‎, Article 20 of the Decree amends par. 141-bis of the SIIQ regime which extends the SIIQ regime to foreign REITs resident in EU/EEA white-list countries and having in Italy a permanent establishment.

In particular, under the new rules, access to the SIIQ regime is also allowed to foreign REITs‎ operating through a permanent establishment which carries out the lease activity in Italy exclusively through investments in Italian SIINQs.
Consequently, starting from the fiscal year for which the option has effect, the lease income connected with the permanent establishment in Italy is subject to a 20% substitute tax.

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1.3. The switch of a REIF into SIIQ

Article 20 of the Decree introduces certain tax reliefs in order to facilitate the conversion of an Italian REIF into a SIIQ. In particular, the Decree introduces rules regarding:

a)the direct and indirect taxation regime applicable to investors in case of changing of the investment model from REIF to SIIQ (see paragraph 3.1.);

b)the indirect taxation regime applicable to the contribution of real estate portfolios mainly consisting of leased properties from an existing REIF to a SIIQ (see paragraph 3.2.).

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1.3.1. Tax reliefs applicable to investors in case of switch of a REIF to SIIQ (Art. 1, par. 140-bis, 140-ter of Law No. 296/2006)

The Decree introduces provisions aimed at facilitating the switch of a REIF into a SIIQ. The steps of this transaction can be summarized as follows:

(i)the REIF contributes (all or part) of its real estate assets into a SIIQ as part of its (total or partial) liquidation process;

(ii)the investors (unit holders) in the REIF receive SIIQ shares in exchange for the REIF units, thereby becoming shareholders of the SIIQ.

Under the new rules, no direct tax shall be applicable on the gain realized by the investors upon the exchange of REIF units with SIIQ shares.
Moreover, in case of subsequent sale of the real estate assets received by the REIF, the tax basis for the SIIQ would be equal to the contribution value.

It is worth pointing out that, pursuant to the Decree, in case of contribution of real estate assets by a REIF to an existing SIIQ (already listed), if certain conditions are met, the REIF is not subject to I.P.O. (initial public offer) provisions. .

The Decree introduces new rules also for VAT purposes.
In particular, under the ordinary regime, the transfer of REIFs units (or SIIQ shares) would be exempt from VAT. As such, this transaction would reduce the VAT pro-rata deduction (i.e. the transferor’s VAT deduction right).
Under the new rules introduced by the Decree, these transfers do not affect the VAT pro-rata deduction.

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1.3.2. Tax reliefs applicable to the contribution of mainly leased real estate assets from REIFs to SIIQs (Art. 1, par. 140-ter, 140-quarter of Law No. 296/2006)


Prior to the amendments introduced by the Decree, the contribution of real estate assets in a SIIQ was subject to the following indirect taxation:
?VAT (the VAT rate depends on the real estate asset - 10% or 22%);
?registration tax (9% for contributions not subject to VAT);
?mortgage and cadastral taxes (2% each).
The Decree introduces new provisions regarding the tax regime applicable to the contribution of real estate portfolios consisting of mainly leased properties (at the time of their contribution) from a REIF to a SIIQ.
“Real estate assets mainly leased at the time of their contribution” means a set of properties that for the greatest part of their total value are leased at the time of their contribution (see Circular letter 19 June 2006, No. 22/E, par. 2.2.1). Under such regime the contribution of mainly leased real estate assets:
?falls out of the scope of VAT;
?is subject to registration tax levied at a fixed amount (€ 200,00);
?is subject to mortgage and cadastral taxes levied at a fixed amount (€ 200,00 each).

Under the new rules, the foregoing tax treatment is also applicable to the transfer from a REIF to a SIIQ carried out as part of a REIF liquidation process (Article 140-quater of the Law No. 296/2006).

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2. AMENDMENTS TO LEASE AND RENT AGREEMENTS PROVISIONS

Articles 18, 19, 21 and 23 of Chapter V of the Decree, have made significant changes to Italian civil and tax Laws on “large” leases for non-residential use, leases for residential use and rents with purchase option.

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2.1 Large leases for non-residential use

Article 18 of the Decree (Liberalization of the market for large leases for non-residential use) provides that in article 79 of Law no. 372 of 27 July 1978 – Rules on municipal properties leases (“Law 392/1978”), after the second paragraph, the following paragraph shall be added: “By way of derogation from the first paragraph, in lease agreements of municipal properties for non-residential purposes, even if used for hotel business, for which an annual rent higher than € 150,000.00 has been agreed, the parties may agree on terms and conditions in derogation from the provisions of this Law. The agreements mentioned in the above paragraph must be evidenced in writing”.

Through this amendment, the legislator seems to have listened to the several requests coming from many operators of the real estate sector, who have long been expressing the need to overcome the rigidity of the lease system imposed by current Italian Laws. Such system is based on a very high level protection of the lessee (always considered "weaker party") from lessors’ (always considered "strong party") abuses in "large" commercial leases where, often, the lessee is a multinational company that does not require the protection provided to small operators. Through such amendment, the parties of a lease agreement, which provides for an annual rent higher than € 150,000.00, may derogate from the rules provided for by the Italian legislation on lease agreements.
In particular, some of the mandatory rules that applied to “large” commercial leases, where the lessees were expert and financially strong parties, and that most jeopardized the parties’ freedom to arrange their agreements, to the detriment of the best protection of their interests, were the following:
(a)minimum duration of the lease (Article 27 of Law 392/1978): six years for commercial leases and nine years for the hotels, with an additional constraint that the lessor could prevent the renewal before the first deadline only in some limited cases;
(b)right of withdrawal of the lessee (Article 27 of Law 392/1978): the lessee has the right to withdraw from the agreement, without exceptions, for "serious reasons" and the Italian Courts have adopted a very broad concept of "serious reasons". This rule has understandably often frightened international funds and investors and prevented several structured finance transactions. This was also due to the fact that the certainty of cash flows from the lease payments was subject to the risks arising from the interpretation of the seriousness of the withdrawal reasons, left to Italian Courts’ decisions;
(c)rent indexation (Article 32 of Law 392/1978) for the leases with a duration not exceeding the minimum referred to in paragraph a): the indexation adjustment cannot exceed 75% of the ISTAT consumer price index for families of workers and employees. This limitation, of course, helped to make investments unattractive for financially strong parties ;
(d)compensation for loss of goodwill (Article 34 of Law 392/1978): if the lessee performed an activity involving contact with the public of users and consumers, in the event of termination of the lease for reasons other than the lessee’s default, withdrawal or termination, the lessee has the right to receive a compensation;
(e)preemption right to purchase (Article 38 of Law 392/1978): if the lessee performed an activity involving contact with the public of users and consumers, in case of sale of the property the lessee has a preemption right to purchase that property;
(f)preemption right for a new lease agreement (Article 40 of Law 392/1978): if the lessor intends to lease the property to a third party at the expiry of the lease agreement the (former) lessee has a preemption right to lease the property.
The above mandatory provisions were limitations that could hinder the decision to invest in Italy, as - for example - being subject to the right of withdrawal for serious reasons prevented investors from achieving certainty on the cash flows arising from a lease agreement, with all the consequent issues on the ability to use lease receivables for future financing transactions, discounting of bills and receivable assignments.

The amendment should, presumably, help to align the Italian system with other European countries and attract more international investors, enabling them to use the standard contractual formats prevailing on International real estate markets for their Italian investments.

For the sake of completeness, we point out that the above considerations where also made, in part, in the Explanatory Report, which accompanied the draft of Legislative Decree, attached to the Stability Law 2014, presented to the Council of Ministers in November of last year and which already contained the above amendments: "The rules in force date back, for the most part, to the original law on the “equo canone” (fair rent) (Law 382/1978) and, despite some reforming measures, they continue to present significant elements of rigidity that are not aligned to the main European countries. Furthermore, the evolution of the economic system has shown that the original protection requirements, where the lessee was considered a priori the "weaker party", are largely overcome. The current restrictive legislation limits the freedom of the parties to freely agree on their contractual relationship, predetermining it in many essential elements (e.g. constraints on the duration of the contract, mandatory provisions for the lessee withdrawal, limitations on rent adjustments, mandatory pre-emption provisions, etc.). Such rigidities make investing in the Italian market unattractive, when compared to foreign markets, and hinder the development of the Italian market of commercial leases and properties for tourist use".

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2.2 Incentives for residential leases

Article 21 of the Decree (Measures to encourage investments in leased residential properties) provides for a 20% deduction from total income for natural persons not engaged in commercial activities who:
(a)purchase real estate units for residential use, newly built or renovated, from construction or renovation companies and from housing associations (“Cooperative Edilizie”) or from the entities that carried out the above works, or
(b)build, by means of works contracts, real estate units for residential use on building areas already owned before the works or on which building rights have been already granted,
subject to the condition that said natural person leases such real estate units for residential use for at least 8 years.

The deduction, divided into eight equal annual instalments (which, assuming the maximum deduction, shall be equal to €7,500 per year), is calculated on the purchase price of the real estate unit or on the costs incurred for the construction of the same, for a total maximum limit of expenditure of € 300,000. The deduction may also be used, subject to the overall maximum limit, for the purchase or construction of a second real estate unit to lease.

The deduction shall be recognized, starting from the tax period in which the lease agreement has been signed, provided that the real estate unit:
(i)is not a luxury residence, villa, castle or a building of significant historical and artistic importance,
(ii)is not located in agricultural land,
(iii)has high energy performance (class A or B),
and that the lease agreement:
(a)has a duration of at least eight consecutive years (in case of termination of the lease for reasons not attributable to the lessor, the right to the deduction is not affected if, within one year after the termination, a new lease agreement is signed),
(b)provides for a rent not exceeding the agreed rent (i.e. the rent fixed in standard local agreements or in municipality building agreements) and
(c)is not entered into between parties with family relationships within the first degree (i.e. between parents and children).
The deduction is temporary (as it refers to the purchase or construction of real estate units made from 1 January 2014 to 31 December 2017) and may not be combined with other tax advantages provided for the same cases.

A Decree of the Ministry of infrastructures and transport and the Ministry of economy and finance will establish further rules for the implementation of the deduction.

It should be noted that in the first draft of the Decree, approved by the Council of Ministers, the deduction was also extended to housing associations and non-profit organization, as well as to natural persons not engaged in commercial activities: the narrowed scope of the beneficiaries of the deduction is, probably, due to lack of financial coverages.

Lastly, it should be noted that Article 19 (Exemption from any taxation of rent reduction agreements) provides that the registration of the agreement, by which the parties have only agreed the reduction of the rent, shall be exempted from registration taxes and stamp duties.

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2.3 Rent with purchase right (“Affitto con riscatto”)

Article 23 of the Decree (Rules for lease agreements entered into for the future sale of real estate properties) provides a set of provisions intended to rule a type of real estate purchase that, probably also due to the credit crunch and difficulties of the real estate market, is showing an increase in terms of number of users, namely the rent agreement with purchase right or rent to buy. This formula is increasingly being used by people with insufficient liquidity, who are not able to get a mortgage: the real estate property is therefore granted immediately by mean of a rent agreement, while the rent payments are allocated as payment of part of the purchase price.

More in detail, the legislator, has introduced provisions to protect lessees and has extended to rent agreements with purchase right the tax benefits, already provided for by Law Decree no. 47 of 28 March 2014, converted with amendments into Law no. 80 of 23 May 2014, "Urgent measures for the housing crisis, for the construction market and for Expo 2015", containing the so-called "House Plan" (“Piano Casa”), until now limited to social housing agreements only.

The main provisions introduced by Article 23 of the Decree, with regard to rent agreements with purchase right are:
(i)the obligation of registration with the real estate register, as already provided for nine years term lease agreements (Article 2643, first paragraph, no. 8 of the Italian Civil Law) and
(ii)the application of Articles 2668, fourth paragraph (cancellation of the registration of the agreement only with the consent of the parties or by a final judgment), 2775-bis (special privilege of the lessee/promissory purchaser’s claims on the real estate property) and 2825-bis (prevalence of the mortgage registered on the real estate property vis à vis the prior registration of the rent agreement, solely with regard to the portion of the loan debt assumed by the lessee/promissory purchaser) of the Italian Civil Code.
Article 23 of the Decree has also provided that the rent agreement with purchase right shall be terminated in the event of non-payment, even if not continuous, of a minimum number of rent instalments, as determined by the parties but not less than one-twentieth of their total number; further, upon termination for default of the lessor, the same lessor shall return to the lessee the part of the rent payments, plus legal interest, already paid. In the event of termination for breach of the lessee, the lessor will be entitled to the return of the real estate property and shall keep the entire amount of the rent payments, by way of indemnity, unless otherwise agreed in the agreement.

Similar forms of protection for the parties of the agreement are provided in the event of bankruptcy of the lessor or the lessee. In the first case, the performance of the lease will continue and will not be subject to claw back actions, provided that the conditions referred to in paragraph 3, letter c) of the Bankruptcy Act are met (i.e. that the agreement has been concluded at the right price and regards a real estate property for residential use, which will be the principal residence of the purchaser). In the event of bankruptcy of the lessee, Article 72 of the Bankruptcy Act shall apply, which means that the performance of the agreement will be suspended and in the event that the trustee opts for its termination, the lessee will have the right to file his claims before the bankruptcy with special privilege over the other creditors.

In addition, the three-year term in which the registration with the real estate register is effective, provided for preliminary purchase agreements, is extended to the entire duration of the rent agreement and, in any case, for a period not exceeding ten years.

Finally, Article 23 of the Decree has introduced an amendment to art. 8 of Law Decree no. 47 of 28 March 2014 converted with amendments into Law no. 80 of 23 May 2014, "Urgent measures for the housing crisis, for the construction market and for Expo 2015" (which was not contained in the original draft of the Decree approved by the Council of Ministers). The Decree added paragraph 5-bis, which provides that the rules set forth in Article 8 of the above decree, relating to rent agreements for social housing purposes, also apply "to lease agreements with clauses that bind both parties to the transfer of the real estate ownership and sales with ownership title reservation, signed after the date of entry into force of this provision."

The effectiveness of this provision, however, is subject to the successful conclusion of the authorization procedure of the European Commission under Article 107 of the Treaty on the Functioning of the European Union (TFEU).

Therefore, should the European Commission grant such authorization, the tax benefits and provisions already provided for by Article 8 for rent agreements with purchase right for social housing purposes, shall also apply to lease agreements with clauses that bind both parties to the transfer of the real estate ownership and sales with ownership title reservation, i.e.:
(i)for the purposes of income tax and regional tax on production activities, the payments shall be considered as lease payments, even if imputable to the future purchase price of the real estate property,
(ii)for the purposes of income tax and regional tax on production activities, income from the sale of real estate properties subject to rent agreements with right of purchase shall be considered earned on the date the purchase right is exercised by the lessee and the taxes related to the amounts received for the future purchase of the real estate property during the term of the rent agreement shall be considered as a tax credit,
(iii)upon the occurrence of certain conditions (set forth by art. 6 of Law Decree no. 47 of 28 March 2014), rental income shall not be included in business income for income tax purposes nor in the net value of production for the purposes of the regional tax on production activities, to the extent of 40 per cent,
(iv)the purchase right may not be exercised before the expiration of the seventh year of rent,
(v)the lessee may not sell the real estate property before five years have elapsed from the exercise of the purchase right.
The above changes seem to be significant, also given that:
(i)our system does not provide a complete framework of rules on rent agreements with purchase right. This has so far given rise to many issues, especially with regard to cases where the lessor was a building constructor and was subject to attachments and seizures of assets, which means the lessee was exposed to the risk of losing both, real estate property and the rent paid, and
(ii)persons who purchase a property through the instrument of the rent agreement with right of purchase has at least two advantages: first, the tax effects of the purchase start on the date the purchase right is exercised rather than at the beginning of the lease term (this also with reference to the seller) and second, the lessee has seven years of time to find the residual amount needed to purchase the property.