Bulgaria Investment Report

Introduction

Bulgaria is situated in Southeast Europe and occupies the eastern part of the Balkan Peninsula. To the north, it borders on Romania, to the west on the Republic of Macedonia and the Federal Republic of Yugoslavia, to the east on the Black Sea, to the south on Greece and to the southeast on Turkey's European part.

Occupying an area of 110,000 sq.km with a population of 8.4 million, Bulgaria’s topology is extremely varied from large plains and lowlands, low and high mountains to valleys and lovely gorges. With so much beauty on such a tiny land, the sights and sounds are breathtaking - curious rock formations and mysterious caves; sunny seashores with golden sands, quiet coves and romantic capes; majestic mountains with fiery peaks, mirror lakes and shady woods full of scent.

The climate is temperate continental with clearly marked four seasons. A Mediterranean influence is felt in the country's southern regions with the average annual temperature around 10.5°C. 0°C is the average for January, whilst the maximum you can expect in summer is around 30°C. With a time difference of only 2 hours, Bulgaria is one country that feels close to home.

A report published recently by The Bollin Partnership shows that significant numbers of Britons are now investing in property in Bulgaria. The report links the demand to an expansion in tourism, and says that low-cost airlines have also increased interest. British tourist numbers are predicted to have doubled in two years to 250,000 visitors in 2004 thanks to the influx of main European tour operators now operating in Bulgaria.

It's only in the last two years that people in Bulgaria have been able to take out a mortgage and buy a home. This has, of course, unlocked a property boom. And with EU membership for Bulgaria less than three years away, eyes are on Bulgaria in anticipation of an economic transformation.

Highlights

• The increasing number of – and lower interest rates for – mortgage loans continues to stimulate the residential market despite the IMF’s new requirement for banks to restrict credit growth.

• Market forces started to override the appreciation trend on the residential segment. After the hectic upward movement through 2003, sale prices increased only at a moderate rate during first half of 2004. Rental rates are stable and are expected to grow for exclusive properties.

• Investment purchases are on the rise with yields from residential properties in Bulgaria exceeding the average returns in the EU and other CEE countries.

• Yields remain in the range of 8% to 12% for single deals of residential properties.

• Large development projects aim to achieve over 15% return on investment.

Why invest?

• Bulgarian property prices are currently some of the cheapest in Europe
• Bulgaria is scheduled to join the European Union in 2007
• The Black Sea airports are about three hours flight from Britain
• All major British tour operators will be on the Black Sea coast next year. Some, such as Thompson, for the first time
• The Black Sea coast boasts 220km of sandy beaches and enjoys more than 1700 hours of sunshine from May to October
• Last year property prices rose by more than 30% - and that BEFORE accession to the EU starts to make the country wealthier. Remember, Spain and Ireland were backwater with supplies of bargain basement property before the EU started pouring billions into their economies
• The country's diverse climate means it has both ski and beach resorts
• The cost of living there is one of the lowest in Europe - with a pint of lager costing about 40p and a three-course meal, with wine, priced at no more than £5 a head
• Bulgaria has recently joined NATO
• Its currency is stable and linked to the Euro

Supply

Supply on the high-end market continued to increase during the first half of 2004. New space emerged both as residential apartment buildings and as compound developments.

Prestigious residential areas close to downtown Sofia traditionally display a lack of free land lots suitable for construction. Yet, supply of new residential space continues to increase in the Lozenets and Iztok neighbourhoods in Sofia.

Compound type developments are situated in more suburban areas. These locations allow for construction of additional amenities such as community and fitness centres, swimming pools as well as sufficient parking space.

A recent trend on the market is that developers start to offer the new apartments fully furnished with kitchen and bathroom equipment.

Demand

Demand for premium residential properties continued to be high during the first half of 2004. Investment purchases of single apartments in prestigious locations remain stable among expatriates and Bulgarian’s.

Newly built properties have become the preferred product compared with the usual purchase of renovated, older apartments. The first half of 2004 saw an increase in the number of residential developments sold off-plan, but expected to be delivered on the market within six to twelve month’s time. Mortgage-financed purchases also gained momentum during the period. As a whole, the number of transactions has increased during the first six months of 2004, compared to the same period last year.

Two and three bedroom apartments still register the highest demand. Compound or “planned community” developments continue to attract strong interests as they offer a completely new concept in living environment. Residents and buyers are increasingly becoming savvier looking for benefits of extra services such as community and sports facilities within the compound as well as professional security and property management.

Forecasts

• Market mechanisms are about to affect the real estate market, and prices will grow only where the properties have real, lasting value. Driven by steady demand, high-end properties will appreciate at a moderate rate. However, the prices of some overestimated properties are expected to remain stable.

• Investment in the residential sector is in the spotlight as developers and investors continue perceiving then as high-yield potential.

• Compound-like developments will continue to gain momentum on the high-end market. Reassured by the stable macroeconomic environment, developers will continue to enter the market, yet with more refined projects.

• Demand for high-end properties will remain stable driven by the steady economic growth of the country. Popularity of apartment houses for short-term accommodation will also rise due to increasing business visits from abroad.

• Professional property management services will gain further importance on the high-end market.

TAX SUMMARY (Courtesy: PWC)

Bulgaria is a politically stable country, and the introduction of a currency board in 1997 stabilised the country's economy. However, as is the case elsewhere in Central and Eastern Europe, legislation, including that governing real estate, is volatile and subject to frequent change.

A foreign investor can invest in properties in Bulgaria either directly or through a local entity. Only Bulgarian-resident individuals and entities can acquire title to land, while non-residents may acquire only buildings and limited rights (e.g., leasehold and construction rights) to land. In some limited cases, acquisition of immovable property by non-residents requires prior permission of the Ministry of Finance. Foreign investors are guaranteed full repatriation of profits resulting from an investment in Bulgaria. The transfer abroad can be made only after the bank effecting the transfer is presented a certificate proving payment of all Bulgarian taxes due.

Investing through a local entity versus direct investment

As indicated above, a foreign investor can invest in properties in Bulgaria either directly or through a local entity. In the case of a direct investment, the tax treatment of the foreign investors depends on whether or not their activities constitute a permanent establishment. The definition of a permanent establishment under Bulgarian law is very broad: the mere fact that a foreign company owns and rents out property in Bulgaria (except where such activity is carried out through an independent agent) may create a permanent establishment under domestic law.

The various tax treaties entered into by Bulgaria usually contain a narrower definition of permanent establishment. If the activities of a foreign person owning real property in Bulgaria do not constitute a permanent establishment, the person will be liable for only 15% withholding tax on the rentals and capital gains, unless an even lower rate is applied under a double tax treaty.

Basis of taxation

The taxation of a local entity or a foreign entity which constitutes a permanent establishment is as follows.

Rental income

The basis of the taxable income of a company, investing in Bulgarian real property is the gross income derived from the property less tax-deductible, property-related expenses and depreciation. Such expenses include repairs, maintenance, renovation and similar costs and interest on loans used for the acquisition of the property. A Municipal Tax at a rate of 10% of profits is due. This is then deductible in calculating taxable profits which are subject to a flat corporate tax rate of 15%.

Depreciation

Land itself is not depreciable, although any immovable property affixed thereto is, provided that it is used for the business activities of the company and is booked as a fixed asset. Depreciation for tax purposes is at a rate of 4% per annum, and is usually calculated using the straight-line method. Real estate acquired for purpose of re-selling it is considered as "investment property". As such, it is non-depreciable and is subject to annual revaluation to the market value. In practice, it is often unclear in which situations a property should be treated as an "investment property" rather than as a fixed asset.

Loss carry-forward

Tax losses can be carried forward for a five-year period. Losses cannot be offset against profits from previous years.

Capital gains

Capital gains are treated as ordinary income subject to corporate income tax.

Transfer taxes

Apart from corporate tax, no other direct taxes are levied on the transfer of real property. The transfer is, however, subject to notary and municipal fees. The notary fees are paid on the higher of the market price or the book value of the property at varying rates, with the maximum being BGN 3, 500. In addition, 2% of the market value of the property is paid to the municipality in which the real property is situated.

Local taxes and rates

The owner of a building or a plot is obliged to pay a real property tax. Where a building is built on a State or municipal plot, the value of the plot will also be included in the tax base. The tax is equal to 0.15% of the book value of the property. Arable land is exempt from local taxes. In addition to the real property tax, owners also pay waste-collection fees.

Value Added Tax

Transactions with land and lease of property for residential purposes are exempt from Value Added Tax (VAT). All other real estate transactions are subject to VAT at the uniform rate of 20%. The buyer/lessee is entitled to a VAT refund, provided that it is registered for VAT purposes.