Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: 1) Whether the German arrangement in issue can be classified as a trust for the purposes of the Income Tax Act. 2) Whether the arrangement is entitled to the benefits of the Canada-Federal Republic of Germany Tax Agreement
Position: 1) yes 2) yes
Reasons: 1) The arrangement meets the essential elements of a trust. 2) The arrangement falls within the ambit of Article 4.
Re: XXXXXXXXXX - Advance Income Tax Ruling
This is in reply to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling in respect of XXXXXXXXXX (the "Fund") regarding the Canadian federal income tax treatment of the Fund and its investors under the Income Tax Act (Canada), including the application of the Canada-Germany Tax Agreement (the "German Treaty"), in connection with a proposed investment by the Fund in Canadian real estate.
You have confirmed that, to the best of your knowledge and to the knowledge of XXXXXXXXXX ("GERMANCO"), the capital investment company that manages the Fund, none of the issues involved in this ruling request are (i) in an earlier return of the Fund or a related person to the Fund, (ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the Fund or a related person to the Fund, (iii) under objection by the Fund or a related person to the Fund, or (iv) before the courts, or the subject of a ruling previously issued by the Directorate to the Fund or a person related to the Fund.
In this letter, unless otherwise noted all statutory references are to the Income Tax Act (Canada), R.S.C. 1985, 5th Supplement, c. 1, as amended (the "Act") and each "technical" tax term used in this request has the same meaning as it has for purposes of the Act.
1. GERMANCO was established on XXXXXXXXXX as a capital investment company that manages investment funds established under the applicable German law. GERMANCO is authorized by the German Federal Agency for Financial Services Supervision (the "Federal Agency") to operate as a capital investment company in relation to the establishment and operation of public funds like the Fund in accordance with the Investment Companies Act (Germany) (Gesetz uber Kapitalanlagegesellschaften)(the "KAGG"), as of October 1, 2005, the Investment Act (Germany). On January 1, 2004, the German Act for the Modernisation of the Investment Sector and for the Taxation of Investment Funds (Investment Modernisation Act) was enacted. This statute replaced the KAGG and the Foreign Investment Act (Auslandinvestment-Gesetz-AuslInvestG) with the Investment Act (Investmentgesetz) and the Investment Tax Act (Investmentsteuergesetz-InvStG).1 Whereas the previous statutes contained both regulatory provisions and tax provisions, the new statute uses a different approach in that the Investment Act (Germany) contains only regulatory provisions, for both domestic and foreign funds, and the Investment Tax Act (Germany) contains the taxation rules for domestic and foreign funds.
2. By its articles of incorporation, except for activities required in connection with its own assets, the activities of GERMANCO are restricted to establishing and managing public funds in accordance with the Investment Act (Germany) and the KAGG (with respect to Funds, such as the Fund, that are still subject to the KAGG under the transitional rules enacted at the time of the coming into force of the Investment Act (Germany) (the "Transitional Rules")).
3. Under the Transitional Rules, the Fund will be subject to the provisions of the KAGG until February 2007 at the latest, after which time the Investment Act (Germany) and the Investment Tax Act (Germany) will govern the operation of the Fund, unless the conditions of the contract governing the legal relationship between the investors and GERMANCO are adapted to the rules of the Investment Act (Germany) earlier.
4. GERMANCO established the Fund as an open-end real estate fund under the KAGG on XXXXXXXXXX and, pursuant to a prospectus, GERMANCO sold the units in the Fund to thousands of retail and institutional investors. At least XXXXXXXXXX% of the units in the Fund are owned and will continue to be owned by residents of Germany for the purposes of the German Treaty, and at least XXXXXXXXXX% of the Fund's investors are and will continue to be residents of Germany for the purposes of the German Treaty. The balance of the unit holders are residents of XXXXXXXXXX for the purposes of the Canada-XXXXXXXXXX Tax Treaty. There are no real commercial or tax incentives under the applicable law of Germany for persons who are not residents of Germany to invest in the Fund.
5. Pursuant to the KAGG and ultimately the Investment Act (Germany) when it applies in February 2007 or earlier, GERMANCO, a resident German investment corporation, acts on behalf of the Fund as its manager and XXXXXXXXXX (the "Custodian") acts as custodian of all of the Fund's assets.
6. As at XXXXXXXXXX, the Fund had XXXXXXXXXX units issued and outstanding. The value of its net investments was € XXXXXXXXXX, and XXXXXXXXXX% of the Fund's investments consisted of liquid assets, which are invested so as to ensure that there is always sufficient liquidity available for future redemptions and to fund property acquisitions that are continually under active consideration by GERMANCO on behalf of the Fund.
Overview of Relevant German Commercial Law
7. The Fund is a commonly-used business version of a fiduziarische Treuhand. Under the KAGG and the Investment Act (Germany), German domestic asset pools like the Fund may be established and managed as public funds for the joint account of public investors by a capital investment company in conjunction with a custodian bank. The KAGG and the Investment Act (Germany) contain detailed provisions governing the duties and responsibilities of the capital investment company (Kapitalanlagegesellschaften) and the custodian bank (Depotbank) in relation to an investment fund. As well, the KAGG and the Investment Act (Germany) provide general rules for the operation of the investment fund (Sondervermogen) and special rules that apply to real property funds (Immobilien-Sondervermogen) like the Fund.
8. The salient provisions of the KAGG and the Investment Act (Germany) in relation to the duties and responsibilities of a capital investment company like GERMANCO, the duties and responsibilities of a custodian bank like the Custodian and the constitution and operation of an investment fund like the Fund, are as set out below. While reference is made below to the provisions of the KAGG, as the KAGG now governs the relationship of GERMANCO and the Custodian with the Fund and its investors and the operation of the Fund and may continue to do so until February, 2007, the provisions of the Investment Act (Germany) contain identical provisions (albeit with different numbering).
Capital Investment Company
9. Investment Company Obligations-A capital investment company is obliged to manage funds for the collective account of investors with the diligence of a prudent businessman, to act, in the performance of its activities, in the sole interest of its investors and the integrity of the market, to perform its activities with due skill, care and diligence in the best interests of the funds which it manages and the integrity of the market, to try to avoid conflicts of interests and, if they cannot be avoided, to ensure that unavoidable conflicts are solved with due regard being paid to the interests of the investors and to assert claims of the investors against the custodian bank. (§ 1(1) and § 10)
10. Capital Requirements-A capital investment company is obliged to ensure that it meets minimum initial capital and additional fund requirements and, for this purpose, investment asset pools that are managed by the investment company are not taken into consideration. (§ 2(2))
11. Appointment of Custodian Bank-A capital investment company is obliged to entrust the safekeeping of investment asset pools with another credit institution as the custodian bank that is authorised to engage in deposit business and safe custody business and meets minimum capital requirements. (§12 and §31)
12. Custodian Bank Obligations-A custodian bank has extensive responsibilities in relation to the investment fund and is obliged to act independently from the capital investment company and exclusively in the interests of the investors, to comply with instructions of the capital investment company to the extent they are not in breach of statutory provisions and the relevant contractual terms and conditions, to hold all assets of the investment fund (other than real property) in blocked accounts that it maintains for the investment fund, to consent to the disposal or encumbrance of real property of the investment fund and to assert claims of investors against the capital investment company. (§ 12(2) § 12a, § 12b and § 12c)
13. Issue/Repurchase of Units-The custodian bank is responsible for the issue and repurchase of units of the investment fund. (§ 12b)
14. Blocked Account-The custodian bank maintains a blocked account for the investment fund. In general, all cash amounts received in respect of the investment fund must be deposited by the custodian bank in the blocked account. This includes cash amounts received by the custodian bank on the issue of units of the investment fund, proceeds from the sale of the assets of the investment fund and other amounts derived from the assets of the investment fund. The repurchase price that is paid to investors for units of the investment fund is paid by the custodian bank from such blocked account. On the instructions of the capital investment company, the custodian bank pays out of the blocked account the purchase price for assets of the investment fund, including real property and the distribution of profit participations to the investors in respect of their units of the investment fund. (§ 12a (1) and (2))
15. Safe Custody-The securities and certificates of deposit of the investment fund must be held by the custodian bank in a blocked securities custody account. In the case of holdings of real property and other assets which the custodian bank cannot hold in custody, the custodian bank is obliged to continually monitor such assets and the cash income derived therefrom, including ensuring that such cash income is deposited by the custodian bank in the blocked account that it maintains for the investment fund, and such real property or other assets of the investment fund cannot be sold or encumbered without the consent of the custodian bank. (§ 12a (1) and, with respect to real estate investment funds, § 31)
16. Fund Assets-The assets of an investment fund may be owned, as is the case for the Fund, by the capital investment company, or jointly owned by the investors. However, in the case of an investment fund that is a real estate investment fund, the assets may only be owned by the capital investment company. Where owned by the capital investment company, such assets must be kept separate from its own assets and from the assets of any other investment fund that is managed by the investment company. The capital investment company is given the power in its own name to dispose of the assets of the investment fund in accordance with the terms of the KAGG and the relevant contract with the investors. (§ 6(1) and, with respect to real estate investment funds, § 30)
17. Limitation on Liabilities-The capital investment company has no power to incur liabilities or to make loans or issue guarantees in the name of the investors or, with limited exceptions, to pledge or encumber the assets of the investment fund. The assets of the investment fund are not subject to any liabilities of the capital investment company, even those liabilities that arise from legal transactions that the capital investment company concludes for the collective account of the investors. Any agreements to the contrary have no effect. In general, claims against the capital investment company may not be set off against claims of a fund. (§ 6(3))
18. Units and Unit Certificates-Units in an investment fund are certified by unit certificates signed by the capital investment company and the custodian bank. Units may be issued in series with different rights regarding the use of income, management remuneration and other items. (§ 18(1) and (2))
19. Unit Value-The value of a unit is determined by the custodian bank, in cooperation with the capital investment company, by dividing the value of the investment fund by the number of issued units. The value of assets is to be determined by the custodian bank in accordance with the provisions of the KAAG. (§ 21)
20. Repurchase Rights-An investor may request that the investor's interest in the investment fund be paid out of the investment fund against the redemption of the investor's units, subject to the terms of the relevant contract. (§12b and § 23 (5) and (6))
21. Loss of Management Right/Winding-up of Fund-If the right of the capital investment company to manage the investment fund terminates, whether at the request of the capital investment company or as the result of its insolvency, the investment fund must either entrust, with the authorisation of the Banking Supervisory Authority, another capital investment company with the management of the investment fund or wind-up the investment fund and distribute the proceeds to the investors. (§ 14)
22. Contractual Terms-The contractual terms governing the legal relationship between the capital investment company and the investors in relation to the investment fund must be in writing, must comply with statutory requirements and must be authorised by the Banking Supervisory Authority. The contract must deal with the principles according to which assets of the investment fund are to be acquired, whether the assets of the fund are to be owned by the capital investment company or jointly by the investors, the repurchase rights of the investors, the distribution entitlements of the investors in the ordinary course and on the winding-up of the investment fund. (§ 15 and § 19(1))
23. Sales Prospectus-The capital investment company may market units of an investment fund in accordance with a sales prospectus that sets out the information necessary for investors to make informed judgements about making an investment in the investment fund, including the kind and main attributes of the units, the proposed assets of the investment fund, the repurchase rights of the investors, the management fees to be paid to the capital investment company as well as other fees to be paid to the custodian bank and third parties, the rules for determining the value of assets and the issue and repurchase price of units, tax treatment of investors and details of the business and other activities of the capital investment company and the custodian bank. (§ 19(2) and § 20)
Real Property Funds
24. General and Special Rules-§8 to 25 of the KAGG set out general rules applicable to capital investment companies that manage Securities Investment Funds regarding the investments such capital investment company may acquire and the investment limits for different types of investment, the limitations on borrowings as well as rules regarding other transactions the capital investment company may enter into, for instance, securities lending and short sales. The rules set out in §8 to 25 apply to all real property funds that, like the Fund, invest in real property, unless the specific provisions of §26 to 37g of the KAGG apply.
25. Permissible Assets-A real property fund is limited to investments in permissible assets or hereditary building rights in assets that are rental income property, business premises and premises for diversified use and, subject to certain limits, real property which is being developed for such use. Where the real property is located outside a Contracting State to the Agreement on the European Economic Area, it may only be acquired if certain conditions are met, including that (i) the contract with the investors permits such acquisition, (ii) a reasonable distribution of the assets is ensured, (iii) these states guarantee the free transfer of the assets and do not restrict the movement of capital, and (iv) the performance of the rights and duties of the custodian bank is ensured. The capital investment company must also ensure that the currency risk to which the real estate fund is exposed does not exceed 30% of the value of the fund. (§§ 27(1), (2) and (2))
26. Risk Diversification and Trusteeship-The value of a single piece of real property may not exceed 15% of the value of the investment fund at the time of its acquisition. The requirement of the consent of the custodian bank to a disposition of the real property must be registered against the title of such property and, if this is impossible in the case of foreign real property, such restriction on disposal must be secured in another manner. (§28(1), (2), (3) and (4)).
27. Suspension of Redemption-If a unitholder requests that his share in the investment fund be paid out to him against surrender of his unit certificate, the capital investment company may delay such payment if the cash deposits and liquid assets held by the investment fund at that time are not sufficient to pay the redemption price and to ensure proper business operation or if they are not immediately available. (§ 36).
28. Notification Duty-The units of a real property fund like the Fund may be marketed by the capital investment company in another Member State of the European Union or in another Contracting State to the Agreement on the European Economic Area, provided that the required notice is given to the applicable authority in Germany and in the other Member or Contracting State and the appropriate approvals are obtained.
Overview of Investment Tax Act (Germany)
29. The basic German income tax treatment of funds such as the Fund is provided under the Ninth Chapter of Part 1 of the KAGG (dealing with tax provisions) or the Investment Tax Act (Germany), the Corporate Income Tax Act (Germany) and the Income Tax Act (Germany)(EinKommen-steuegesetz). With respect to such tax treatment, there are two important points to note. First, in the relevant German tax legislation relating to the Fund it is clear that the Fund is treated as a company that is thereby made liable to comprehensive German corporate income tax and then, through specific relieving provisions, is effectively exempted from such tax. In this way, the Fund is exempted from such tax in a manner similar to that used under section 149 of the Act to exempt Canadian charities, not-for-profit organizations and other tax-exempt entities from Canadian income tax. Second, the Fund is effectively taxed in the same manner as a mutual fund trust under the Act. As such, the Fund provides no tax deferral for its German investors in that any net income of the Fund that is not distributed by the Fund to its investors is deemed to be distributed for German income tax purposes.
30. The Fund is treated as a corporation for German tax purposes by reason of a provision of the Corporate Income Tax Act (Germany). As such, the Fund is subject to unrestricted liability to corporation tax under that German statute and is required to calculate its income in accordance with the Corporate Income Tax Act (Germany) and the Income Tax Act (Germany), as elaborated upon in the special rules set out in the Investment Tax Act (Germany). Subsection 1(1) of the Corporate Income Tax Act (Germany) provides as follows:
The following corporations, associations and estates have an unrestricted liability to corporation tax if they have an inland seat or place of management:
Associations, foundations, trusts and other estates of private law.
31. The tax provisions of the KAGG provide that the Fund "is deemed a special purpose fund within the meaning of subsection 1(1) of the Corporate Income Tax Act no.5 of the Corporate Income Tax Act". Furthermore, in its application to the Fund after February 2007, subsection 1(1) of the Corporate Income Tax Act is supplemented by subsection 11(1) of the Investment Tax Act (Germany) which provides that in the foregoing provision, a domestic fund, like the Fund, "shall be deemed to constitute an estate". Notwithstanding the foregoing, the Investment Tax Act (Germany) provides further rules which specifically relieve domestic funds, like the Fund, from German corporate income tax. Under these relieving rules, German corporate income tax is not imposed on domestic funds, like the Fund, per se.
32. Instead, under these rules the Fund investors are subject to income tax on amounts that are distributed or are deemed to be distributed to them by the Fund. Such distributions lose their source and are treated as investment income of the investors. Investors are not subject to income tax on distributed earnings to the extent that such earnings include certain gains realised on the disposition of real property and income from a foreign source that is not subject to tax in Germany by virtue of an applicable tax treaty. Where distributed earnings include foreign source income that is subject to German taxation, investors are entitled to claim a foreign tax credit in respect of foreign tax paid. Alternatively, the investment fund may deduct the foreign taxes in calculating its earnings.
33. The Fund is required to withhold 30% of the amount distributed or deemed to be distributed in respect of an investor's tax liability (other than distributions that comprise German domestic earnings for which the withholding tax rate is 20%). Investors are required to include the gross amount distributed or deemed to be distributed in computing income. Withholding is not imposed on distributions to investors without a place of residence or a place of abode in Germany.
34. GERMANCO is required to provide detailed information regarding the amount and nature of its distributions each time a distribution is made by the Fund. This information must be published in the Federal Gazette along with the Fund's annual report and a certificate of a professional tax advisor confirming that the information has been determined in accordance with the rules of German tax law. If this information is not provided, investors are taxable on additional income. An investor in the Fund will be taxable on the distributions plus 70% of the annual increase in the redemption value of the investor's Fund units (which will be a minimum of 6%).
Fund Prospectus and Rules
35. A review of the Fund's prospectus and the Fund's rules confirms that in nature and operation the Fund is substantively identical to a Canadian mutual fund trust.
36. The Prospectus confirms XXXXXXXXXX.
37. Further, the fiduciary role of GERMANCO in relation to the assets it acquires and holds for the account of the Fund is succinctly described in the Fund's rules XXXXXXXXXX.
38. XXXXXXXXXX may be charged to the investors at the time of issuance of the Fund units. XXXXXXXXXX. Furthermore, for its services, GERMANCO is entitled to receive a management fee XXXXXXXXXX. In addition to the annual management fee, GERMANCO receives special fees XXXXXXXXXX. For its services, the Custodian receives an annual fee XXXXXXXXXX.
39. At present, the real estate investments of the Fund include XXXXXXXXXX. As part of the Fund's long-term strategy to diversify its real estate portfolio, the Fund intends to make substantial real estate investments in XXXXXXXXXX. To that end, the Fund is actively considering the acquisition of real estate properties in XXXXXXXXXX and other locations in Canada. XXXXXXXXXX. The properties are referred to in this request as the "Canadian real property".
40. The proposed acquisition of the Canadian real property will be by a limited partnership (the "Partnership") that will be formed under the laws of a Canadian province. The Fund will be the sole limited partner of the Partnership and will hold a XXXXXXXXXX% limited partnership interest in the Partnership. The Fund will establish a Canadian corporation under the laws of Canada or a Canadian province and will subscribe for all of its common shares. The Canadian corporation will be the sole general partner of the Partnership and will hold a XXXXXXXXXX% partnership interest.
41. In addition to its limited partnership interest, the Fund will hold debt issued by the Partnership. The debt of the Partnership held by the Fund will be a term debt that is interest-bearing and in no case will the principal amount of the debt held by the Fund exceed more than two times the amount of the Fund's partnership capital in the Partnership in respect of the Fund's limited partnership interest.
42. The Fund will acquire and hold its investments in the equity and debt of the Partnership as long-term investments.
43. The basic structure of the proposed investment by the Fund in the Partnership is illustrated in the following diagram.
44. As the limited partner of the Partnership holding a XXXXXXXXXX% limited partnership interest, the Fund will receive partnership distributions and for Canadian income tax purposes be allocated its share of net partnership income. The Fund will also receive interest payments on the debt of the Partnership that is held by the Fund.
45. In connection with the proposed investment by the Fund in the partnership interest in, and the debt of, the Partnership, GERMANCO, on behalf of the Fund, will (i) advise the CRA of any change in the facts and circumstances of the Fund that differ from those described in this letter including, in particular, any change in the Fund investors as a result of which less than XXXXXXXXXX% of the Fund unit holders or investors would be residents of Germany for purposes of the German Treaty; and (ii) file tax returns under Part I of the Act in respect of the Partnership income and pay, in the manner and at the times provided in the Act, any Canadian tax or such other amounts, if any, that the Fund is obliged to pay under the Act on the basis that the Fund is an inter-vivos trust.
Purpose of the Proposed Transactions
The purpose of the proposed transactions is to allow the Fund to diversify its real estate portfolios by making real estate investments in Canada.
Provided that the preceding statements constitute complete and accurate disclosure of all the relevant facts, Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, and subject to the comments set out below, our rulings are as follows:
A. The Fund will be treated as an inter vivos trust that is not a personal trust for purposes of the Act in respect of the proposed investments in the partnership interests in, and debt of, the Partnership.
B. The Fund will be treated as a resident of Germany for the purposes of Article 4 of the German Treaty, and its business profits from the Partnership will be taxable in Canada in accordance with article 7 of the German Treaty.
C. The partnership interest in the Partnership held by the Fund will be treated as taxable Canadian property of the Fund (and not the Fund investors) for purposes of the Act and immovable property of the Fund (and not the investors) for purposes of the German Treaty including, in particular, Articles 6 and 13 thereof, and any gains derived by the Fund from the alienation of such interests may be taxed in Canada as provided in paragraph 4(b) of Article 13 of the German Treaty.
D. The Fund (and not the Fund investors) will be treated as the beneficial owner of the interest paid on the debt of the Partnership that is held by the Fund for purposes of Article 11 of the German Treaty.
Nothing in this Advance Income Tax Ruling should be construed as implying that we will not invoke the provisions of paragraphs 3 and 6 of Article 29 of the German Treaty if the percentage of German resident investors drops below the amounts mentioned in paragraphs 4 and 45 above.
Nothing in this Advance Income Tax Ruling should be construed as implying that we are ruling on, or have considered, or discussed with you any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above. Facts and proposed transactions in the documents submitted with your request not described above do not form part of the facts and proposed transactions on which this ruling is based and any reference to these documents is provided solely for the convenience of the reader.
The Rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 and are binding on the Canada Revenue Agency provided that the proposed transactions are completed within 6 months of the date of issuance of the present letter.
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
1 As noted, the Investment Act (Germany) came into force on January 1, 2004. The provisions of the Investment Act (Germany) that regulate the activities of an investment company are identical in all respects to those of the KAGG, except for the differences in the section numbers of the relevant provisions. Investment companies are required to amend their fund agreements to refer to the provisions of the Investment Act (Germany) by 2007. Until then, the KAGG is still applicable.
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2006
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2006