2007 Ruling 2007-0235881R3 - Class of German Arrangement & Treaty Benefits

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 of the Treaty.

XXXXXXXXXX 							2007-023588

XXXXXXXXXX , 2007

Dear Sir:

Re: Advance Income Tax Ruling - XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX and to your electronic mail dated 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 "Tax Treaty"), in connection with a proposed investment by the Fund in Canadian real estate.

We understand that to the best of your knowledge, and that of the XXXXXXXXXX, the capital investment company, none of the matters considered in this ruling request are:

a) dealt with in an earlier return of the Fund or a related person;

b) being considered by a tax services office or tax centre in connection with a previously filed tax return of the Fund or a related person;

c) under objection by one or any of the Fund or a related person;

d) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; and

e) the subject of a ruling previously issued by this Directorate XXXXXXXXXX.

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") each "technical" tax term used in this request has the same meaning as it has for purposes of the Act and each monetary reference is to CDN $.

Facts

a. Relevant Parties

1. XXXXXXXXXX (the "Company") was established on XXXXXXXXXX as a capital investment company that manages investment funds established under the applicable German law. The Company 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 "KAAG"), 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 KAAG and the Foreign Investment Act (Auslandinvestment-Gesetz-AuslInvestG) with the Investment Act (Investmentgesetz ("InvG")) and the Investment Tax Act (Investmentsteuergesetz ("InvStG")). The provisions of the Investment Act (Germany) that regulate the activities of an investment company are nearly identical to those of the KAAG, except that the section numbers of relevant provisions may differ. Investment companies were required to amend their fund agreements to refer to the provisions of the Investment Act (Germany) by 2007 and, until then, the KAAG remained applicable. 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 the Company are restricted to establishing and managing XXXXXXXXXX funds in accordance with the Investment Act (Germany).

3. The Company established the Fund as an open-end XXXXXXXXXX fund for retail and institutional investors and manages the Fund as a XXXXXXXXXX fund under the Investment Act (Germany) and pursuant to the Terms of Contract included in the Fund's prospectus. The Fund is marketed and sold by the Company almost exclusively to retail and institutional investors who are residents of Germany for purposes of the Tax Treaty. At present, (i) all the investors of the Fund are residents of Germany for purposes of the Tax Treaty, (ii) the units of the Fund are currently held by XXXXXXXXXX investors, XXXXXXXXXX that are resident and based in Germany, each owning between XXXXXXXXXX% and XXXXXXXXXX% of the units of the Fund, (iii) in the future, at least XXXXXXXXXX% of the shareholders of the Fund will continue to be persons who are residents of Germany for purposes of the Tax Treaty, and (iv) 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.

4. Pursuant to the Investment Act (Germany), the Company, 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.

5. 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 to fund future redemptions and to fund property acquisitions that are continually under active consideration by the Company on behalf of the Fund.

b. Overview of Relevant German Commercial Law

6. The Fund is a commonly-used business version of a fiduziarische Treuhand. Under the Investment Act (Germany), German domestic asset pools like the Fund may be established and managed as mutual public funds for the joint account of retail and institutional investors by a capital investment company in conjunction with a custodian bank. The Investment Act (Germany) contains detailed provisions governing the duties and responsibilities of the capital investment company and the custodian bank in relation to an investment fund. As well, the Investment Act (Germany) provides general rules for the operation of an investment fund like the Fund.

7. The salient provisions of the Investment Act (Germany) in relation to the duties and responsibilities of a capital investment company like the Company, 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.

Capital Investment Company

8. 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. (Sections 9 and 28)

9. 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. (Section 11)

Custodian Bank

10. 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 meet minimum capital requirements. (Section 20)

11. 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. (Sections 22, 24, 26 and 28)

12. Issue/Repurchase of Units-The custodian bank is responsible for the issue and repurchase of units of the investment fund. (Section 23)

13. Blocked Account-The custodian bank maintains one or more blocked accounts 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. (Sections 23, 24 and 25)

14. Safe Custody-The securities and certificates of deposit of the investment fund must be held by the custodian bank in one or more blocked securities custody accounts. 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. (Sections 24, 26 and 27)

Investment Funds - General Rules

15. Fund Assets-The assets of an investment fund may be owned 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, such as the 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 Investment Act (Germany) and the relevant contract with the investors. (Sections 31 and 32)

16. 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.

(Section 31)

17. 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. (Section 34)

18. Unit Value-The value of a unit is determined by the capital investment company in cooperation with the custodian bank, by dividing the value of the investment fund by the number of issued units. The value of assets is to be determined in accordance with the provisions of the Investment Act (Germany). (Section 36)

19. 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. (Section 37)

20. 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. (Sections 38 and 39)

21. 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. (Section 43)

22. Sales Prospectus-The capital investment company must 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. (Section 42)

Investment Funds-Special Rules for Real Property Funds

23. General Rules-Sections 46 to 65 of the Investment Act (Germany) set out general rules applicable to all capital investment companies regarding the investments a capital investment company may acquire and the investment limits regarding different types of investments, the limitations on borrowing as well as rules regarding other transactions the capital investment company may enter into, for instance, securities lending and short-sales.

24. Special Rules-The general rules set out in sections 46 to 65 apply to all funds, including real property funds, such as the Fund, that invest in real property, unless the specific provisions of sections 67 to 82 of the Investment Act (Germany) provide otherwise. These specific provisions apply only to the management of funds which invest in real property.

25. Permissible Assets-A real property fund is limited to investments in permissible 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 in a state that is not 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) the state guarantees the free transfer of the assets and does 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 assets held for the account of the real estate fund are exposed will be limited to a currency risk that does not exceed 30% of the value of the particular fund. (Section 67)

26. Risk Diversification and Trusteeship-The value of particular real property investment may not exceed 15% of the value of assets of the investment fund at the time of its acquisition. Further, the assets of a real property fund may only be owned by the capital investment company. 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.

Investment Funds-Marketing

27. Marketing Rules-Sections 121 to 142 set out special rules that apply to the marketing of investment funds. Sections 121 (information for investors) and 123 (German language) do not apply to an investment fund that is a special fund.

28. Notification Duty-Unlike the units of certain other investment funds, the units of a real property fund like the Fund may not 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 without a special permission. An investment by a resident of another Member State of the European Union or in another Contracting State to the Agreement on the European Economic Area may be possible on a private placement basis. (Section 128)

c. Overview of Investment Tax Act (Germany)

29. The basic German income tax treatment of funds such as the Fund is provided under the Investment Tax Act (Germany), the Corporate Income Tax Act (Germany) and the Income Tax Act (Germany). 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:

No. 5

Associations, foundations, trusts and other estates of private law.

31. The tax provisions of the KAAG 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". Further, 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, such as 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 relieving rules the Fund's 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 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. The Company 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 each 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 in the Fund 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%).

d. Certain Fund Terms

35. A review of the Fund's General Terms of Contract and Special Terms of Contract confirms that in nature and operation the Fund is substantively identical to a Canadian mutual fund trust.

36. The Fund's General Terms of Contract confirm XXXXXXXXXX.

37. The expenses and fees that can be charged to the Fund to which the Company, the Custodian and third parties are entitled are contained in the Special Terms of the Contract. For its services, the Company receives a management fee of XXXXXXXXXX . In addition to the annual management fee, the Company receives special fees of XXXXXXXXXX . For its services, the Custodian receives an annual fee of XXXXXXXXXX

Proposed Transactions

38. 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 . In furtherance of the Fund's strategy, on XXXXXXXXXX , the Company, on behalf of the Fund, proposes to acquire property (the "Property") located at XXXXXXXXXX .

39. On XXXXXXXXXX , the Company, as Purchaser on behalf of a XXXXXXXXXX corporation to be incorporated ("Newco"), and XXXXXXXXXX , as Vendor, entered into an Agreement of Purchase and Sale in respect of the Property (the "Purchase Agreement"). More specifically, the Purchase Agreement provides that the purchaser of the Property is to be the Company, on behalf of Newco, that Newco is intended to be the general partner of a XXXXXXXXXX limited partnership to be established, and that the purchase price for the Property is $XXXXXXXXXX subject to certain adjustments. The Company, on behalf of the Fund, will establish Newco and will subscribe for all of the common shares of Newco on behalf of the Fund.

40. Section XXXXXXXXXX of the Purchase Agreement allows the Purchaser to assign its rights under the Purchase Agreement as follows:

XXXXXXXXXX

41. The Company, on behalf of the Fund, and Newco will form a limited partnership ("LP") under the laws of the Province of XXXXXXXXXX. The Fund will be the only limited partner of the LP and will hold a XXXXXXXXXX% limited partnership interest and Newco will be the only general partner of the LP and will hold a XXXXXXXXXX % general partnership interest.

42. It is contemplated that, before the closing of the Transactions, the rights and obligations of Newco under the Purchase Agreement will be assigned to LP and LP will acquire the Property pursuant to the Purchase Agreement.

43. In addition to its limited partnership interest, the Fund will hold debt issued by LP, which debt will be evidenced by a promissory note, will be debt with a term of at least XXXXXXXXXX years, and will bear interest at a rate that reflects a market rate of interest, calculated and payable monthly.

44. XXXXXXXXXX% of the LP's funding will come from arm's length indebtedness.

45. The investments of the Company, on behalf of the Fund, in the limited partnership interest in, and debt of, LP will be held as long-term investments. The amount of the investment to be held by the Company, on behalf of the Fund, in the equity and debt of LP has not been settled but in no case will the principal amount of the debt held by the Company for the Fund exceed more than XXXXXXXXXX times the amount of the partnership capital of the limited partnership interest in LP that is held by the Company on behalf of the Fund.

46. The Company will receive partnership distributions for the account of the Fund as to the partnership interest that is held by the Company for the Fund and the Company, for the account of the Fund, will be allocated for Canadian tax purposes XXXXXXXXXX% of the net partnership income of LP on an annual basis. The Company for the account of the Fund will also receive interest payments on the debt of LP that is held by the Company for the Fund.

47. In connection with the proposed Canadian investments of the Fund in the partnership interest in, and the debt of, LP, the Company, on behalf of the Fund, will undertake (i) to advise the CRA of any change in the facts and circumstances of the Fund that differs 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 investors would be residents of Germany for purposes of the Tax Treaty; and (ii) file tax returns under Part I of the Act in respect of the Fund's share of LP income and to 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.

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to permit the Fund to diversify its real estate investment portfolio by making real estate investments in Canada.

Rulings

Assuming that the preceding statements constitute complete and accurate disclosure of all the relevant facts and Proposed Transactions, and assuming 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, LP.

B. The Fund will be treated as a resident of Germany for the purposes of Article 4 of the Tax Treaty, and its business profits from LP will be taxable in Canada in accordance with Article 7 of the Tax Treaty.

C. The partnership interest in LP 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 Fund investors) for purposes of the Tax Treaty including, in particular, Articles 6 and 13 thereof, and any gains derived by the Fund from the alienation of such interest may be taxed in Canada as provided in paragraph 4(b) of Article 13 of the Tax Treaty.

D. The Fund (and not the Fund investors) will be treated as the beneficial owner of the interest paid on the debt of LP that is held by the Fund for purposes of Article 11 of the Tax Treaty.

Comments

Nothing in these rulings should be construed as implying that we will not invoke the provisions of paragraphs 3 and 6 of Article 29 of the Tax Treaty if the percentage of German resident investors drops below the amounts mentioned in paragraphs 3 and 47 above.

The rulings given herein are based solely on the facts, proposed transactions and purposes of the proposed transactions described 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 these rulings are based and any reference to these documents is provided solely for the convenience of the reader.

The above rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act. Nothing in these rulings 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. These rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002, and are binding on the Canada Revenue Agency provided that the Proposed Transactions are completed before XXXXXXXXXX.

Yours truly,

XXXXXXXXXX
for the Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch