Application of Australia/Germany DTA to a German Investment Fund

Can an investment fund created under the German Investment Company Act claim benefits, under the Australia/Germany double taxation agreement (German tax treaty) as a resident of Germany if Australia treats the fund as a non-resident company and Germany taxes the members of the fund on the income of the fund, rather than the fund itself?

Yes, the investment fund can claim benefits under the German tax treaty to the extent the fund's members are taxable in Germany on income derived through the fund and would be entitled to claim benefits under the German tax treaty if they had derived the income directly.

The investment fund is created under German law and proposes to acquire a number of income producing commercial buildings and expects to derive rental income as well as some interest income in Australia. The income producing buildings will be acquired as a long term investment. The investment fund will not be a resident of Australia.

The investment fund is exempt from income tax in Germany (ie, it is treated as a transparent entity) and as a company (ie. a separate taxable entity) for the purposes of Australia's domestic law.

The investment fund would not be entitled to claim the benefits of the German tax treaty based on a literal interpretation of the treaty. In this regard, only residents of Germany as defined in Article 4 of the German tax treaty can claim treaty benefits in Australia. In particular, Article 4(1)(b) provides that a person must be subject to an unlimited tax liability in Germany to be treated as a resident of Germany for the purposes of the treaty. The investment fund, however, does not satisfy this "unlimited tax liability" requirement because the members of the fund, rather than the fund itself, are taxable in Germany.

Paragraphs 2 to 6.7 of the OECD Commentary on Article 1 of the OECD Model Tax Convention, based on outcomes from the OECD's partnership report, indicate that the above literal interpretation of the residence definition in a tax treaty would provide a result inconsistent with the intent of the treaty. Guidance is also provided in the paragraphs on how treaties should be interpreted to resolve this conflict. In particular, paragraph 6.3 of the OECD Commentary on Article 1 states the general principle that: "...the State of source should take into account, as part of the factual context in which the Convention is to be applied, the way in which an item of income, arising in its jurisdiction, is treated in the jurisdiction of the person claiming the benefits of the Convention as a resident."

While the above guidance is for partnerships, we consider the underlying reasoning to be applicable in other cases where an entity is regarded as a separate taxable entity in the country of source and as transparent for taxation purposes in the country of residence. Accordingly, taking into account the factual context referred to by the OECD, Australia should provide treaty benefits for income derived by the investment fund to the extent that Germany has allocated the income to fund members who would have been entitled to treaty benefits if they had derived the income directly. The above general principle would not apply, however, if the investment fund were treated as a resident of Australia (paragraph 6.3 of the OECD Commentary on Article 1).

The need to interpret tax treaties according to their intent and the importance of taking into account guidance provided in the OECD Commentary is discussed in Taxation Ruling TR2001/13. Based on this interpretative approach, it is considered that the investment fund can claim benefits under the German tax treaty, to the extent the fund's members are taxable in Germany on income derived through the fund and would be entitled to claim benefits under the German tax treaty if they had derived the income directly.