Classification of a German Kommanditgesellschaft for Australian income tax purposes

Is the German Kommanditgesellschaft (KG) a foreign hybrid limited partnership for the purposes of subsection 830-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. A German KG is a foreign hybrid limited partnership for the purposes of subsection 830-10(1) of the ITAA 1997.

German investors hold their interests in an Australian fund (the fund) through a German KG. The German investors own their interests in the German KG through a nominee company which holds the interests on behalf of the investors.

The constitution of the German KG is executed in Germany in accordance with the German Commercial Code and will be governed by German commercial and tax law.

The German KG is registered in Germany.

The German KG has a general partner and two limited partners (a managing limited partner and the nominee company). They are all German resident limited liability companies. The activities, management and control of the German KG lie solely with the general partner and the managing limited partner. The German KG's sole activity is passive investment in the fund. Accordingly, the German KG is not an Australian resident. The German KG is not taxed in any country as a resident.

The German KG is a limited partnership as defined in section 995-1 of the ITAA 1997.

The German KG is not subject to any German tax, including the German trade tax (Gewerbesteuer). The partners are liable to German income tax in respect of their share of taxable income of the KG.

The trustee of the fund, an Australian taxpayer, holds a call option over the German investors' interests in the German KG, with the exception of the managing limited partner's interest in the German KG which is approximately 1% of the total interest. The call option is exercisable at the end of a specified period of time.

Subsection 830-10(1) of the ITAA 1997 provides that a limited partnership is a foreign hybrid limited partnership in relation to an income year if: (a) it was formed in a foreign country; and (b) foreign tax is imposed under the law of the foreign country on the partners, not the limited partnership, in respect of the income or profits of the partnership for the income year; and (c) at no time during the income year is the limited partnership, for the purposes of a law of any foreign country that imposes foreign tax on entities because they are residents of the foreign country, a resident of that country; and (d) disregarding subsection 94D(5) of the Income Tax Assessment Act 1936, at no time during the income year is it an Australian resident; and (e) disregarding that subsection, in relation to the same income year of another taxpayer: (i) the limited partnership is a controlled foreign company (CFC) at the end of a statutory accounting period that ends in the income year; and (ii) at the end of the statutory accounting period, the taxpayer is an attributable taxpayer in relation to the CFC with an attribution percentage greater than nil.

In the present case, paragraph 830-10(1)(a) of the ITAA 1997 is satisfied because the German KG is a limited partnership whose constitution is executed in Germany and is therefore formed in Germany.

Paragraph 830-10(1)(b) of the ITAA 1997 is satisfied because the German KG is not subject to German tax and Germany taxes the profits of the limited partnership on the partners and not the limited partnership.

The Explanatory Memorandum to Taxation Laws Amendment Act (No. 1) 2004 , which inserted Division 830 of the ITAA 1997, states that paragraph 830-10(1)(c) of the ITAA 1997: requires that if there is another foreign country (apart from the country of formation) which taxes the limited partnership as a resident entity, it will not qualify as a foreign hybrid.

The German KG's central management and control lie with its general and managing limited partners, which are both German resident limited liability companies. It is also formed in Germany and registered in Germany. Its sole activity is passive investment in the fund. The German KG is not taxed in any country as a resident. Accordingly paragraphs 830-10(1)(c) and 830-10(1)(d) of the ITAA 1997 are satisfied.

Paragraph 340(a) of the Income Tax Assessment Act 1936 (ITAA 1936) provides that a company is a CFC at a particular time if, at the time, there is a group of five or fewer Australian 1% entities the aggregate of whose associate-inclusive control interests in the company is not less than 50%.

Australian 1% entity is defined in section 317 of the ITAA 1936 to mean an Australian entity whose associate-inclusive control interest in the company or trust is at least 1%. The term 'Australian entity' is defined in section 336 of the ITAA 1936 and includes an Australian trust. As the fund is an Australian trust within the meaning of section 338 of the ITAA 1936, it is an Australian entity.

Associate-inclusive control interest in a company includes direct control interests held by an entity in the company (section 349 of the ITAA 1936). Direct control interest includes the percentage of the total paid-up capital of the company that an entity is entitled to acquire at the time (subsection 350(1) of the ITAA 1936). 'Entitled to acquire' is defined in section 322 of the ITAA 1936 to include an absolute entitlement to acquire because of the exercise of an option. Paragraph 25 of Taxation Ruling TR 2002/3 states that a date-deferred type call option constitutes an absolute entitlement to acquire.

The Australian entity (that is, the fund) holds a date-deferred type call option to acquire all the German investors' interest in the German KG with the exception of the managing limited partner's interest which is approximately 1%. Therefore, the Australian entity is entitled to acquire close to 100% of the total paid-up share capital of the German KG. Accordingly, the Australian entity has an associate-inclusive control interest of close to 100% in the German KG.

Therefore, disregarding subsection 94D(5) of the ITAA 1936, the German KG is a CFC in relation to the Australian entity as the Australian entity is an Australian 1% entity which has an associate-inclusive control interest of 50% or more in the German KG by virtue of the call option.

Paragraph 361(1)(a) of the ITAA 1936 defines an entity to be an attributable taxpayer in relation to a CFC if, at the time, the entity has an associate-inclusive control interest of at least 10% in the CFC. As the Australian entity has close to 100% associate-inclusive control interest in the German KG, it is an attributable taxpayer in relation to the German KG under section 361 of the ITAA 1936.

Section 362 of the ITAA 1936 defines attribution percentage to be the aggregate of both direct and indirect attribution interests in the CFC by the taxpayer at a particular time. A direct attribution interest in a CFC at a particular time includes the percentage of the total paid-up share capital of the CFC that the entity is entitled to acquire (section 356 of the ITAA 1936). As discussed above, the Australian taxpayer has an absolute entitlement to acquire close to 100% of the total paid-up share capital of the German KG by virtue of the call option. Accordingly, under section 362 the Australian taxpayer is an attributable taxpayer with an attribution percentage of greater than nil in relation to the German KG.

Therefore, paragraph 830-10(1)(e) of the ITAA 1997 is satisfied because, disregarding subsection 94D(5) of the ITAA 1936, the limited partnership is a CFC in relation to an Australian taxpayer and the Australian taxpayer is an attributable taxpayer with an attribution percentage of greater than nil in relation to the CFC.

Accordingly, as all the requirements of subsection 830-10(1) of the ITAA 1997 are satisfied, the German KG is a foreign hybrid limited partnership for the purposes of subsection 830-10(1) of the ITAA 1997.