Senate

Treasury Laws Amendment (Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2018

Income Tax (Managed Investment Trust Withholding Tax) Amendment Bill 2018

Income Tax Rates Amendment (Sovereign Entities) Bill 2018

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Josh Frydenberg MP)
This memorandum takes account of amendments made by the House of Representatives to the bill as introduced.

Chapter 4 Sovereign immunity

Outline of chapter

4.1 Schedule 4 to this Bill amends the ITAA 1936 and the ITAA 1997 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by codifying and limiting the scope of the sovereign immunity tax exemption.

4.2 The Income Tax Rates Amendment (Sovereign Entities) Bill 2018 makes consequential amendments to the Income Tax Rates Act 1986 to specify that sovereign entities are liable to income tax on taxable income at a rate of 30 per cent.

4.3 All references in this Chapter are to the ITAA 1997 unless otherwise stated.

Context of amendments

4.4 Broadly, certain income and gains from Australian investments are currently exempt from Australian income tax if they are derived by a foreign government, or by a foreign entity that is wholly-owned by a foreign government (commonly known as a sovereign wealth fund).

4.5 The exemption is based on the international law doctrine of sovereign immunity (see I Congreso del Partido (1981) 2 All ER 1064). This international law doctrine is unclear in its application and different countries take different approaches to how the immunity is implemented in practice.

4.6 In ATO ID 2002/45, the Commissioner states that: Certain income derived from within Australia by foreign governments is exempt from Australian tax under the international law doctrine of sovereign immunity. In accordance with that doctrine, Australia accepts that any income derived by a foreign government from the performance of governmental functions within Australia is exempt from Australian tax. An activity undertaken by a foreign Government Agency will generally be accepted as the performance of governmental functions provided that it is functions of government, provided that the agency is owned and controlled by the government and does not engage in commercial activities.

4.7 In practice, the Commissioner exempts investment income and gains derived by foreign governments and foreign government agencies from tax where:

·
the monies invested are and will remain government monies; and
·
the income is derived from a non-commercial activity.

4.8 In determining whether an investment in an entity is a commercial activity, the Commissioner takes into account the size of the direct and indirect investment and the actual or potential influence that may be exercised in respect of the entity's financial, operating and policy decisions.

4.9 Where the sovereign immunity tax exemption applies, the Commissioner accepts that the sovereign entity will be exempt from income tax and withholding tax.

4.10 The Government has decided to create a legislative framework for the existing tax concession for foreign governments (including sovereign wealth funds) and, among other things, limit the exemption to portfolio-like investments in certain assets.

4.11 In addition, income flowing through Australian trusts will only be able to access the sovereign immunity tax exemption if the paying trust is a MIT and the income is not non-concessional MIT income.

Summary of new law

4.12 Schedule 4 to this Bill amends the ITAA 1936 and the ITAA 1997 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by codifying and limiting the scope of the sovereign immunity tax exemption.

4.13 An amount of ordinary income or statutory income of a sovereign entity will be NANE income if, broadly:

·
the amount is a return on a portfolio-like membership interest, debt interest or non-share equity interest in an Australian company or MIT; and
·
no member of the sovereign entity group has influence (either directly or indirectly) over decisions that comprise the control and direction of the operations of the Australian company or MIT.

4.14 An amount of ordinary income or statutory income that is NANE income of a sovereign entity is also exempt from withholding tax.

4.15 Unless another provision in the Income Tax Rates Act 1986 applies to set a different rate, a sovereign entity will be liable to pay income tax on its taxable income at a rate of 30 per cent - that is, the rate equal to the top corporate tax rate.

Comparison of key features of new law and current law

New law Current law
An amount of ordinary income or statutory income of a sovereign entity will be NANE income if, broadly:

·
the amount is a return on a portfolio-like membership interest, debt interest or non-share equity interest in an Australian company or MIT; and
·
no member of the sovereign entity group has influence (either directly or indirectly) over decisions that comprise the control and direction of the operations of the Australian company or MIT.

An amount of ordinary income or statutory income that is NANE income of a sovereign entity is also exempt from withholding tax.

Unless another provision in the Income Tax Rates Act 1986 applies to set a different rate, a sovereign entity will be liable to pay income tax on its taxable income at a rate of 30 per cent.

No equivalent.

Detailed explanation of new law

4.16 Schedule 4 to this Bill amends the ITAA 1936 and the ITAA 1997 to codify and limit the scope of the sovereign immunity tax exemption.

What is a sovereign entity?

4.17 A sovereign entity is any of the following:

·
a body politic of a foreign country or a part of a foreign country;
·
a foreign government agency; or
·
a foreign resident entity in which a body politic of a foreign country or a part of a foreign country, or a foreign government agency, holds a total participation interest of 100 per cent.

[Schedule 4, items 6 and 9, section 880-15 and the definition of 'sovereign entity' in subsection 995-1(1)]

4.18 A foreign government agency is defined in subsection 995-1(1) to mean:

·
the government of a foreign country or a part of a foreign country;
·
an authority of the government of a foreign country; or
·
an authority of the government of part of a foreign country.

4.19 A sovereign entity is liable to pay tax on its taxable income. [Schedule 4, item 6, section 880-55]

4.20 For the purposes of applying the income tax law, a body politic of a foreign country or a part of a foreign country, or a foreign government agency in relation to a foreign country (including a foreign government agency in relation to part of a foreign country), is taken to be:

·
a person who is a foreign resident; and
·
a resident of the foreign country.

[Schedule 4, item 6, section 880-60]

4.21 Unless another provision in the Income Tax Rates Act 1986 applies to set a different rate, the rate of income tax payable by a sovereign entity on its taxable income is 30 per cent - that is, the rate equal to the top corporate tax rate. [Schedule 1 to the Income Tax Rates Amendment (Sovereign Entities) Bill 2018, items 1 to 3, section 30 of the Income Tax Rates Act 1986]

4.22 Another provision in the Income Tax Rates Act 1986 will apply if, for example, a sovereign entity is a company or a trust. In these circumstances, the rate of income tax payable by the sovereign entity on its taxable income will be the relevant corporate tax rate or the relevant trustee tax rate.

What is a covered sovereign entity?

4.23 Certain income of a sovereign entity that is covered by section 880-125 (a 'covered sovereign entity') will be NANE income. A sovereign entity is a covered sovereign entity if:

·
the sovereign entity is funded solely by public monies;
·
all returns on the sovereign entity's investments are public monies;
·
the sovereign entity is not a partnership; and
·
the sovereign entity is not:

-
a public non-financial entity; or
-
a public financial entity (other than a public financial entity that only carries on central banking activities).

[Schedule 4, item 6, subsection 880-125(1)]

4.24 An entity is a public non-financial entity if its principal activity is:

·
producing or trading non-financial goods; and/or
·
providing services that are not financial services.

[Schedule 4, items 6 and 9, subsection 880-130(1) and the definition of 'public non-financial entity' in subsection 995-1(1)]

4.25 An entity is a public financial entity if:

·
the entity trades in financial assets;
·
the entity operates commercially in the financial markets; and/or
·
the principal activities of the entity include providing any of the following financial services:

-
financial intermediary services, including deposit-taking and insurance services;
-
financial auxiliary services, including brokerage, foreign exchange and investment management services; and/or
-
capital financial institution services, including financial services in relation to assets or liabilities that are not available on open financial markets.

[Schedule 4, items 6 and 9, paragraphs 880-130(2)(a) to (c) and the definition of 'public financial entity' in subsection 995-1(1)]

4.26 The definitions of public non-financial entity and public financial entity are based on concepts in:

·
the International Monetary Fund Government Finance Statistics Manual 2014; and
·
the Australian Bureau of Statistics manual ABS - Australian System of Government Finance Statistics: Concepts, Sources And Methods - 5514.0 of 2015.

4.27 Public non-financial entities include entities such as airline corporations, postal authorities, state water corporations and port authorities. They also include public non-profit institutions engaging in market production (such as hospitals, schools, or colleges) if they are separate institutional units and charge economically significant prices.

4.28 Public financial entities include deposit-taking corporations, financial intermediaries (such as banks), financial auxiliaries and captive financial institutions.

NANE income of a covered sovereign entity - income from holding certain interests

4.29 If a sovereign entity is a covered sovereign entity, an amount of its ordinary income or statutory income is NANE income if:

·
the amount is a return on a membership interest, a debt interest or a non-share equity interest that the sovereign entity holds in another entity (the test entity);
·
at the time the amount becomes ordinary income or statutory income of the sovereign entity (the income time), the test entity is either an Australian resident company or a MIT (including a MIT that is an AMIT);
·
the sovereign entity group of which the sovereign entity is a member satisfies the portfolio interest test in subsection 880-105(4) in relation to the test entity:

-
at the income time; and
-
throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time; and

·
the sovereign entity group of which the sovereign entity is a member does not have influence of the kind described in subsection 880-105(6) in relation to the test entity at the income time.

[Schedule 4, item 6, subsection 880-105(1)]

4.30 For these purposes, a membership interest, a debt interest or a non-share equity interest that a sovereign entity holds as a partner in a partnership is disregarded. [Schedule 4, item 6, subsection 880-105(2)]

4.31 If an amount is ordinary income of a sovereign entity, the income time will generally be the time that the income is derived. If the amount is statutory income of a sovereign entity, the income time will generally be the time that is stated in the provision that creates the statutory income or the time when the income is taken to be derived.

4.32 However, if the test entity is a MIT in relation to the income year in which the sovereign entity derives or receives the amount, the amount will not be NANE income of the sovereign entity to the extent that:

·
the amount is attributable to a fund payment; and
·
the fund payment is attributable to non-concessional MIT income (including MIT cross staple arrangement income that is disregarded because of the approved economic infrastructure facility exception or the non-concessional MIT income transitional rule).

[Schedule 4, item 6, subsection 880-105(3)]

4.33 A covered sovereign entity cannot deduct an amount if:

·
the amount is a loss in respect of a membership interest, a debt interest or a non-share equity interest that the sovereign entity holds in an Australian resident company or a MIT (the test entity); and
·
the portfolio interest test in subsection 880-105(3) or the influence test in subsection 880-105(5) would be satisfied in relation to the test entity on the assumption that the amount were an amount of ordinary or statutory income at the time it arose.

[Schedule 4, item 6, section 880-110]

4.34 This ensures that, if a covered sovereign entity makes a loss on the disposal of a membership interest, a debt interest or a non-share equity interest in another entity, the sovereign entity cannot deduct an amount in respect of the loss on the assumption that the investment is of a kind that would have been NANE income. Similarly, under the general deduction provision in the income tax law, losses and outgoings incurred by a sovereign entity in deriving NANE income are not deductible.

4.35 A capital gain made by a covered sovereign entity from a CGT event that happens in relation to a CGT asset will be disregarded if:

·
the CGT asset is a membership interest, non-share equity interest or debt interest in another entity (the test entity) that is an Australian resident company or a MIT; and
·
the portfolio interest test in subsection 880-105(3) or the influence test in subsection 880-105(5) would be satisfied in relation to the test entity on the assumption that the capital gain were an amount of ordinary or statutory income immediately before the time the CGT event happened.

[Schedule 4, item 6, section 880-115]

4.36 Similarly, a capital loss of a covered sovereign entity from a CGT event that happens in relation to a CGT asset will be disregarded if, on the assumption that the capital loss was a capital gain, the capital gain would be disregarded because of section 880-115. [Schedule 4, item 6, section 880-120]

4.37 Broadly, the following amounts derived, received or made by a covered sovereign entity may be NANE income (or disregarded in calculating statutory income):

·
dividends - including non-share dividends and dividends that pass through a MIT;
·
interest - including interest that passes through a MIT;
·
fund payments made by a MIT (other than fund payments that are attributable to non-concessional MIT income); and
·
net capital gains and revenue gains made on the disposal of an interest in the test entity - including gains that pass through a MIT.

4.38 An amount of ordinary income or statutory income that is NANE income of a sovereign entity is also exempt from withholding tax.

4.39 In addition, if a sovereign entity is a beneficiary of a trust, the trustee of the trust will not be liable to tax under subsection 98(3) of the ITAA 1936 on any amount that is NANE income of the sovereign entity. [Schedule 4, item 1, section 99GA of the ITAA 1936]

Example 4.1 : Sovereign wealth fund acquires an interest in a stapled structure

Sovereign wealth fund acquires an interest in a stapled structure entity chart

SWF is a covered sovereign entity that holds a portfolio (5 per cent) interest in:

·
ordinary units in Asset Trust (which is a MIT); and
·
ordinary shares in Op Co.

Asset Trust and Op Co are stapled entities that entered a cross staple arrangement in respect of an economic infrastructure facility. SWF (or other members in its sovereign entity group) have no other rights in respect of the stapled entities.Because of the operation of the transitional rules that apply to cross stapled arrangements, the cross staple lease payments are not MIT cross staple arrangement income of Asset Trust until 1 July 2034.SWF acquired its interest in the stapled entities on 1 July 2018. In addition, SWF satisfies the portfolio interest test and the influence test in section 880-105.Therefore, any dividends or other distributions that SWF receives on the shares it holds in Op Co will be NANE income.In addition, any distributions that SWF receives on the units it holds in Asset Trust will be NANE income if they are not fund payments attributable to non-concessional MIT income (or MIT cross staple arrangement income that is disregarded in certain circumstances).In this regard, the cross staple rental payments from Op Co to Asset Trust are not non-concessional MIT income until 1 July 2034 because of the MIT cross staple arrangement income transitional rule which applies to stapled structures with an economic infrastructure facility.However, ignoring those transitional provisions, these amounts would be MIT cross staple arrangement income from 1 July 2019. Therefore, any fund payments from Asset Trust to SWF made on or after 1 July 2019 that are attributable to this cross staple rental arrangement will not be NANE income under Division 880.

Sovereign entity groups

4.40 In determining whether a covered sovereign entity can access the sovereign immunity tax exemption, the entity must consider the total level of interest and influence that it, together with its sovereign entity group, has in the investment asset.

4.41 A sovereign entity group consists of each entity that is a part of the sovereign entity group. [Schedule 4, items 6 and 9, section 880-20 and the definition of 'sovereign entity group' in subsection 995-1(1)]

4.42 Each entity that is part of a sovereign entity group is a member of the group. [Schedule 4, items 6 and 8, subsection 880-20(3) and paragraph (bd) of the definition of 'member' in subsection 995-1(1)]

4.43 Consequently:

·
sovereign entities of the same foreign government will be members of the same sovereign entity group; and
·
sovereign entities of the same part of a foreign government will be members of the same sovereign entity group.

4.44 Therefore, for countries with different levels of government (such as federal and state governments, or federal, state and provincial governments):

·
the federal government would be considered the government of a foreign country under subsection 880-20(1); and
·
the state and provincial governments would respectively be considered governments of separate parts of that foreign country under subsection 880-20(2).

4.45 Consequently, the grouping of the sovereign entities occurs at:

·
the federal level for federal entities; and
·
the state or provincial level respectively for entities that are part of the state or provincial level government.

Example 4.2 : Sovereign entity groups for multiple levels of government

Sovereign entity groups entity chart

Country A is a country that has a federal system of government. State X is a state of Country A.Federal Government Investment Authority and Federal Government Reserve Fund are agencies of Country A's federal government that satisfy the requirements to be a sovereign entity.SPV is a wholly-owned entity of Federal Government Investment Authority and also satisfies the requirements to be a sovereign entity.State X Investment Authority and State X Reserve Fund are agencies of State X of Country A that satisfy the requirements to be a sovereign entity.SPV 1 is a wholly-owned entity of State X Investment Authority and also satisfies the requirements to be a sovereign entity.For the purposes of Division 880, there are two sovereign entity groups.The Federal Government and the State Government each has its own sovereign entity group.Under subsection 880-20(1), one sovereign entity group consists of:

·
the Federal Government Investment Authority;
·
the Federal Government Reserve Fund; and
·
SPV.

Under subsection 880-20(2), another sovereign entity group consists of:

·
the State X Investment Authority;
·
the State X Reserve Fund; and
·
SPV 1.

Portfolio interest test

4.46 A sovereign entity group satisfies the portfolio interest test in subsection 880-105(4) in relation to an entity (the test entity) at a time if, at that time, the sum of the total participation interests (as defined in section 960-180) that each member of the sovereign entity group holds in the test entity:

·
is less than 10 per cent; and
·
would be less than 10 per cent if, in working out the direct participation interest (under section 960-190) that any entity holds in a company:

-
an equity holder were treated as a shareholder; and
-
for any non-share equity interests, the total amount contributed to the company in respect of non-share equity interests were included in the total paid-up share capital of the company.

[Schedule 4, item 6, subsection 880-105(4)]

4.47 In working out the sum of the total participation interests held by each member of the group in the test entity, a particular direct or indirect participation interest held in the test entity is taken into account only once. [Schedule 4, item 6, subsection 880-105(5)]

4.48 A sovereign entity group must apply the portfolio interest test in respect of the interest it holds in the test entity. The test entity is the entity from which the sovereign entity group derives or receives an amount of ordinary income or statutory income - that is, it is the entity in which the sovereign entity group holds the first level of its investment into Australia. Consequently, where a sovereign entity invests in an Australian MIT, an assessment must be made of the sovereign entity group's level of interest in that MIT.

The influence test

4.49 A sovereign entity group has influence of the kind described in subsection 880-105(6) in relation to an entity (the test entity) at a time if, at that time:

·
a member of the sovereign entity group, acting alone or in concert with others, is directly or indirectly able to determine the identity of at least one of the persons who, individually or together with others, make (or might reasonably be expected to make) the decisions that comprise the control and direction of the test entity's operations; and/or
·
at least one of those persons is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of a member of the sovereign entity group (whether those directions, instructions or wishes are expressed directly or indirectly, or through the member of the sovereign entity group acting in concert with others).

[Schedule 4, item 6, subsection 880-105(6)]

4.50 For the purposes of determining whether a sovereign entity group has the requisite level of influence, any breach of terms of a debt interest by any entity is disregarded. [Schedule 4, item 6, subsection 880-105(7)]

4.51 For the purposes of applying the influence test in subsection 880-105(6) in relation to a test entity, an entity is taken to be a member of the sovereign entity group if it is a foreign resident entity in which the relevant body politic or foreign government agency holds a total participation interest of more than 50 per cent. [Schedule 4, item 6, subsection 880-105(8)]

4.52 A sovereign entity group will indirectly have influence of the kind described in the influence test where, for example, the influence or ability to influence the tested entity is held by an Australian resident entity that is controlled by the sovereign entity group.

4.53 A sovereign entity group must apply the influence test in respect of the influence it has in relation to the test entity. The test entity is the entity from which the sovereign entity group derives or receives an amount of ordinary income or statutory income - that is, it is the entity in which the sovereign entity group holds the first level of its investment into Australia.

Example 4.3 : Portfolio interest test satisfied SWF is a corporate entity which is wholly-owned by a foreign government. SWF:

·
is fully funded by general tax revenue raised by the foreign government;
·
will ultimately distribute all profits made to the foreign government as dividends; and
·
is a foreign resident for income tax purposes.

As part of its portfolio investments, SWF has acquired less than 1 per cent of the ordinary share capital of Listed Company. Listed Company is an Australian resident company listed on the Australian Securities Exchange. No other member of SWF's sovereign entity group holds a direct or indirect interest in Listed Company.The rights attached to the ordinary shares acquired by SWF are identical to the rights of all other ordinary shareholders in Listed Company. SWF has no capacity to influence (either directly or indirectly) Listed Company in any way outside of its basic rights as a minority holder of ordinary shares.In addition, the sovereign entity group of which SWF is a member has no capacity to influence Listed Company in any way.SWF's sovereign entity group holds a total participation interest in Listed Company of less than 10 per cent and does not have influence in relation to Listed Company of the kind described in the influence test.Therefore, any dividends paid by Listed Company to SWF will be NANE income under Division 880.

Example 4.4 : Portfolio interest test not satisfied SWF 1 and SWF 2 are corporate entities which are wholly-owned by the same foreign government. Both SWF 1 and SWF 2:

·
are fully funded by general tax revenue raised by the foreign government;
·
will ultimately distribute all profits made to the foreign government as dividends; and
·
are foreign residents for income tax purposes.

SWF 1 has acquired 7 per cent of the ordinary share capital of ABC Pty Ltd. SWF 2 has acquired 8 per cent of the ordinary share capital of ABC Pty Ltd.As SWF 1 and SWF 2 are both wholly-owned by the same foreign government, they are members of the same sovereign entity group. Consequently, the total participation interest of the sovereign entity group in ABC Pty Ltd is 15 per cent.Therefore, any dividends paid by ABC Pty Ltd to SWF 1 and SWF 2 will not be NANE income under Division 880.

Example 4.5 : Portfolio interest test not satisfied SWF is a covered sovereign entity that owns 5 per cent of the ordinary shares in Portfolio Company, an Australian resident company. No other member of SWF's sovereign entity group holds a direct or indirect interest in Portfolio Company.Portfolio Company has $1 million of paid-up ordinary share capital. It does not have any other classes of share on issue.SWF holds a profit participating loan issued by Portfolio Company. The profit participating loan is non-share equity for Australian tax purposes under Division 974. The subscription amount for the profit participating loan was $200,000.Other than the profit participating loan held by SWF, there are no other non-share equity interests issued by Portfolio Company.To determine whether the sovereign entity group of which SWF is a member satisfies the portfolio interest test for the purposes of Division 880, SWF must work out the sovereign entity group's total participation interests in Portfolio Company assuming that the total amount contributed to the company in respect of non-share equity interests were included in the total paid-up share capital of the company.SWF would have a total participation interest of (at least) 20 per cent by virtue of its rights to the capital in the company (taking into account the modifications in paragraph 880-105(4)(b)). That is, SWF holds $250,000 of the total capital of $1.2 million.Therefore, the sovereign entity group of which SWF is a member fails the portfolio interest test and distributions on the profit participating loan and the ordinary shares will not be NANE income under Division 880.

Example 4.6 : Influence test not satisfied SWF is a corporate entity which is wholly-owned by a foreign government. SWF:

·
is fully funded by general tax revenue raised by the foreign government;
·
will ultimately distribute all profits made to the foreign government as dividends; and
·
is a foreign resident for income tax purposes.

SWF has acquired 9.95 per cent of the issued units in ABC Unit Trust. ABC Unit Trust is an Australian resident MIT with a small number of investors.Under the constituent documents of ABC Unit Trust, any investor who holds issued units of 5 per cent or more is entitled to appoint an individual to an Advisory Board of ABC Unit Trust. The Board of Directors of ABC Unit Trust cannot make certain decisions in relation to the control and direction of the Trust's operations without the Advisory Board's approval.In these circumstances, SWF has influence in relation to the ABC Unit Trust of the kind described in the influence test.Therefore, any payments made by ABC Unit Trust to SWF will not be NANE income under Division 880.

Example 4.7 : Influence test not satisfied SWF is a covered sovereign entity that has acquired 4 per cent of the issued units of DEF Unit Trust. SWF has engaged an investment manager, IM Co, to manage its investment in DEF Unit Trust.IM Co has also been engaged as investment manager in respect of a 9 per cent investment in the issued units of DEF Unit Trust by SFFR, a superannuation fund for foreign residents unrelated to SWF.DEF Unit Trust is an Australian resident MIT with a small number of investors. Under the constituent documents of DEF Unit Trust, an investor holding 10 per cent or more of the issued units is entitled to appoint an individual to an Advisory Board of DEF Unit Trust. The Board of Directors of DEF Unit Trust cannot make certain decisions in relation to the control and direction of the Trust's operations without the Advisory Board's approval.The constituent documents of DEF Unit Trust operate such that IM Co is entitled to appoint an individual to the Advisory Board of DEF Unit Trust (as it is the investment manager of a combined 13 per cent holding of the issued units of the Trust).In these circumstances, both SWF and SFFR have influence in relation to the DEF Unit Trust of the kind described in the particular influence test relevant to each entity.Therefore, any payments made by DEF Unit Trust to SWF will not be NANE income under Division 880. In addition, the withholding tax exemption in paragraph 128B(3)(jb) of the ITAA 1936 will not apply to SFFR in respect of interest, dividend and non-share dividend income arising from this investment.

NANE income of a covered sovereign entity - income from consular functions

4.54 An amount of ordinary income or statutory income of a sovereign entity is NANE income if that income arises from the entity's consular functions. [Schedule 4, item 6, section 880-205]

Liability to withholding tax

4.55 A foreign resident that derives dividends or interest that is paid by an Australian resident generally has a liability to withholding tax in respect of the payment (section 128B of the ITAA 1936). However, a withholding tax liability does not arise in relation to income that is excluded under subsection 128B(3) of the ITAA 1936.

4.56 Therefore, subsection 128B(3) of the ITAA 1936 is amended to ensure that dividend and interest income derived by a sovereign entity that is NANE income is exempt from withholding tax. [Schedule 4, item 2, paragraph 128(3)(n) of the ITAA 1936]

4.57 A sovereign entity may still be subject to withholding tax on dividend and interest income (at the relevant dividend or interest withholding tax rate) that is not NANE income. In this event, income which is subject to withholding tax will be NANE income under section 128D of the ITAA 1936.

4.58 A foreign resident that receives a fund payment from an Australian MIT is liable to MIT withholding tax in respect of the payment (section 840-805). A fund payment that is made to a sovereign entity that is NANE income is not subject to MIT withholding tax. [Schedule 4, item 5, subsection 840-805(9)]

4.59 A sovereign entity will be subject to MIT withholding tax on a fund payment that is not NANE income. In this event, section 840-815 will apply so that the income which is subject to withholding tax is NANE income - as a result, tax will be payable on these amounts at the fund payment withholding tax rates rather than the corporate tax rate.

4.60 An entity may withhold an amount under the withholding provisions in error. For example, an entity may withhold an amount from a payment of interest to a covered sovereign entity that is exempt from withholding tax because of paragraph 128B(3)(n) of the ITAA 1936. In these circumstances, any amounts withheld or paid to the Commissioner in error can be refunded to the covered sovereign entity under Subdivision 18-B in Schedule 1 to the TAA 1953.

Consequential amendments

4.61 Consequential amendments are made to insert guide material into new Division 880:

·
Subdivision 880-A defines several terms that are fundamental to the operation of the Division;
·
Subdivision 880-B provides that a sovereign entity is liable to pay tax;
·
Subdivision 880-C sets out when investment income of a sovereign entity is NANE income; and
·
Subdivision 880-D specifies that income derived by a sovereign entity from consular activities is NANE income.

[Schedule 4, item 6, sections 880-10, 880-50, 880-100 and 880-200]

4.62 Consequential amendments are also made to:

·
modify the table in section 9-1 to add a reference to a sovereign entity - that table lists entities that must pay income tax; and
·
modify the table in section 11-55 to add a reference to sovereign entities - that table lists provisions in the income tax law that make amounts NANE income.

[Schedule 4, items 3 and 4, sections 9-1 and 11-55]

Application and transitional provisions

4.63 The amendments to codify and limit the scope of the sovereign immunity tax exemption apply to the 2019-20 income year and to later income years. [Schedule 4, item 7, section 880-1 of the IT(TP)A 1997]

Transitional rules to protect existing investments

4.64 Transitional rules apply to protect income and gains from existing investments of a sovereign entity for which the Commissioner provides a tax exemption under the doctrine of sovereign immunity.

4.65 These transitional rules ensure that there is no immediate adverse impact on sovereign entity for investments held at the time the changes were announced.

4.66 To access the transitional rules, the sovereign entity must hold a positive ruling from the Commissioner in respect of an investment asset, which applies at any time between the announcement of the policy (27 March 2018) and the end of the transitional period (1 July 2026).

4.67 In addition, the circumstances relating to the investment asset must not materially change during the transition period. For example, if an existing investment asset (such as a loan) that qualifies for the transitional rules is rolled over before 1 July 2026, the transition period would not cease to apply if all other features of the loan remain the same.

4.68 Under the transitional rules, an amount of ordinary income or statutory income of a sovereign entity is NANE income if:

·
the amount is a return on an investment asset under a scheme;
·
the sovereign entity acquired the investment asset on or before 27 March 2018;
·
on or before that date, the sovereign entity applied for a private ruling in relation to the scheme;
·
before 1 July 2026, the Commissioner gave the sovereign entity a private ruling confirming that the investment asset was not subject to income tax or withholding tax because of the doctrine of sovereign immunity;
·
the private ruling applied during at least part of the period starting on 27 March 2018 and ending before 1 July 2026 (regardless of whether the private ruling started to apply before 27 March 2018, or ceased to apply before 1 July 2026); and
·
the scheme carried out is not materially different to the scheme specified in the private ruling.

[Schedule 4, item 7, paragraphs 880-5(a) to (f) of the IT(TP)A 1997]

4.69 In these circumstances, the amendments will not apply in relation to that investment asset until the later of:

·
the 2025-26 income year; and
·
if the last income year to which the private ruling applies is a later income year than the 2025-26 income year - that later income year.

[Schedule 4, item 7, paragraph 880-5(g) of the IT(TP)A 1997]

4.70 If the transitional rules apply, a sovereign entity cannot deduct an amount for an income year if the amount arises from an investment asset under a scheme. [Schedule 4, item 7, section 880-10 of the IT(TP)A 1997]

4.71 In addition, a capital gain of a sovereign entity from a CGT event that happens in relation to a CGT asset is disregarded if:

·
the capital gain arises under a scheme;
·
the CGT asset is a membership interest, non-share equity interest or debt interest in another entity; and
·
the requirements in paragraphs 880-5(b) to (g) of the IT(TP)A 1997 are satisfied (on the assumption that references in those paragraphs to the investment asset were references to the CGT asset) - that is, broadly, the CGT asset was acquired before 27 March 2018 under the scheme and a relevant private ruling applies in relation to the scheme.

[Schedule 4, item 7, section 880-15 of the IT(TP)A 1997]

4.72 A capital loss of a sovereign entity from a CGT event that happens in relation to a CGT asset in these circumstances is also disregarded. [Schedule 4, item 7, section 880-20 of the IT(TP)A 1997]

Transitional rule to reset the tax costs of assets

4.73 A separate transitional rule applies to reset the tax costs of assets held by a sovereign entity that currently qualify for sovereign immunity. The transitional rule applies if:

·
a sovereign entity acquired an asset (other than money) on or before 27 March 2018;
·
on or before that date, the sovereign entity applied for a private ruling in relation to the asset;
·
before 1 July 2026, the Commissioner gave the sovereign entity a private ruling confirming that the income and gains from the asset were not subject to income tax or withholding tax because of the doctrine of sovereign immunity;
·
the private ruling applied to income and gains during at least part of the period starting on 27 March 2018 and ending before 1 July 2026 (regardless of whether the private ruling started to apply before 27 March 2018, or ceased to apply before 1 July 2026); and
·
the sovereign entity holds the asset on the day that is:

-
the later of 1 July 2026 and the day before the private ruling ceases to apply; or
-
an earlier day that is the day on which the scheme carried out is materially different to the scheme specified in the private ruling.

[Schedule 4, item 7, subsections 880-25(1) and (5) of the IT(TP)A 1997]

4.74 If the transitional rule applies to an asset, then the sovereign entity is taken to have disposed of and re-acquired the asset, for consideration equal to the higher of its market value or cost base immediately before that disposal, on the day that is:

·
the later of 1 July 2026 and the day before the private ruling ceases to apply; or
·
an earlier day that is the day on which the scheme carried out is materially different to the scheme specified in the private ruling.

[Schedule 4, item 7, subsections 880-25(2) and (5) of the IT(TP)A 1997]

4.75 The reset tax cost for an asset may apply, for example, for the purposes of:

·
working out the amount of a capital gain or capital loss that arises when a CGT event happens to the asset; or
·
if the asset is a revenue asset, working out the amount that is included in, or can be deducted from, the assessable income of the sovereign entity.

[Schedule 4, item 7, subsection 880-25(3) of the IT(TP)A 1997]

4.76 In addition, if the transitional rule applies to an asset, any capital gain or capital loss, or any revenue gain or revenue loss, that is made because of the deemed disposal is disregarded. [Schedule 4, item 7, subsection 880-25(4) of the IT(TP)A 1997]


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