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Edited version of private advice

Authorisation Number: 1051681352886

Date of advice: 25 September 2020

Ruling

Subject: Sovereign immunity

Question 1

Is the ordinary and statutory income derived by the Bank from its interests in the investments listed in Appendix 1 (the Test Entities) not assessable and not exempt income under section 880-105 of the ITAA 1997?

Answer

Yes.

Question 2

Does section 880-110 of the ITAA 1997 operate to deny the Bank a deduction for any loss it incurs in respect of its interests in the Test Entities?

Answer

Yes.

Question 3

Is any capital gain or capital loss made by the Bank with respect to its interests in the Test Entities disregarded under sections 880-115 and 880-120 of the ITAA 1997 respectively?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Bank is the central bank of Country X.

The Bank was established by Country X's government.

The Bank is governed by the Law in Country X (the Law).

The Bank is not subject to corporate income tax in Country X.

The head office for the Bank is located in Country X.

The capital of the Bank is wholly owned by Country X.

The Bank is administered by the Board of the Bank.

The Government of Country X supervises the Bank.

The Bank advises the Government of Country X on monetary policy and other matters pertaining to the execution of the Bank's tasks.

The Bank cooperates with foreign national central banks and other financial institutions.

The Bank participates in promoting the smooth operation of payment systems in compliance with the provisions of the Treaty and the Statute.

Pursuant to the Law, the primary goal of the Bank is to maintain price stability. The Bank has the following primary tasks:

·         monetary policy;

·         manage the foreign reserves and other financial investments;

·         ensure currency circulation

·         participate in promoting smooth functioning of payment systems;

·         compile and publish statistical information

·         act as the financial agent of the Government of Country X and provide financial services to other market participants;

The Bank neither seeks nor takes instructions from the Government of Country X. The Bank is independent in setting and implementing policy under its legal mandate.

For the purpose of fulfilling its tasks, the Bank may open accounts for the Government of Country X, credit institutions, international institutions and other financial market participants. On the accounts opened for the Government, the Bank shall keep the state budget resources and the resources of special funds, and shall effect the transfer of the budget resources free of charge.

In order to achieve the objectives and carry out the tasks, the Bank is entitled to conduct credit operations, based on adequate collateral, with credit institutions and other financial market participants.

The Bank's execution of operating activities is mainly financed from income received from its investment management and monetary policy operations.

Equity securities consist of investments in marketable capital instruments made in the course of investment management by the Bank. Participating interest includes permanent investments of the Bank in equity. The Bank has no control or significant influence in any institution, therefore participating interest is not accounted for as an investment in a subsidiary or an associate.

For the purpose of investment management, including management of the related financial risks, the Investment Committee of the Bank develops an investment management strategy, approves tactical decisions and sets detailed limits for financial risks, as well as oversees the operation of the external managers.

The Investment Committee of the Bank reviews the investment strategy once a quarter, and on a weekly basis receives and reviews reports on and forecasts for developments in financial markets, prepared by financial investment portfolio managers, reports by financial risk managers, and approves the investment management tactical decisions for the forthcoming week.

There is a need to review and approve the annual budget of the Bank, stipulating that all expenses shall be financed from the Bank revenue.

The Bank shall hold and manage its foreign reserves, taking into account the provisions of the Law. The government shall deposit its foreign exchange working balances with the Bank. Upon receipt of specific authorisation from the government, the Bank shall be entitled to act as the government's financial agent in banking transactions.

The Bank shall be independent in the adoption of its decisions and in their practical implementation.

The Bank shall not participate in any commercial activity.

The appropriation of profit of the Bank is stipulated by the Law

All distributions made by the Bank, as funded by the returns on its investments, are received by the Government of Country X.

Investments in the Test Entities

The Bank has made investments listed on the Australian Securities Exchange (ASX) in the Test Entities as at the date shown in Appendix 1.

The Bank has invested in Australian equity investments (as detailed in Appendix 1). These equity investments have the following characteristics:

(a)  The Bank and all members of its sovereign entity group hold collectively less than 10% of the total participation interests in each of the Test Entities.

(b)  The Bank and all members of its sovereign entity group would hold collectively less than 10% of the total participation interests in the Test Entities in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997.

(c)   Neither the Bank, nor any members of its sovereign entity group, has involvement in the day to day management of the business of any of the Test Entities.

(d)  Neither the Bank, nor any members of its sovereign entity group, has the right to appoint a director to the Board of Directors of any of the Test Entities.

(e)  Neither the Bank, nor any members of its sovereign entity group, holds the right to representation on any investor representative or advisory committee (or similar) of the Test Entities.

(f)    Neither the Bank, nor any members of its sovereign entity group, has the ability to direct or influence the operation of the Test Entities outside of the ordinary rights conferred by the equity interest held.

(g)  The Bank only holds rights to vote in proportion to its equity interest in each investment.

(h)  The Bank's interests in the Test Entities do not provide it with an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations.

(i)    The Bank's interests, when combined with the other interests held within its sovereign entity group, do not provide an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations.

(j)    No person involved in the control and direction of the Test Entities' operations is accustomed or obliged to act in accordance with the directions, instructions or wishes of the Bank or members of the Bank's sovereign entity group.

Appendices to the relevant facts and circumstances

Appendix 1 - List of Relevant Investments as at 30 June 20XX

Relevant legislative provisions

Reasons for decision

Question 1

Is the ordinary and statutory income derived by the Bank from its interests in the investments listed in Appendix 1 (the Test Entities) not assessable and not exempt income under section 880-105?

Answer

Yes.

Detailed reasoning

Section 880-105 provides that amounts of ordinary and statutory income derived by a sovereign entity are not assessable and not exempt income if certain conditions are met. Those conditions are listed in subsection 880-105(1):

(a) the sovereign entity is covered by section 880-125; and

(b) the amount is a return on any of the following kinds of interest that the sovereign entity holds in another entity (the test entity):

(i) a *membership interest;

(ii) a *debt interest;

(iii) a *non share equity interest; and

(c) the test entity is:

(i) a company that is an Australian resident at the time (the income time) when the amount becomes ordinary or statutory income of the sovereign entity; or

(ii) a *managed investment trust in relation to the income year in which the income time occurs; and

(d) the *sovereign entity group of which the sovereign entity is a member satisfies the portfolio interest test in subsection (4) in relation to the test entity:

(i) at the income time; and

(ii) throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time; and

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

These conditions are considered below.

The Bank is a covered sovereign entity

Section 880-125 states:

A *sovereign entity is covered by this section if it satisfies all of the following requirements:

(a) the entity is funded solely by public monies;

(b) all returns on the entity's investments are public monies;

(c) the entity is not a partnership;

(d) the entity is not any of the following:

(i) a *public non-financial entity;

(ii) a *public financial entity (other than a public financial entity that only carries on central banking activities).

These conditions are considered below.

The Bank is a sovereign entity

For an entity to be covered by section 880-125, it must be a sovereign entity. Section 880-15 defines a sovereign entity to be any of the following:

(a) a body politic of a foreign country, or a part of a foreign country;

(b) a *foreign government agency;

(c) an entity:

(i) in which an entity covered by paragraph (a) or (b) holds a *total participation interest of 100%; and

(ii) that is not an Australian resident; and

(iii) that is not a resident trust estate for the purposes of Division 6 of Part III of the Income Tax Assessment Act 1936.

Section 960-180 provides that an entity's total participation interest in another entity is the sum of:

(a) the entity's direct participation interest in the other entity at that time; and

(b) the entity's indirect participation interest in the other entity at that time.

Country X is a foreign country.

Through its 100% ownership of the Bank, Country X has a total participation interest of 100% in the Bank. The Bank is not an Australian resident, nor is the Bank a resident trust estate for the purposes of Division 6 of Part III of the Income Tax Assessment Act 1936.

As such, the Bank meets the requirements of being a sovereign entity in accordance with subsection 880-15(c) as it is an entity in which Country X, being a foreign country, holds a total participation interest of 100%.

The Bank is funded solely by public monies

The phrase 'public monies' is not defined and as such takes its ordinary meaning. In the context of Division 880, this phrase essentially means monies raised by a foreign government (or part of a foreign government) for a public purpose which form part of the foreign government's (or part of the foreign government's) equivalent to Australia's Consolidated Revenue Fund (Roy Morgan Research Pty Ltd v FC of T & Anor [2011] HCA 35). This would ordinarily include general tax revenue, proceeds from the issue of government bonds, the proceeds of privatisations etc.

The capital of the Bank is wholly owned by the Country X.

The income derived by the Bank from its investments in the Test Entities (which may be used for re-investment purposes) is also wholly owned by Country X.

As such, the Bank is funded solely by public monies.

All returns on the Bank's investments are public monies

As a wholly owned entity of Country X, all distributions made by the Bank as funded by the returns on its investments are received by Country X.

As such, all returns on the Bank's investments are public monies.

The Bank is not a partnership

The Bank was established by the Law and is not a partnership. As such, it passes this condition.

The Bank is not a public non-financial entity or public financial entity

Subsection 880-130(1) defines the term public non-financial entity:

An entity is a public non financial entity if its principal activity is either or both of the following:

(a) producing or trading non financial goods;

(b) providing services that are not financial services.

Subsection 880-130(2) defines the term public financial entity:

An entity is a public financial entity if any of the following requirements are satisfied:

(a) it trades in financial assets and liabilities;

(b) it operates commercially in the financial markets;

(c) its principal activities include providing any of the following financial services:

(i) financial intermediary services, including deposit taking and insurance services;

(ii) financial auxiliary services, including brokerage, foreign exchange and investment management services;

(iii) capital financial institution services, including financial services in relation to assets or liabilities that are not available on open financial markets.

It is noted that subparagraph 880-125(d)(ii) excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

The Bank was established for the purpose of carrying on the business of central banking. The Bank satisfies the definition of a public financial entity provided for in subsection 880-130(2). However subparagraph 880-125(d)(ii) excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

Paragraph 75 of the Draft Law Companion Ruling LCR 2019/D4 The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2019/D4) lists the following as being considered as 'central banking activities':

  • monetary policy development
  • issuing national currency
  • acting as custodian of international reserves, and
  • providing banking services to government.

It is considered that the activities of the Bank are consistent with the Bank only being an entity that only carries on central banking activities. As such, the Bank passes the condition in paragraph 880-125(d).

As the Bank satisfies each of the requirements in paragraphs 880-125(a) through (d) it is a sovereign entity that is covered by section 880-125 for the purposes of paragraph 880-105(1)(a).

The Bank's return is received on a relevant interest in the Test Entities

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(b), it must be a 'return on' a membership interest, debt interest or non-share equity interest held by the sovereign entity in the test entities.

As detailed in paragraph 4.37 of the Explanatory Memorandum to the Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Act 2019 ('the EM'), a 'return on' a membership interest, debt interest or non-share equity interest for the purposes of paragraph 880-105(1)(b) will include:

1.            dividends - including non-share dividends and dividends that pass through a managed investment trust (MIT)

2.            interest - including interest that passes through a MIT

3.            fund payments made by a MIT (other than fund payments that are attributable to non-concessional MIT income), and

4.            revenue gains made on the disposal of an interest in the test entity - including revenue gains that pass through a MIT.

The Bank holds either shares and/or units in each of the Test Entities (which meet the requirements of being membership interests as defined by the interaction of sections 960-135 and 960-130). The Test Entities are entities of which the Bank holds a membership interest and earns returns in the form of fund payments and/or dividends.

As such, the Bank will receive amounts which satisfy the requirements of paragraph 880-105(1)(b).

The Bank's income is received from Australian resident companies or managed investment trusts

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(c), it must be received from an entity that is either:

(i) a company that is an Australian resident at the time (the income time) when the amount becomes ordinary or statutory income of the sovereign entity; or

(ii) a *managed investment trust in relation to the income year in which the income time occurs.

The Test Entities are Australian resident companies or managed investment trusts at the relevant times.

As such, the Bank receives income from entities which satisfy the requirements of paragraph 880-105(1)(c).

The Bank's sovereign entity group satisfies the portfolio interest test

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(d), the sovereign entity and the sovereign entity group to which it belongs must satisfy the portfolio interest test in relation to the test entities at both 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.

The portfolio interest test is outlined in subsection 880-105(4), which states:

A *sovereign entity group satisfies the portfolio interest test in this subsection in relation to the test entity at a time if, at that time, the sum of the *total participation interests that each *member of the group holds in the test entity:

(a) is less than 10%; and

(b) would be less than 10% if, in working out the *direct participation interest that any entity holds in a company:

(i) an *equity holder were treated as a shareholder; and

(ii) 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.

Section 880-20 provides the definition of sovereign entity group. Broadly, 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.

The Bank is part of the sovereign entity group of Country X. At the relevant times (as required by paragraph 880-105(1)(d)), the Bank, and its sovereign entity group collectively, holds less than 10% of the total participation interests in each of the Test Entities and the Bank and its sovereign entity group collectively, would hold less than 10% of the total participation interests in the Test Entities in the circumstances detailed in paragraph 880-105(4)(b).

Therefore, the portfolio test is satisfied.

The Banks's sovereign entity group does not have influence of a kind described in subsection (6) in relation to the Test Entities at the income time

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(e), at the income time the sovereign entity group to which the sovereign entity belongs must not have influence over the test entity of a kind described in subsection 880-105(6).

Subsection 880-105(6) states:

A *sovereign entity group has influence of a kind described in this subsection in relation to the test entity at a time if any of the following requirements are satisfied at that time:

(a) a *member of the group:

(i) is directly or indirectly able to determine; or

(ii) in acting 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;

(b) 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 group (whether those directions, instructions or wishes are expressed directly or indirectly, or through the member acting in concert with others).

As such, there are two distinct sub-tests within the influence test.

Sub-test 1 of the influence test, as contained in paragraph 880-105(6)(a), assesses whether the sovereign entity group is able to determine the identity of at least one of the persons who, individually or together with others, makes or is reasonably expected to make, decisions comprising the control and direction of the test entity's operations. This includes situations where the sovereign entity group is able to act in concert with others to determine the identity of a relevant decision-maker in the test entity.

Sub-test 1 also extends to situations where the sovereign entity group, in its own right, holds the ability to approve or veto decisions which go to the control or direction of the test entity.

The Bank's interests in the Test Entities do not provide it with an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations. Furthermore, the Bank's interests, when combined with the other interests held within its sovereign entity group, do not provide an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations.

Sub-test 2 of the influence test, as contained in paragraph 880-105(6)(b), assesses whether at least one of the relevant decision-making persons of the test entity is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of the sovereign entity group.

No person involved in the control and direction of the Test Entities' operations is accustomed or obliged to act in accordance with the directions, instructions or wishes of the Bank or members of the Bank's sovereign entity group.

Based upon the above, the sovereign entity group of the Bank does not have influence of a kind described in subsection 880-105(6) and will, therefore, satisfy the requirements of paragraph 880-105(1)(f).

Conclusion

As all of the conditions listed in subsection 880-105(1) have been satisfied, section 880-105 will apply to the effect that amounts of ordinary and statutory income derived by the Bank from its investments in the Test Entities are not assessable and not exempt income.

Question 2

Does section 880-110 of the ITAA 1997 operate to deny the Bank a deduction for any loss it incurs in respect of its interests in the Test Entities?

Answer

Yes.

Detailed reasoning

Section 880-110 provides that a sovereign entity cannot deduct an amount if:

(a) the sovereign entity is covered by section 880-125; and

(b) the amount is a loss in respect of any of the following kinds of interest that the sovereign entity holds in another entity:

(i) a membership interest;

...

(c) the requirements in paragraphs 880-105(1)(c), (d) and (e) would be satisfied, on the assumptions that:

(i) the amount were ordinary income or statutory income; and

(ii) the amount became ordinary income or statutory income of the sovereign entity at the time it arose; and

(iii) references in those paragraphs to the test entity were references to the other entity mentioned in paragraph (b) of this section.

As established in Question 1, the Bank:

(a) is covered by section 880-125

(b) holds membership interests in the Test Entities, and

(c) satisfied the requirements in paragraphs 880-105(1)(c), (d) and (e) in relation to ordinary or statutory income that it will derive from the Test Entities.

Therefore, the Bank cannot deduct an amount if it is a loss in respect of its ownership interests in the Test Entities.

Question 3

Is any capital gain or capital loss made by the Bank with respect to its investments in the Test Entities disregarded under sections 880-115 and 880-120 respectively?

Answer

Yes.

Detailed reasoning

Section 880-115 provides that a sovereign entity disregards a capital gain from a CGT event that happens in relation to a CGT asset if:

(a) the sovereign entity is covered by section 880-125; and

(b) the CGT asset is a membership interest, non-share equity interest or debt interest in another entity; and

(c) the requirements in paragraphs 880-105(1)(c), (d) and (e) would be satisfied, on the assumptions that:

(i) the capital gain were an amount of ordinary income or statutory income; and

(ii) the amount mentioned in subparagraph (i) became ordinary income or statutory income of the sovereign entity immediately before the time the CGT event happened; and

(iii) references in those paragraphs to the test entity were references to the other entity mentioned in paragraph (b) of this section.

Section 880-120 provides that a sovereign entity disregards a capital loss from a CGT event if, on the assumption that the loss were a capital gain, the capital gain would be disregarded because of section 880-115.

As established in Question 1, the Bank:

(a) is covered by section 880-125

(b) holds membership interests in the Test Entities, and

(c) satisfied the requirements in paragraphs 880-105(1)(c), (d) and (e) in relation to ordinary or statutory income that it will derive from the Test Entities.

Therefore, the Bank will be required to disregard any capital gain or loss made in respect of its ownership interests in the Test Entities.