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Ruling

Subject: Sovereign immunity for a foreign government entity

Question

Is X Ltd exempt from Australian income tax and withholding tax on its interest income, dividend income, trust distributions and any other income , including capital gains, derived from the minority investment in the Y Fund under the principle of sovereign immunity?

Answer

Yes. X Ltd is exempt from Australian income tax and withholding tax on its interest income, dividend income, trust distributions and any other income, including capital gains, derived from the minority investment in the Y Fund under the principle of sovereign immunity.

This ruling applies for the following period<s>:

30 June 2011

30 June 2012

30 June 2013

30 June 2014

30 June 2015

The scheme commences on:

1 July 2010

Ruling Reasons for Decision.

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. The doctrine of sovereign immunity only applies to foreign governments and their instrumentalities that engage in governmental functions. In determining whether a particular activity constitutes the performance of governmental functions we need to examine the nature of the activity conducted by the foreign government or its instrumentality. This approach is consistent with the decision of the British House of Lords in the case I Congreso del Partido [1981] 2 All ER 1064 which held that activities of a trading, commercial or other private law character were not governmental functions.

When determining whether sovereign immunity applies to a particular operation or activity, it is necessary to establish whether the operation or activity is commercial in nature. Whether an operation or activity is commercial in nature will depend on the facts of each particular case. However, as a guide, a commercial activity is generally an activity concerned with the trading of goods and services, such as buying, selling, bartering and transportation, and includes the carrying on of a business.

Income derived by a foreign government or by any other body exercising governmental functions from interest bearing investments or investments in equities is generally not considered to be income derived from a commercial operation or activity. Accordingly, provided the funds used to make such investments are and remain government moneys, the income is accepted as being exempt from tax under the common law doctrine of sovereign immunity.

In relation to a holding of shares in a company, there would be instances where the extent of the holding gives rise to questions as to whether it constitutes a passive investment or the carrying on of a business, but this would depend on the particular circumstances. A portfolio holding in a company (that is, a holding of 10% or less of the equity in a company) will generally be accepted as a non-commercial activity and any dividends received from such a holding would be exempt from tax.

To establish that sovereign immunity applies to exempt passive income including rent, dividend and interest income from income tax including withholding tax, it is necessary to establish the following:

§ that the person making the investment (and therefore deriving the income) is a foreign government or an agency of a foreign government;

§ that the moneys being invested are and will remain government moneys; and

§ that the income is being derived from a non-commercial activity.

If these three conditions are satisfied, then any income will not be subject to Australian income or withholding taxes.

Condition 1

That the person making the investment (and therefore deriving the Income) is a foreign government or an agency of a foreign government

The foreign government entity has been established solely as a special purpose vehicle that is wholly owned and controlled by the foreign government and through which the foreign government will invest in the Investment.

The foreign government entity is therefore a foreign government owned and controlled entity carrying out government functions.

Condition 2

That the moneys being invested are and will remain government moneys

The investment in the Australian managed investment scheme (MIS) is made with funds raised by the issue of the foreign government entity's shares. The funds subscribed for those shares were sourced from the foreign government.

The foreign government's contribution consists of funds from the general revenue raised through taxes and other levies.

The assets are invested subject to legislation and investment policies of the foreign government's investment body.

As investment manager it decides or approves investment policies and decisions. These investments must adhere to the conditions set out in the relevant investment policy. It has full investment discretion, subject to the investment policies and compliance with applicable laws.

As a result, the moneys are, and remain at all times, within the control of the foreign government, through its investment body, and are administered in accordance with applicable legislation.

Condition 3

That the income is being derived from a non-commercial activity

The foreign government entity will derive dividend income, interest income and trust distributions from its investment in the MIS

A portfolio holding will generally be accepted as a non-commercial activity, but a non-portfolio holding (that is, of more than 10% of the total equity of a company or a trust) may still constitute a non-commercial activity depending upon the particular circumstances of the investment.

A 50% resolution is required for ordinary investor decisions in the MIS.

An arms length trustee, as advised by the Manager, will have day to day control of the investments of the MIS

The foreign government entity's lack of involvement in day to day management of the investment is consistent with the holding of a passive investment.

Certain matters cannot be actioned without prior approval of a resolution passed by 80% or unanimous consent of the voting rights of investors. The foreign government entity will not have sufficient voting power to pass or block these resolutions on its own and does not have a sufficient interest to veto a matter requiring unanimous consent.

Matters requiring 80% or unanimous approval of the rights held by investors in respect of their investment include such matters as:

- any material amendment to the MIS' constitution; - any issue of units;

- the sale of the assets of the business of the MIS;

- the cessation or material alteration of the business and the liquidation or winding up of the MIS.

The foreign government entity's investments in Australia are considered to be of a passive and non-commercial nature.

Accordingly, an exemption from income tax including withholding taxes under the principles of sovereign immunity for dividend, interest and ordinary income derived through its investment in the MIS will be available.

Note: The then Assistant Treasurer issued a press release no .033 on 20 August 2009 advising that the government will introduce amendments to the income tax law to formalise the existing tax practice of exempting certain income earned by foreign governments. He stated:

These changes will provide greater certainty to foreign governments investing in Australia as to the income tax treatment of "passive' investments. At present, such income is not taxed because of the doctrine of sovereign immunity.

This doctrine exempts a foreign government's income from passive portfolio investments such as interest, dividends and managed funds distributions. Income from commercial activities will continue to be subject to Australian tax.

The proposed changes will codify this existing practice.

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