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Ruling

Subject: Sovereign Immunity

Question 1

Is the foreign government entity entitled to an exemption from liability to interest withholding tax under the common law principle of sovereign immunity in respect of interest derived from debt instruments, provided that the entity is deriving this interest income from passive debt instruments and not from any commercial activity (in particular from the business of money lending)?

Answer

No.

This ruling applies for the following period:

Numerous income years from 1 July 2003

The scheme commenced on:

1 July 2003

Question 2

Is the foreign government entity entitled to an exemption from liability to dividend withholding tax under the common law principle of sovereign immunity in respect of its passive portfolio investments (i.e. Investments in which the entity holds less than 10% of the total interests)?

Answer

No.

This ruling applies for the following period:

Numerous income years from 1 July 2003

The scheme commenced on:

1 July 2003

Question 3

Is the foreign government entity entitled to an exemption from liability to income tax under the common law principle of sovereign immunity in respect of distributions from passive investments in widely held management investment funds or unit trusts in which the entity holds less than 10% of the total fund?

Answer

No.

This ruling applies for the following period:

Numerous income years from 1 July 2003

The scheme commenced on:

1 July 2003

Relevant facts and circumstances

1. A pension plan (the Fund) was established for employees of a Foreign Government.

2. The Fund contracts for the services of various independent consultants, investment advisory, actuarial and financial professionals to assist the Board of Trustees in carrying out their fiduciary duty to manage the funds.

3. The Fund was established under a Trust Agreement entered into between the Foreign Government and the Fund's Board of Trustees.

4. The applicant has submitted that the Fund is an indefinitely continuing fund and a provident, benefit superannuation fund or retirement fund. The moneys in the Fund are sourced from employee and employer contributions.

5. Employees must contribute to the Trust Fund through regular payroll deductions, from and after the effective date of his or her participation in the plan. Such amounts are actuarially determined to be required to provide 50% of the cost of providing benefits under the Fund.

6. Employers (Foreign Government) must contribute to the Trust Fund from time to time such amounts as are actuarially determined to be required to provide 50% of the cost of providing benefits under the Fund.

7. No participant will be entitled to any benefit under the plan until they have completed a minimum eligibility service period or have attained normal retirement date.

8. Benefits are payable monthly for the life of the participant.

9. With prior approval of the Board of Trustees, the Fund may engage an actuary to make an actuarial valuation of the liabilities, to recommend the mortality and other tables and the interest rates to be used in actuarial and other computations for any purpose of the Fund. With prior approval by the Board of Trustees, The Fund may also employ or engage such accountants, counsel, other experts and other persons deemed necessary or desirable in connection with the administration of the Fund.

10. The Trust Fund will be held and disbursed by the Trustees in trust in accordance with the provisions of the Trust Agreement for use in accordance with the provisions of the Trust Agreement. No person will have an interest in or rights to the Trust Fund except as expressly provided under the Fund's plan, and then only to the extent of the amounts payable to such person under the plan.

11. According t the Fund's plan rules no part of the assets of the Trust Fund will, by reason of any modification, amendment, termination or otherwise, revert to the benefit of the Foreign Government prior to the satisfaction of all liabilities with respect to participants and their beneficiaries, nor will any part of the Trust Fund assets otherwise be used for or diverted to purposes other than for the exclusive benefit of participants, or their designated beneficiaries. After the satisfaction of all such liabilities, any excess remaining as the result of actuarial errors in the funding required will revert to the Foreign Government.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Question 1

Is the foreign government entity entitled to an exemption from liability to interest withholding tax under the common law principle of sovereign immunity in respect of interest derived from debt instruments, provided that the entity is deriving this interest income from passive debt instruments and not from any commercial activity (in particular from the business of money lending)?

Detailed reasoning

1. 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.

2. According to ATO ID 2002/45, in order to establish that sovereign immunity applies to exempt dividend and interest income from 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 the dividend and interest income will not be subject to Australian income or withholding taxes.

3. An 'agency of a foreign government' is not defined in ATO ID 2002/45. However, the definition of a 'foreign government agency' in the Income Tax Assessment Act 1997 (ITAA 1997) is an appropriate definition in the context of the ATO ID.

4. Subsection 995-1(1) of the ITAA 1997 provides that a foreign government agency is:

a. the government of a foreign country or part of a foreign country;

b. the authority of the government of a foreign country; or

c. the authority of the government of part of a foreign country.

Is the Fund an agency of a foreign government?

5. The definition of a 'foreign government agency' in Subsection 995-1(1) of the ITAA 1997 provides that a foreign government agency can be the 'authority' of the government of a foreign country or the 'authority' of the government of part of a foreign country

6. Since the Fund itself is not a 'government', it is necessary to consider whether it is an 'authority' of the foreign government.

Is the Fund an 'authority' of a foreign government?

7. In Commissioner of Taxation v Bank of Western Australia; State Bank of New South Wales (1995) 96 ATC 4009, the Full Federal Court considered the ordinary meaning of the term 'authority' in the context of the former Sales Tax (Exemptions and Classifications) Acts of 1935 and 1992. The Court nevertheless considered the broader definition of the term, concluding that the general characteristic of an 'authority' is a body 'which has the right or power to exercise authority or command' (96 ATC 4009 at 4025 and 4026).

8. Although stating that 'it is fair to say that no test of universal applicability has emerged', Justice Hill quoted the following passage from the judgement of Gibbs J in Committee of Direction of Fruit Marketing v Australian Postal Commission (1980) 144 CLR 577 at 580 as being 'the closest any judicial comment has come to attempting a definition of the word "authority"':

"The expression 'authority of a State' refers to a body which exercises power derived from or delegated by the State, but the fact that a body is established under State law and possess power conferred upon it by State law will not necessarily mean the body is an authority of a State. … In all cases, it is necessary to have regard to all the relevant circumstances in order to determine the character of the body in question".

9. Justice Hill (with whom Wilcox and Drummond JJ agreed) listed several propositions that can be derived from the decided cases that consider the ordinary meaning of the term 'authority', including the fact that 'a private body, corporate or unincorporated, established for profit will not be an authority' (96 ATC 4009 at 4026).

10. In the context of sovereign immunity, an 'authority' will include an entity that is wholly-owned by a foreign government as an 'authority' where that entity is performing a function for the public advantage or executes a function in the public interest and not a private body established exclusively for private profit.

11. This is also consistent with the approach of the courts in the context of the meaning of 'a State' in section 114 of the Australian Constitution, which is summarised in Goods and Services Tax Ruling GSTR 2006/5. In cases such as the High Court decision of SGH Ltd v Commissioner of Taxation (2002) ATC 4366, the courts have held that if a corporation is discharging governmental functions for the State, then the corporation is the State. On the other hand, if the intention is for the corporation to perform its functions independently of, and not as an instrument of, the State, the corporation is not the State.

12. Although this principle is separate to the meaning of 'authority' in the definition of 'foreign government agency' in subsection 995-1(1) of the ITAA 1997, it provides guidance as to the inclusion of corporations that carry on the governmental functions of a foreign government as part of the foreign government for the purposes of applying sovereign immunity.

13. The Fund has been established under a Trust Agreement between a foreign government and the Board of Trustees.

14. The investment activity of the Board of Trustees (acting on the authority of the Foreign Government and under the Trust Agreement) is an activity that is the function of the government (the payment of pensions to the Foreign Government's employees) and it is accepted that the Fund is an 'authority' of the Foreign Government.

15. Accordingly, as an authority of the Foreign Government, the Fund is therefore a 'foreign government agency' for the purposes of applying the test of sovereign immunity in ATO ID 2002/45.

Are the moneys being invested government moneys and will they remain government moneys?

16. The next condition set out in ATO ID 2002/45 is that the moneys being invested are 'government moneys'. To be 'government moneys', the moneys must be available as part of the general funds of the foreign government, used for general government functions as required.

17. It has been submitted that the Fund is an indefinitely continuing fund and a provident, benefit superannuation fund or retirement fund. The moneys in the Fund are sourced from employee and employer contributions.

18. Employees must contribute to the Trust Fund through regular payroll deductions, from and after the effective date of their participation in the plan. Such amounts are actuarially determined to be required to provide 50% of the cost of providing benefits under the Fund's plan.

19. Employers (Foreign Government) must contribute to the Trust Fund from time to time such amounts as are actuarially determined to be required to provide 50% of the cost of providing benefits under the Fund's plan.

20. It is established then, that the moneys being invested by the Fund are not government moneys in its entirety, this is because contributions sourced from participants (employees) are not government moneys.

21. According to the Fund's plan rules no part of the assets of the Trust Fund will, by reason of any modification, amendment, termination or otherwise, revert to the benefit of the Foreign Government prior to the satisfaction of all liabilities with respect to participants and their beneficiaries, nor will any part of the Trust Fund assets otherwise be used for or diverted to purposes other than for the exclusive benefit of participants, or their designated beneficiaries. After the satisfaction of all such liabilities, any excess remaining as the result of actuarial errors in the funding required will revert to the Foreign Government.

22. It is established then, that the moneys will not remain government moneys as they will not be available as part of the general funds of the foreign government or subject to be used for general government functions as required.

23. Accordingly, not all the moneys being invested by the Fund are government moneys or will remain government moneys, therefore the Fund fails the second requirement in ATO ID 2002/45.

Question 2

Is the foreign government entity entitled to an exemption from liability to dividend withholding tax under the common law principle of sovereign immunity in respect of its passive portfolio investments (i.e. Investments in which the entity holds less than 10% of the total interests)?

Detailed reasoning

Please see analysis in question 1.

Question 3

Is the foreign government entity entitled to an exemption from liability to income tax under the common law principle of sovereign immunity in respect of distributions from passive investments in widely held management investment funds or unit trusts in which the entity holds less than 10% of the total fund?

Detailed reasoning

Please see analysis in question 1.

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