Edited version of private advice

Authorisation Number: 1012631113907

Ruling

Subject: Sovereign Immunity

Question 1

Is the non-resident entity a 'superannuation fund for foreign residents' in accordance with the definition in section 118-520 of the ITAA 1997?

Answer

No.

Question 2

Is the non-resident entity exempt from liability to withholding tax and income tax on interest income derived from its Australian debt instruments?

Answer

Yes.

Question 3

Will the Australian Taxation Office (ATO) impose liability to withholding tax and income tax on the non-resident entity on income (other than interest income) derived from its passive Australian investments in widely held equities or funds in which it holds less than 10% interest in those equities or funds?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commenced on:

1 July 2012

Relevant facts and circumstances

1. The non-resident entity was established by a foreign government as part of the foreign government.

2. The non-resident entity's purpose is to invest funds for the purpose of funding a pension scheme. It is required to invest funds so that high returns are achieved on a long term basis.

3. The non-resident entity's board is appointed by the foreign government.

4. The non-resident entity receives its funds from the government.

5. The non-resident entity's investments, assets, and all income and gains derived from them are beneficially owned by the government, which reserves the right to use the money for other governmental functions.

6. The non-resident entity currently invests in Australian listed equities and bonds. The non-resident entity holds less than 10% of the equity in the corporations in which it invests.

7. The non-resident entity will derive dividend and interest income from its investments.

8. The non-resident entity intends to hold these investments on a long-term basis.

9. The non-resident entity will have no control rights, no representation on the board of directors, and no involvement in the operating of the corporations in which it invests.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1997 section 4-1

Income Tax Assessment Act 1997 section 118-520

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Question 1

Is the non-resident entity a 'superannuation fund for foreign residents' in accordance with the definition in section 118-520 of the ITAA 1997?

Detailed reasoning

The non-resident entity is not a 'superannuation fund for foreign residents.'

Question 2

Is the non-resident entity exempt from liability to withholding tax and income tax on interest income derived from its Australian debt instruments?

Detailed reasoning

Non-resident taxpayers will generally be liable to pay income tax under section 4-1 of the ITAA 1997 or withholding tax under section 128B of the ITAA 1936 on Australian-sourced income, unless an exemption or exclusion applies.

In determining liability to tax on Australian income derived by a foreign resident, it is necessary to also consider the applicable agreement as defined in section 3AAA or section 3AAB of the International Tax Agreements Act 1953 (the Agreements Act).

Subsection 4(1) of the Agreements Act incorporates the ITAA 1936 and the ITAA 1997 so that those Acts are read as one with the Agreements Act.

Subsection 4(2) of the Agreements Act, provides that the Agreements Act effectively overrides the ITAA 1936 and the ITAA 1997 where there are inconsistent provisions (except for some limited provisions).

Tax agreement

There is a tax agreement between Australia and the country in which the non-resident entity resides. The agreement provides that interest income derived by a government of a contracting state be exempt from tax in the other contracting state.

The non-resident entity derives interest income from its Australian debt instruments.

Is the non-resident entity a part of the government of a contracting state?

The non-resident entity was established by, and is a part of the foreign government with whom Australia has a tax agreement. It is part of the government of a contracting state.

Question 3

Will the ATO impose liability to withholding tax and income tax on the non-resident entity on income (other than interest income) derived from its passive Australian investments in widely held equities or funds in which it holds less than 10% interest in those equities or funds?

Detailed reasoning

Non-resident taxpayers will generally be liable to pay income tax under section 4-1 of the ITAA 1997 or withholding tax under section 128B of the ITAA 1936 on Australian-sourced income, unless an exemption or exclusion applies.

While the ITAA 1936 and ITAA 1997 do not provide an exemption or exclusion for foreign governments, liability to income tax and withholding tax may not be imposed on foreign governments or entities of foreign governments under the common law doctrine of sovereign immunity.

Sovereign immunity background

The Foreign States Immunities Act 1985 (Immunities Act) is an Australian Commonwealth Act which reflects a more restrictive view of the common law doctrine of sovereign immunity.

It has been long-standing practice for the ATO to use the principles delineated in the Immunities Act to apply the more restrictive view of the doctrine of sovereign immunity when considering taxation matters.

Pursuant to this approach, an entity claiming sovereign immunity must satisfy three conditions:

1. the entity must be a foreign state, or a separate entity of a foreign state

2. the scheme to which the claim applies must not be a commercial transaction, and

3. the monies being invested in the scheme are and will remain government monies.

If these three conditions are satisfied, it has been the long-standing practice of the ATO to not impose the entity's liability to income tax and withholding tax in respect of ordinary income and statutory income on the basis that the entity has satisfied the common law doctrine of sovereign immunity.

Condition 1: a 'foreign state' or 'separate entity' of a foreign state

A claim for sovereign immunity may only be made by a 'foreign state' (section 9 of the Immunities Act).

A foreign state is defined in section 3 of the Immunities Act to be a country outside of Australia that is either:

• an independent sovereign state, or

• a separate territory (whether or not it is self-governing) that is not part of an independent sovereign state.

Sovereign immunity also extends to a 'separate entity' of a foreign state pursuant to section 22 of the Immunities Act.

A separate entity of a foreign state is defined in section 3 of the Immunities Act to be a natural person, body corporate or corporation sole that:

• is an agency or instrumentality of the foreign state, and

• is not a department or organ of the executive government of the foreign state.

The lower court decision of the PT Garuda Case (PT Garuda Indonesia Ltd v. Australian Competition and Consumer Commission [2011] FCAFC 52) considered when an entity may be an agency or instrumentality of the foreign state.

The court decided (at paragraph 128), that the correct approach is to consider, on the whole of the evidence, whether the person is acting for, or being used by, the foreign state as its means to achieve some purpose or end of that state in the relevant circumstances.

Is the non-resident entity a 'foreign state' or 'separate entity of a foreign state?

The non-resident entity is a part of the foreign government, and therefore satisfies this condition.

Condition 2: commercial transaction

Under section 11 of the Immunities Act, a foreign state does not enjoy sovereign immunity in so far as the proceeding concerns a commercial transaction.

As suggested by the High Court in the PT Garuda Case at paragraph 5, the necessity for sovereign immunity to be excluded from commercial transactions came about as a result of governments increasingly becoming engaged in various commercial activities and that immunity of governments involved in commercial activities was inconsistent with international law and it was undesirable.

As a result, Australia accepts that foreign states performing only governmental functions, rather than undertaking commercial transactions, may claim sovereign immunity.

This approach is consistent with the decision of the British House of Lords in I Congreso del Partido [1981] 2 All ER 1064, where it was held that activities of a trading, commercial or other private law character were not governmental functions.

Whether an operation or activity is a commercial transaction will depend on the facts of each particular case. As a guide, a commercial transaction 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.

In relation to the 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 a commercial investment, but this would depend on the particular circumstances. A portfolio holding in a company or fund (that is, a holding of 10% or less of the equity in a company) will generally be accepted as a non-commercial transaction.

Are the non-resident entity's investments commercial transactions?

The non-resident entity currently holds Australian publicly listed equities, corporate and government bonds.

Interest income derived from the bonds is already exempt under the previous question. Dividend income is derived from the holdings in the publicly listed equities.

ATO Interpretative Decision ATOID 2002/45 states that a holding of 10% or less of the equity in a company will generally be accepted as a passive investment, and therefore a non-commercial activity. However, determining whether a holding in an entity represents a commercial activity is dependent on all the particular circumstances of the investment.

All investments are into publicly listed equities and held on a long-term basis. The investments are stakes of not more than 1% in the relevant equities.

The non-resident entity also has no involvement in the affairs of the businesses in which it invests. It is not represented on any board of directors of the corporations in which it invests, and has no influence in the management or operating of the businesses. As a shareholder, the non-resident entity retains shareholder rights such as voting that they exercise. However as its holdings are less than 1%, its voting in shareholder meetings is completely insignificant.

Conclusion

The non-resident entity's investments into publicly listed Australian securities are passive, non-commercial investments, satisfying this requirement with respect to sovereign immunity.

Condition 3: monies are and will remain government monies

In line with the principle that sovereign immunity applies to foreign states performing only governmental functions, an entity claiming sovereign immunity must establish that the monies being invested in the scheme are and will remain government monies.

The non-resident entity receives its funds for investment from the foreign government. The money is invested, and called upon by the foreign government when it needs to exercise governmental functions.

As a result, the money the subject of this scheme is and will remain government monies, satisfying this requirement with respect to sovereign immunity.

Conclusion

As the three conditions have been satisfied, the ATO will not impose liability to income tax or withholding tax on the non-resident entity on income (other than interest income) derived from passive Australian investments in widely held equities or funds in which it holds less than 10% interest in those equities or funds.

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