Edited version of private advice

Authorisation Number: 1012635575578

Ruling

Subject: Sovereign Immunity

Question

Will the Australian Tax Office (ATO) impose liability to income tax (including capital gains tax) or withholding tax on the non-resident entity on its interest income, dividend income, trust distributions, managed investment trust distributions and any other income derived from any passive portfolio investments or non-commercial activities within Australia?

Answer

No.

This ruling applies for the following periods:

Year ending 31 May 2015

Year ending 31 May 2016

Year ending 31 May 2017

Year ending 31 May 2018

Year ending 31 May 2019

Year ending 31 May 2020

Year ending 31 May 2021

Year ending 31 May 2022

Year ending 31 May 2023

Year ending 31 May 2024

The scheme commences on:

1 June 2014

Relevant facts and circumstances

1. The non-resident entity is a separate entity of a foreign state.

2. The non-resident entity receives funds for investment purposes from its foreign government.

3. The non-resident entity proposes to invest in publicly listed Australian entities and publicly tradeable trusts.

4. The stakes in the entities invested in is to be no more than 5%, and often considerably less.

5. The non-resident entity generally models its investments on a long-term basis.

6. The non-resident entity will derive income from its investments.

7. The non-resident will not be involved in the day to day management of the entities.

8. The non-resident entity will not have any control rights, representation on the board of directors, or any control or influence over the financial and strategic direction of the entities in which it invests.

9. The foreign government can request that the income received by the non-resident entity be distributed to it.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1997 section 4-1

Income Tax Assessment Act 1997 section 840-805

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

Reasons for decision

Detailed reasoning

Unless an exemption or exclusion applies, a non-resident taxpayer that derives Australian sourced income will generally be liable to pay:

• income tax under section 4-1 of the Income Tax Assessment Act 1997 (ITAA 1997)

• withholding tax under section 128B of the Income Tax Assessment Act 1936, or

• withholding tax under section 840-805 of the ITAA 1997 for managed investment trust payments.

While the taxation legislation does 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 wholly-owned and controlled offshore subsidiary of an agency of a foreign state. It is therefore a separate entity of a foreign state, satisfying 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 proposed investments commercial transactions?

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 in publicly listed securities and held on a long-term basis. The investments are stakes of less than 5% in the relevant equities and trusts.

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.

Conclusion

The above factors indicate that the non-resident entity's proposed future portfolio investments will be passive investments, and therefore non-commercial activities.

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 monies that are invested by the non-resident entity are and will remain government monies. The funds used for investment are provided to the non-resident entity by a foreign government, who may request a withdrawal of funds at any time for government purposes.

Conclusion

As the three conditions have been satisfied, the ATO will not impose liability to income tax (including capital gains tax) or withholding tax on the non-resident entity on its interest income, dividend income, trust distributions, managed investment trust distributions and any other income derived from its passive portfolio investments or non-commercial activities within Australia.

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