| Disclaimer This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law. You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4. |
Edited version of your written advice
Authorisation Number: 1012826144436
Date of advice: 19 June 2015
Ruling
Subject: Sovereign Immunity
Question
Will the Australian Taxation Office (ATO) impose liability to income tax (including capital gains tax) or withholding tax on the non-resident entity on dividend income, interest income, trust income, capital gains, and other income derived from its portfolio investments?
Answer
No.
This ruling applies for the following periods:
Year ended 30 June 2015
Year ended 30 June 2016
Year ended 30 June 2017
Year ended 30 June 2018
Year ended 30 June 2019
The scheme commenced on:
The scheme has commenced
Relevant facts and circumstances
1. The non-resident entity is the legal personification of a foreign state.
2. The non-resident entity invests funds from its resident state's consolidated revenue fund.
3. The non-resident entity invests funds for the purposes of funding governmental functions.
4. The non-resident entity proposes to invest in infrastructure funds.
5. The stakes in the infrastructure funds are to be no more than 3% of the units.
6. The non-resident entity will derive trust, dividend, interest and other income from its investments, and gains from disposal of the investments.
7. The non-resident entity will have no participation in the management of the entities in which it invests. It will have no presence on the Board or any other overseeing committee, and will not be involved in any capacity in the day to day management of the entities.
Relevant legislative provisions
Income Tax Assessment Act 1936 section 128B
Income Tax Assessment Act 1997 section 4-1
Reasons for decision
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 dividend income, interest income, trust income, capital gains, and other income derived from its portfolio investments?
Detailed reasoning
Non-resident taxpayers will generally be liable to pay income tax under section 4-1 of the Income Tax Assessment Act 1997 (ITAA 1997) or withholding tax under section 128B of the ITAA 1936 on Australian-sourced income, unless an exemption or exclusion applies.
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 ATO follows the principles delineated in the Immunities Act which represents Australia's restrictive approach when considering sovereign immunity claims to 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 monies being invested in the scheme are and will remain government monies, and
3. the scheme to which the claim applies must not be a commercial transaction.
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?
As the legal personification of the state, the non-resident entity is a foreign state, satisfying this condition.
Condition 2: 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 invests monies from its resident state's consolidated fund, and the income derived from those investments is returned to the consolidated fund. These monies are used to fund governmental functions. The monies, and income derived from the monies are therefore government monies that remain government monies, satisfying this condition.
Condition 3: 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.
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.
Are the non-resident entity's investments commercial transactions?
ATO Interpretative Decision ATOID 2002/45 - Sovereign Immunity 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. Although the Commissioner only refers to shares in a company, this view is considered equally applicable to units in a trust.
Regardless of size, whether a holding in an entity represents a commercial activity depends on the particular circumstances of the investment.
The factors relevant to determining whether the non-resident entity's investment is a commercial transaction are as follows:
• the non-resident entity's investment into the infrastructure funds will not exceed 3% of the equity in each of those entities, making the investments only small portfolio holdings.
• The non-resident entity will have no participation in the management of the infrastructure funds. It will have no presence on the Board or any other overseeing committee, and will not be involved in any capacity in the day to day management of these entities.
• The non-resident entity will only have the rights of an ordinary unit holder.
The above factors indicate that the non-resident entity's proposed portfolio investments will be passive investments, and therefore non-commercial activities, satisfying this condition.
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, and any other income derived from its portfolio investments in the entities.
Copyright notice
© Australian Taxation Office for the Commonwealth of Australia
You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).
