Edited version of your written advice

Authorisation Number: 1013030147233

Date of advice: 15 June 2016

Ruling

Subject: Sovereign Immunity

Question 1

Is the non-resident entity exempt from liability to income tax and withholding tax on interest income derived from its proposed investment in up to 15.5% of the units in an unregistered managed investment scheme (MIS) under a double tax agreement?

Answer

Yes.

Question 2

Will the non-resident entity be immune from income tax and withholding tax on any ordinary income or statutory income derived from its proposed investment in up to 15.5% of the units in the MIS, under the common law doctrine of sovereign immunity?

Answer

Yes.

This ruling applies for the following periods:

1 July 2016 to 30 June 2021

The scheme commences on:

1 July 2016

Relevant facts and circumstances

Non-resident entity

1. The non-resident entity was established and capitalised by a foreign government.

2. The non-resident entity is in a country that has a double tax agreement (DTA) with Australia.

3. Any contracts or agreements entered into by the non-resident entity are binding on the foreign government.

4. The non-resident entity's purpose is to invest funds for the purpose of funding a social security pension scheme.

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

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

7. The non-resident entity's investments, assets, and all income and gains derived from them are beneficially owned by the government.

The MIS

8. The MIS is an unregistered managed investment scheme structured as a unit trust.

9. The trustee of MIS employs a manager to operate the day to day business of the MIS and to manage the assets of the MIS on its behalf.

10. The MIS has an investor advisory board. Any decision which is or relates to a reserved matter must be put before the investor advisory board. The trustee cannot take action regarding a reserved matter if the decision is rejected by the investor advisory board. A decision made by the investor advisory board must be made by a majority vote of advisory board members.

11. Reserved matters include:

a. Changes in the nature and scope of the business of the MIS

b. Approving the MIS business plan and annual budgets

c. Material amendments to the business plan and annual budgets

d. Large acquisitions and disposals by the MIS

e. Incurring indebtedness greater than AUD $5 million

f. Changes to the Management Agreement between the trustee and the manager, and

g. Changes to accounting and tax policies.

12. The investor advisory board may have up to 10 members. For every 10% unitholding that an investor holds in the MIS, it is entitled to appoint one representative to the investor advisory board. Investors may also aggregate their interests with other investors to form a 10% unitholding and jointly appoint a representative to the investor advisory board.

13. The MIS may also put matters to its members. Members can vote on resolutions relating to governance according to the MIS Constitution, including:

a. MIS can be wound up as a result of a unanimous vote by members, and

b. The members may by majority vote remove or replace the trustee.

14. The non-resident entity holds an indirect holding in the MIS of X%.

15. A related party to the non-resident entity has a Y% indirect interest in the MIS.

16. The non-resident entity proposes to acquire up to 15.5% of the units in the MIS.

17. Through its proposed holding of 15.5% of the units in the MIS, the non-resident entity will also hold 15.5% of the voting rights at member meetings.

18. The non-resident entity will not:

a. appoint a representative to the investor advisory board,

b. aggregate its interest with another investor to assist another investor in attaining the right to a representative on the investor advisory board,

c. assign its right to appoint a representative to the investor advisory board to another party or

d. otherwise participate in any form on the investor advisory board.

19. The non-resident entity will not have any involvement in the day to day management of the MIS.

20. The non-resident entity will derive trust distributions from MIS, made up of ordinary and statutory income as well as capital gains. The non-resident entity may also in the future receive capital gains from the disposal of its units in the MIS.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1997 section 4-1

Income Tax Assessment Act 1997 section 995-1

International Tax Agreements Act 1953 section 3AAA

International Tax Agreements Act 1953 section 4

Double Tax Agreement

Reasons for decision

Question 1

Summary

The non-resident entity is exempt from liability to withholding and income taxes on interest income derived from its investment in the MIS.

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 Income Tax Assessment Act 1936 (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 double 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 as part of its interest in the MIS.

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

The non-resident entity is a part of the government of a foreign state as:

• it was established by, is funded by, and is part of the foreign government with whom Australia has a tax agreement

• any contracts or agreements the non-resident entity enters are binding on the state

• its board of directors, chairman, and deputy chairman are all appointed by the foreign government

• it is evaluated and audited by the foreign government and the auditors it appoints, and

• its assets are all beneficially owned by the foreign government.

As the non-resident entity satisfies this condition, it is exempt from liability to withholding and income taxes on interest income derived from its investment in the MIS.

Question 2

Summary

The non-resident entity is immune from income tax and withholding tax on any ordinary income or statutory income derived from its investment in the MIS under the common law doctrine of sovereign immunity.

Detailed reasoning

Sovereign Immunity

For Australian income tax and withholding tax purposes it is accepted that the doctrine of sovereign immunity applies to a foreign government or an agency of a foreign government that engages in governmental functions. 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.

In determining whether the doctrine of sovereign immunity applies to Australian income tax and/or withholding tax, it is necessary to establish the following:

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

2. that the moneys invested are and will remain government moneys, and

3. that the income or gain is being derived from a non-commercial activity.

If these three conditions are satisfied, then the income or gains will not be subject to Australian income tax and/or withholding tax.

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

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

For the reasons outlined in the answer to question 1 above, the non-resident entity is a part of a foreign government satisfying this requirement.

Condition 2: The monies invested 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.

Are the contributions received by the non-resident entity government monies?

The non-resident entity was established by, and received its initial capital from, a foreign government. It receives all of its funds for investment from the foreign government. The money is invested by the non-resident entity, and called upon by the foreign government when it needs to exercise governmental functions, including funding the social security pension scheme.

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

Condition 3: Non-commercial transaction

Whether an operation or activity is a commercial transaction will depend on the facts of each case. As a guide, a commercial transaction is generally considered to be an activity concerned with the trading of goods and services, such as buying, selling, bartering, transportation, and includes the carrying on of a business.

In relation to the ownership of shares in a company or other similar equity interests, there would be instances where the extent of the holding gives rise to questions as to whether the interests constitute a passive investment or a commercial investment. A determination of commerciality will depend on the particular circumstances.

Importantly, consideration will be given to factors relating to the influence and control that is exercised by the investor in relation to the acquired company or similar equity investment, particularly in relation to its influence on day to day management and key business, strategy and financial decisions.

Is the non-resident entity's proposed investment in the MIS a commercial transaction?

The non-resident entity proposes to hold up to 15.5% of the units in the MIS. The factors relevant to determining whether this investment by the non-resident entity is reflective of a commercial transaction are as follows;

• The non-resident entity has no influence on the day to day management of the MIS.

• The non-resident entity will have no representative on the investor advisory board of MIS, and as such will take no part in decisions relating to the reserved matters. The non-resident entity by virtue of its unit holding does have the right to appoint a member to the advisory board, or aggregate its interest with other unitholders to appoint a member to the advisory board, but will not exercise this right. The non-resident entity will also not assign its right to appoint a member to the advisory board of the MIS to another investor.

• The non-resident entity holds 15.5% of the units, and by extension, 15.5% of the voting rights in the MIS. Member resolutions relate primarily to issues of governance and investor protection rather than business management, such as the winding up of the MIS and the replacement of the MIS's trustee. The presence of a dominant investor with a 50.1% holding also means that this investor can solely decide member resolutions requiring a majority vote.

• The non-resident entity's insignificant indirect interest in the MIS via another entity does not further taint the direct interest in the MIS.

Together, the above factors indicate that the non-resident entity's investment into the MIS is a passive holding, and therefore non-commercial transaction, satisfying this condition.

Conclusion

As the three conditions have been satisfied, the non-resident entity is immune from income tax and withholding tax on income derived from its investment into the MIS under the common law doctrine of sovereign immunity.

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