Edited version of your written advice

Authorisation Number: 1013066129098

Date of advice: 23 August 2016

Ruling

Subject: Sovereign Immunity

Question 1

Is the entity immune from income tax or withholding tax on any interest and capital gains income derived from its investments into:

a. Australian and state government bonds

b. Australian and state government agency bonds, and

c. Supranational bonds

under the common law doctrine of sovereign immunity?

Answer

Yes.

This ruling applies for the following periods:

Year ended 31 December 2016

Year ended 31 December 2017

Year ended 31 December 2018

Year ended 31 December 2019

Year ended 31 December 2020

Year ended 31 December 2021

The scheme commenced on:

January 20YY

Relevant facts and circumstances

1. The non-resident entity is the central bank of a foreign state and is created and governed by statute.

2. The non-resident entity's principal mission is to determine and direct the monetary policy aimed at maintaining price stability in order to facilitate economic development within the framework of the nation's economic and financial policy.

3. The non-resident entity has a number of functions including:

a. Determining monetary policy objectives in consultation with the government

b. To formulate, implement and monitor monetary and exchange policies aimed at the determined objectives

c. To conduct regular economic and monetary analysis, make public the results, and submit proposals and measures to the government

d. To license, delicense, regulate, and supervise banks and financial institutions

e. To oversee payments systems in the state, and to enhance interbank payments

f. To act as the sole issuer of the national currency

g. To undertake and perform, in the name of the state, transactions resulting from the participation of the state in public international institutions in the banking, credit and monetary spheres

h. To establish the balance of payments

i. To participate in the management of external debt and claims

j. To participate in the formation and supervision of the money and financial markets

k. To license, delicense, regulate and supervise all those operating in the securities and foreign exchange markets, the market for precious stones and precious metals

l. To set interest rates, and

m. Manage and maintain the state's international reserves.

4. The non-resident entity is the banker for the government, government agencies, domestic banks, foreign central banks, and public international financial institutions.

5. The non-resident entity acts as the agent for the foreign government when marketing securities issued by these entities.

6. The non-resident entity reports to the foreign government regularly on the economic and financial condition of the state, and on the performance of the non-resident entity.

7. The non-resident entity is managed by a Board of Directors, chaired by the Governor.

8. The non-resident entity's Governor and Deputy Governor are appointed, replaced, and dismissed by a royal decree on the government's recommendation. All other members of the Board of Directors are appointed, replaced, and dismissed by sub decree.

9. All of the capital of the non-resident entity is subscribed for and held exclusively by the government and is not transferable or subject to encumbrance.

10. The balance of net income of the non-resident entity is transferred to the state budget after various deductions.

11. The assets, property, income operations and transactions of the non-resident entity is exempt from all duties and taxes.

Proposed investments to be held by the non-resident entity

12. The non-resident entity, as part of managing its foreign reserves holds a number of low volatility debt instruments. It invests in and is limited to investing in the following types of instruments:

a. Australian and state government bonds

b. Australian and state government agency bonds, and

c. Supranational bonds.

13. The non-resident entity manages the foreign reserves conservatively in order to ensure that the state is able to cover any foreign currency net imbalances, maintain confidence in its monetary and exchange policies, and protect the economic well-being of the state in the event of national disaster or external events.

14. The current value of the non-resident entity's investments in Australia or Australian currency total xxxx million.

15. The non-resident entity derives interest and capital gains from these investments.

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

Reasons for decision

Detailed reasoning

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 exempt Australian sourced income and gains from 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: that the person making the investment (and therefore deriving the income) is a foreign government or agency of a foreign government

The non-resident entity is a central bank. Its ownership, purpose, functions, governance and global status are consistent with being an agency of a foreign government.

All of the non-resident entity's capital is subscribed for and held exclusively by the foreign government and is not transferable or subject to encumbrance. The balance of net income of the non-resident entity is also transferred to the state budget. The non-resident entity is effectively owned by the foreign government as it has all rights to the non-resident entity's capital and income. Further, where the non-resident entity's assets on its balance sheet falls below the sum of its liabilities, the foreign government transfers its government securities to the non-resident entity to remedy the deficiency. In that respect, the non-resident entity is effectively guaranteed or indemnified by the foreign government.

The non-resident entity's purpose and functions are consistent with a foreign agency executing governmental functions and responsibilities. Its primary purpose is to, in consultation with the foreign government, determine, develop, implement and evaluate monetary policy objectives in order to facilitate economic development. This includes setting interest rates, maintaining the international reserves, and issuing currency. One of its other functions is as a regulatory body for the banking, financial, and securities sectors of the state, a clear governing role. Finally, the non-resident entity is the sole banker of the foreign government and its agencies.

The non-resident entity's governance is also consistent with it being considered an agency of a foreign government. It is an autonomous public entity created by statute. Its leadership, including the Governor and Deputy Governor, are appointed, replaced and dismissed by royal decree on the recommendation of the foreign government. Its Board of Directors consists of representatives from the government. The non-resident entity is directly accountable to and is supervised by the foreign government. It is required to regularly report to the foreign government on its performance, its annual budget, the nation's economic and financial policy, and the implementation of monetary and exchange policies.

Finally, the non-resident entity's global standing is consistent with that of a government agency. The non-resident entity, as the Central Bank, opens accounts on behalf of other foreign central banks and public international financial institutions. It deals directly with these international agencies, and acts as the foreign government's agent for the marketing of securities issued by the foreign government and its agencies.

Together, these factors explain why the non-resident entity is considered a foreign government agency, and satisfies the first requirement of the doctrine of sovereign immunity.

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 are and will remain government monies.

The monies being invested by the non-resident entity are considered to be government monies. The monies invested are from a mix of sources including government deposits, government agency deposits, accumulation of reserve monies from previous years, and deposits made by commercial banks to the non-resident entity in its role as the regulatory body of the banking and financial sector in the state.

The monies being invested by the non-resident entity will also remain government monies. The non-resident entity will use the income generated from this investment to manage and maintain the reserves, and pay its operating expenses.

Any remaining net income is then transferred to the state budget for government spending. The foreign government is the final beneficiary of the income generated by the non-resident entity.

Condition 3: Non-commercial transaction

Income derived by a foreign government or by any other body exercising governmental functions from interest bearing investments or investments in equities is generally not considered to be income derived from a commercial operation or activity.

For foreign government bodies deriving income from interest bearing investments, the nature of the activities may be such as to constitute a money-lending business and thus a commercial activity.

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

The non-resident entity currently invests in Australian government and government agency bonds, as well as some supranational bonds. The non-resident entity only derives interest income and capital gains from these investments.

The factors relevant to determining whether these proposed investments are reflective of a commercial transaction are as follows:

• The investments are to be held for the medium to long term primarily to derive interest income and capital gains.

• The investments into debt instruments are held as part of managing the state's foreign reserves rather than any business of money-lending. The non-resident entity manages the foreign reserves conservatively in order to ensure that the state is able to cover any foreign currency net imbalances, maintain confidence in its monetary and exchange policies, and protect the economic well-being of the country in the event of national disaster or external events.

• The investments are all in government bonds, government agency bonds, and supranational bonds. There are no interests in commercial ventures or entities.

The above factors indicate that the non-resident entity's current and future investments into debt instruments will be passive investments, and therefore non-commercial activities, satisfying this condition.

Conclusion

As the three conditions have been satisfied, the non-resident entity will be immune from income tax or withholding tax with respect to interest income and capital gains derived from its investments into debt instruments under the common law doctrine of sovereign immunity.

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