Edited version of private advice

Authorisation Number: 1051672047901

Date of advice: 6 May 2020

Ruling

Subject: Sovereign immunity

Question 1

Is the ordinary and statutory income derived by Sovereign Fund from its Australian investments not assessable income and not exempt income under section 880-105 of the ITAA 1997?

Answer

Yes.

Question 2

Is any capital gain or loss made by Sovereign Fund with respect to its Australian investments disregarded under sections 880-115 and 880-120 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period

1 July 20xx to 30 June 20xx

The scheme commences on

1 July 20xx

Relevant facts and circumstances

Operations Co

Operations Co was established by the government of the Foreign Country to manage and use national resources in accordance with a consistent national policy, improve the management of national resources, and develop the industry.

In accordance with the Operations Co Charter, the assets of Operations Co and enterprises belonging to it are in the possession of the Foreign Country.

Operations Co is wholly owned by the government of the Foreign Country.

Operations Co exercises ownership and acts as the trader over all Foreign Country's national resources.

Operations Co does not have an Australian tax file number, maintain an office or engage in any trade or business in Australia.

Sovereign Fund

Sovereign Fund was established for the purpose of acting as a sovereign wealth fund for Foreign Country to invest and manage revenues from national resources towards the socio-economic progress of Foreign Country.

Sovereign Fund is accountable to the Head of State of Foreign Country.

Sovereign Fund and its assets are wholly owned by the Foreign Country.

Sovereign Fund is an extra-budgetary, state institution.

Sovereign Fund does not have an Australian tax file number, maintain an office or engage in any trade or business in Australia.

Sovereign Fund does not have customers nor operate accounts, or hold funds, for third parties.

Management and control of Sovereign Fund

Sovereign Fund's assets are utilised in accordance with the main directions approved by the Head of State.

Sovereign Fund's assets may neither be used for lending to government bodies, public and non-public enterprises, nor as collateral for debts or other liabilities of any entity under the Foreign Country.

Sovereign Fund is not in the business of money lending.

Contributions into Sovereign Fund

Sovereign Fund's funding sources include revenues received from national resources.

Sovereign Fund does not enter into agreements to receive revenue on behalf of the Foreign Country's national resources. This is undertaken by Operations Co.

Liquidation of Sovereign Fund

On liquidation of Sovereign Fund, any remaining moneys and/or assets will remain assets of the government of Foreign Country.

Australian Investments

Sovereign Fund has investments in fixed income securities in Australia and shares in Australian companies. It has no other investments in Australia.

Sovereign Fund does not actively trade in financial assets and liabilities, operate commercially in financial markets or provide any of the services listed in paragraph 880-130(2)(c) of the ITAA 1997.

Sovereign Fund's externally managed equity portfolio is rebalanced quarterly.

All Australian dollar (AUD) investments are held through the Custodian.

All income received from the shares held by Sovereign Fund is immediately paid for the benefit of Sovereign Fund via the Custodian.

Each shareholding held by Sovereign Fund in each Australian company is less than 10% of the total shares on issue for each company.

Sovereign Fund is not entitled to and has not appointed a director to the Board of Directors of any of the Australian companies in which it holds shares.

The Australian investments held by Sovereign Fund have the following characteristics:

(a)  The shares are listed on the Australian Securities Exchange (ASX)

(b)  Sovereign Fund and the members of its sovereign entity group hold less than 10% of the total shares on issue of each Australian company

(c)   Sovereign Fund and the members of its sovereign entity group have no involvement in the day to day management of the business of any of the Australian companies

(d)  Sovereign Fund and the members of its sovereign entity group have no right to appoint a director to the Board of Directors of any issuing Australian company

(e)  Sovereign Fund and the members of its sovereign entity group have no right to representation on any investor representative or advisory committee (or similar) of any issuing Australian company

(f)    Sovereign Fund and the members of its sovereign entity group have no ability to direct or influence the operation of the Australian company outside of the ordinary rights conferred by the share interest held, and

(g)  Sovereign Fund and the members of its sovereign entity group only hold rights to vote as shareholders in proportion to their share interest in the Australian company.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 880

Reasons for decision

Question 1

Is the ordinary and statutory income derived by Sovereign Fund from its Australian investments not assessable income and not exempt income under section 880-105 of the ITAA 1997?

Summary

The ordinary and statutory income derived by Sovereign Fund from its Australian investments is not assessable and not exempt income due to the operation of section 880-105 of the ITAA 1997.

Detailed reasoning

All legislative references are to the ITAA 1997 unless stated otherwise.

Section 880-105 provides that amounts of ordinary and statutory income derived by a sovereign entity are not assessable and not exempt income if certain conditions are met. Those conditions are listed in subsection 880-105(1):

(a) the sovereign entity is covered by section 880-125; and

(b) the amount is a return on any of the following kinds of interest that the sovereign entity holds in another entity (the test entity):

(i) a *membership interest;

(ii) a *debt interest;

(iii) a *non-share equity interest; and

(c) the test entity is:

(i) a company that is an Australian resident at the time (the income time) when the amount becomes ordinary or statutory income of the sovereign entity; or

(ii) a *managed investment trust in relation to the income year in which the income time occurs; and

(d) the *sovereign entity group of which the sovereign entity is a member satisfies the portfolio interest test in subsection (4) in relation to the test entity:

(i) at the income time; and

(ii) throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time; and

(e) the sovereign entity group of which the sovereign entity is a member does not have influence of a kind described in subsection (6) in relation to the test entity at the income time.

These conditions are considered below.

Sovereign Fund is a covered sovereign entity

Section 880-125 states:

A *sovereign entity is covered by this section if it satisfies all of the following requirements:

(a) the entity is funded solely by public monies;

(b) all returns on the entity's investments are public monies;

(c) the entity is not a partnership;

(d) the entity is not any of the following:

(i) a *public non-financial entity;

(ii) a *public financial entity (other than a public financial entity that only carries on central banking activities).

These conditions are considered below.

Sovereign Fund is a sovereign entity

For an entity to be covered by section 880-125, it must be a sovereign entity. Section 880-15 defines a sovereign entity to be any of the following:

(a) a body politic of a foreign country, or a part of a foreign country;

(b) a *foreign government agency;

(c) an entity:

(i) in which an entity covered by paragraph (a) or (b) holds a *total participation interest of 100%; and

(ii) that is not an Australian resident; and

(iii) that is not a resident trust estate for the purposes of Division 6 of Part III of the Income Tax Assessment Act 1936.

A 'foreign government agency' is defined in subsection 995-1(1) of the ITAA 1997 as:

(a) the government of a foreign country or of part of a foreign country; or

(b) an authority of the government of a foreign country; or

(c) an authority of the government of part of a foreign country.

Based upon the Facts, Sovereign Fund meets the requirements of being a sovereign entity in accordance with section 880-15 as it is a foreign government agency as defined in subsection 995-1(1).

Therefore, this requirement is satisfied.

Sovereign Fund is funded solely by public monies

The phrase 'public monies' is not defined and as such takes its ordinary meaning. In the context of Division 880, this phrase essentially means monies raised by a foreign government (or part of a foreign government) for a public purpose which form part of the foreign government's (or part of the foreign government's) equivalent to Australia's Consolidated Revenue Fund (Roy Morgan Research Pty Ltd v FC of T & Anor [2011] HCA 35). This would ordinarily include general tax revenue, proceeds from the issue of government bonds, the proceeds of privatisations etc.

Sovereign Fund was established for the purpose of acting as a sovereign wealth fund for Foreign Country to invest and manage revenues from national resources towards the socio-economic progress of Foreign Country. Operations Co implements the collection of fees and revenues generated from national resources and Sovereign Fund receives capital contributions from Operations Co that represents revenue derived from national resources which are wholly owned by the Foreign Country.

Therefore, Sovereign Fund is funded by public monies attributable to the government of the Foreign Country.

As such, Sovereign Fund is funded solely by public monies.

All returns on Sovereign Fund's investments are public monies

Sovereign Fund and its assets are wholly owned by the Foreign Country. As such, the government is the beneficial owner of all the capital invested, and all income derived from that capital by Sovereign Fund. Surplus income derived by Sovereign Fund is available for use by the government.

Utilisation of Sovereign Fund's assets, including returns on Australian investments, shall be carried out in accordance with the directions of the Head of State.

Sovereign Fund's assets may neither be used for lending to government bodies, public and non-public enterprises, as collateral for debts or other liabilities of any entity. Upon liquidation all assets of Sovereign Fund will be returned to the government of Foreign Country.

Therefore, all returns on Sovereign Fund's investments are public monies and will remain assets of the government.

Accordingly, this condition is satisfied.

Sovereign Fund is not a partnership

In accordance with the Statute, Sovereign Fund is an extra-budgetary, state institution. Sovereign Fund is a legal entity, wholly owned by the Foreign Country and therefore is, not a partnership.

Therefore, this condition is satisfied.

Sovereign Fund is not a public non-financial entity or public financial entity

Subsection 880-130(1) of ITAA 1997 defines the term public non-financial entity:

An entity is a public non-financial entity if its principal activity is either or both of the following:

(a) producing or trading non-financial goods;

(b) providing services that are not financial services.

Subsection 880-130(2) defines the term public financial entity:

An entity is a public financial entity if any of the following requirements are satisfied:

(a) it trades in financial assets and liabilities;

(b) it operates commercially in the financial markets;

(c) its principal activities include providing any of the following financial services:

(i) financial intermediary services, including deposit-taking and insurance services;

(ii) financial auxiliary services, including brokerage, foreign exchange and investment management services;

(iii) capital financial institution services, including financial services in relation to assets or liabilities that are not available on open financial markets.

Public non-financial entities include entities such as airline corporations, postal authorities, state water corporations and port authorities. They also include public non-profit institutions engaging in market production (such as hospitals, schools, or colleges) if they are separate institutional units and charge economically significant prices.

Sovereign Fund was established for the purpose of acting as a sovereign wealth fund. Sovereign Fund was established to accumulate and effectively manage national resource revenues and foreign currency assets for the benefit of socio-economic progress of the Foreign Country. Therefore, the principal activity of Sovereign Fund for the purposes of subsection 880-130(1) is to invest and manage funds in a manner benefiting Foreign Country.

Sovereign Fund does not produce or trade non-financial goods and does not provide non-financial services. Operations Co exercises ownership over all national resources. Operations Co is wholly owned by the Foreign Country and enters into agreements on behalf of the Foreign Country. Operations Co transfers revenues received and fees collected from national resources to Sovereign Fund, as capital contributions. Therefore, Sovereign Fund is not in the business of producing or trading non-financial goods and/or providing non-financial services.

Sovereign Fund does not actively trade in financial assets and liabilities, operate commercially in financial markets or provide any of the services listed in paragraph 880-130(2)(c). Therefore, Sovereign Fund is not a public financial entity, nor a public non-financial entity and passes the condition in 880-125(d).

As Sovereign Fund satisfies each of the requirements in paragraphs 880-125(a) through (d) it is considered a sovereign entity that is covered by section 880-125 for the purposes of paragraph 880-105(1)(a).

Sovereign Fund's return is received on a relevant interest in the test entities

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(b), it must be a 'return on' a membership interest, debt interest or non-share equity interest held by the sovereign entity in the test entities.

As detailed in paragraph 4.37 of the Explanatory Memorandum to the Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Act 2019 ('the EM'), a 'return on' a membership interest for the purposes of paragraph 880-105(1)(b) will include:

1. dividends - including non-share dividends and dividends that pass through a managed investment trust (MIT)
2. interest - including interest that passes through a MIT
3. fund payments made by a MIT (other than fund payments that are attributable to non-concessional MIT income), and
4. revenue gains made on the disposal of an interest in the test entity - including revenue gains that pass through a MIT.

The test entities in this regard are Australian resident companies listed on the ASX.

Sovereign Fund's investments are held through the Custodian and all income is immediately paid to Sovereign Fund via the Custodian.

Sovereign Fund's investments in the test entities are represented through shareholdings (which meet the requirements of being a membership interest as defined by the interaction of sections 960-135 and 960-130 of the ITAA 1997) and Sovereign Fund receives dividend payments and proceeds from any disposals of such shares.

Therefore, Sovereign Fund will receive amounts which satisfy the requirements of paragraph 880-105(1)(b).

Sovereign Fund's income is received from Australian resident companies or managed investment trusts

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(c), it must be received from an entity that is either:

(i) a company that is an Australian resident at the time (the income time) when the amount becomes ordinary or statutory income of the sovereign entity; or

(ii) a *managed investment trust in relation to the income year in which the income time occurs.

The test entities are Australian resident companies for Australian income tax purposes. It is expected that the test entities will continue to be Australian residents at the time the ordinary and statutory income is derived by Sovereign Fund.

As such, Sovereign Fund's income is received from entities that satisfy the requirements of paragraph 880-105(1)(c).

Sovereign Fund sovereign entity group satisfies the portfolio interest test

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(d), the sovereign entity and the sovereign entity group to which it belongs must satisfy the portfolio interest test in relation to the test entity/ies at both the income time and throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time.

The portfolio interest test is outlined in subsection 880-105(4) of the ITAA 1997, which states:

A *sovereign entity group satisfies the portfolio interest test in this subsection in relation to the test entity at a time if, at that time, the sum of the *total participation interests that each *member of the group holds in the test entity:

(a)  is less than 10%; and

(b)  would be less than 10% if, in working out the *direct participation interest that any entity holds in a company:

(i) an *equity holder were treated as a shareholder; and

(ii) the total amount contributed to the company in respect of *non-share equity interests were included in the total paid-up share capital of the company.

Section 880-20 provides the definition of sovereign entity group. Broadly, sovereign entities of the same foreign government will be members of the same sovereign entity group and sovereign entities of the same part of a foreign government will be members of the same sovereign entity group.

The Foreign Country invests in Australia through Sovereign Fund. The sovereign entity group to which Sovereign Fund belongs collectively hold less than 10% of the total shares on issue of each of the test entities. Sovereign Fund's interest and, therefore, the collective interest held in the test entities of its sovereign entity group, is less than 10%.

Sovereign Fund and its sovereign entity group collectively held less than 10% interest in the test entities at both the income time and throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time.

Therefore, Sovereign Fund's interest in the test entities satisfies the requirements of paragraph 880-105(1)(d).

Sovereign Fund's sovereign entity group does not have influence of a kind described in subsection (6)

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(e), at the income time the sovereign entity group to which the sovereign entity belongs must not have influence over the test entity of a kind described in subsection 880-105(6) of the ITAA 1997.

Subsection 880-105(6) states:

A *sovereign entity group has influence of a kind described in this subsection in relation to the test entity at a time if any of the following requirements are satisfied at that time:

(a) a *member of the group:

(i) is directly or indirectly able to determine; or

(ii) in acting in concert with others, is directly or indirectly able to determine;

the identity of at least one of the persons who, individually or together with others, make (or might reasonably be expected to make) the decisions that comprise the control and direction of the test entity's operations;

(b) at least one of those persons is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of a member of the group (whether those directions, instructions or wishes are expressed directly or indirectly, or through the member acting in concert with others).

There are two distinct sub-tests within the influence test.

Sub-test 1 of the influence test, (as contained in paragraph 880-105(6)(a)), assesses whether the sovereign entity group is able to determine the identity of at least one of the persons who, individually or together with others, makes or is reasonably expected to make, decisions comprising the control and direction of the test entity's operations. This includes situations where the sovereign entity group is able to act in concert with others to determine the identity of a relevant decision-maker in the test entities.

Sub-test 1 also extends to situations where the sovereign entity group, in its own right, holds the ability to approve or veto decisions which go to the control or direction of the test entity.

Sovereign Fund's sovereign entity group collectively hold less than 10% interest in the entities. Sovereign Fund, nor any member of its sovereign entity group, does not hold rights to appoint a director to the Board of Directors nor the right to representation on any investor representative or advisory committee (or similar) of any entities.

Sovereign Fund's interest of less than 10% does not provide it with an entitlement to either directly or indirectly determine the identity of any person who makes decisions that comprise the control and direction of the test entities' operations.

In addition, Sovereign Fund's interest holding does not provide Sovereign Fund or the sovereign entity group with the right to approve or veto decisions which contribute to the control or direction of the test entity.

Sub-test 2 of the influence test, (as contained in paragraph 880-105(6)(b)), assesses whether at least one of the relevant decision-making persons of the test entity is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of the sovereign entity group.

Sovereign Fund, nor any member of its sovereign entity group, does not have any involvement in the day to day management of the business of any of the entities. Sovereign Fund nor any member of its sovereign entity group, are not able to appoint a director to the Board of Directors nor hold the right to representation on any investor representative or advisory committee (or similar) of any of the entities.

Sovereign Fund, nor any member of its sovereign entity group, does not have the ability to exert actual or potential influence over the operations or investments of the test entities outside of the ordinary rights conferred by the share interest held. Sovereign Fund only holds rights to vote as a shareholder in proportion to its share interest in the test entities.

Therefore, no person involved in the control and direction of the test entities' operations are accustomed or obliged to act in accordance with the directions, instructions or wishes of Sovereign Fund or any member of its sovereign entity group.

Based on the above, the sovereign entity group of Sovereign Fund does not have influence of a kind described in subsection 880-105(6). Therefore, Sovereign Fund satisfies the requirements of paragraph 880-105(1)(e).

Conclusion

As all of the conditions listed in subsection 880-105(1) have been satisfied, section 880-105 will apply such that amounts of ordinary and statutory income derived by Sovereign Fund from its investments in the test entities are not assessable and not exempt income.

Question 2

Is any capital gain or loss made by Sovereign Fund with respect to its Australian investments disregarded under sections 880-115 and 880-120 of the ITAA 1997?

Detailed Reasoning

Section 880-115 of the ITAA 1997 provides that a sovereign entity disregards a capital gain from a CGT event that happens in relation to a CGT asset if:

(a) the sovereign entity is covered by section 880-125; and

(b) the CGT asset is a membership interest, non-share equity interest or debt interest in another entity; and

(c) the requirements in paragraphs 880-105(1)(c), (d) and (e) would be satisfied, on the assumptions that:

(i) the capital gain were an amount of ordinary income or statutory income; and

(ii) the amount mentioned in subparagraph (i) became ordinary income or statutory income of the sovereign entity immediately before the time the CGT event happened; and

(iii) references in those paragraphs to the test entity were references to the other entity mentioned in paragraph (b) of this section.

Section 880-120 of the ITAA 1997 provides that a sovereign entity disregards a capital loss from a CGT event if, on the assumption that the loss were a capital gain, the capital gain would be disregarded because of section 880-115.

As established in Question 1, Sovereign Fund:

(a)      is covered by section 880-125

(b)       holds membership interests in the entities, and

(c)       satisfies the requirements in paragraphs 880-105(1)(c), (d) and (e) in relation to ordinary or statutory income that it will derive from the test entities.

As such, Sovereign Fund will be required to disregard any capital gain or loss made in respect of its ownership interests in the test entities, being the Australian, by virtue of the operation of sections 880-115 and 880-120 respectively.

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