Edited version of private advice

Authorisation Number: 1051748199874

Date of advice: 3 September 2020

Ruling

Subject: Sovereign immunity

Question 1

Is the ordinary and statutory income derived by Entity A, Entity B and Entity C from their investment in Entity D not assessable and not exempt income under section 880-105 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will any capital gain arising to Entity A, Entity B and Entity C in respect of their investment in Entity D, be disregarded pursuant to section 880-115 of the ITAA 1997?

Answer

Yes.

Question 3

Does paragraph 128B(3)(n) of the Income Tax Assessment Act 1936 (ITAA 1936) apply to exclude Entity A, Entity B and Entity C from liability to withholding tax on income that is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997?

Answer

Yes.

Question 4

Does subsection 840-805(9) of the ITAA 1997 apply to exclude Entity A, Entity B and Entity C from liability to withholding tax on income that is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period(s)

1 July 20XX to 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

Entity E

Entity E is recognised under law as a government authority of Country A.

Entity E is a resident in Country A for income tax purposes and is not subject to income tax.

Entity E has the power to and has established a number of entities that will hold investments.

Entity E is managed by its own Board, consisting of a Chairman, a Deputy Chairman and a number of Members.

No personal monies of any individual have been contributed to Entity E.

The income generated by Entity E on the investment of the reserve funds is re-invested by Entity E or distributed to the Government of Country A.

No distributions of income or gains from Entity E have been made or can be made to any person other than Country A.

Entity E's wholly owned entities relevant to its investments

Entity A

Entity A is a wholly owned subsidiary of Entity E. As the sole shareholder, Entity E controls 100% of the voting rights of Entity A.

Entity A is a special purpose vehicle established by Entity E and holds an investment in Entity D, as well as several other investments.

Entity A is not a tax resident in Australia and does not maintain an office in Australia or engage in any trade or business in Australia.

Entity B

Entity B is a wholly-owned subsidiary of Entity. As the sole shareholder, Entity E controls 100% of the voting rights of Entity B.

Entity B is a special purpose vehicle established by Entity E and holds an investment in Entity D, as well as several other investments.

Entity B is not a tax resident in Australia and does not maintain an office in Australia or engage in any trade or business in Australia.

Entity C

Entity C is a wholly-owned subsidiary of Entity E. As the sole shareholder, Entity E controls 100% of the voting rights of Entity C.

Entity C is a special purpose vehicle established by Entity E which holds an investment in Entity E, as well as several other investments.

Entity C is not a tax resident in Australia and does not maintain an office in Australia or engage in any trade or business in Australia.

Entity D

Entity D is an open-ended Australian unit trust that is a registered managed investment scheme and is also a managed investment trust (MIT) for Australian tax purposes.

Entity C seeks to provide returns through long-term ownership, development and repositioning of quality, diversified and sustainable assets.

The Entity C is allowed to hold securities in a company or trust if that company or trust invests in property.

The Trustee of the Entity C holds all legal title to its investment properties and is responsible for leasing and maintaining them.

Entity D Investments in Australia

Entity A, Entity B and Entity C are expected to receive the following returns from their Entity D investments:

·         MIT fund payments

·         Capital gains

·         Returns of capital

Based on the nature of the investment it is possible that Entity A, Entity B and Entity C could earn interest and dividend income but this is unlikely. Non-concessional MIT is also not expected to be derived.

In relation to Entity A, Entity B and Entity C's investments in the Entity D:

a.    Entity A, Entity B and Entity C have no involvement in the day to day management of the business of Entity D,

b.    Entity A, Entity B and Entity C have no right to appoint a director to the Board of Directors of Entity D,

c.     Entity A, Entity B and Entity C have no right to appoint a member on the Entity D,

d.    Entity A, Entity B and Entity C have no right to representation on any investor representative or advisory committee (or similar) of Entity D,

e.    Entity A, Entity B and Entity C has no ability to direct or influence the operation of Entity D outside of the ordinary rights conferred by the unit interests held, and

f.      Entity A, Entity B and Entity C only hold rights to vote as a unitholder in proportion to its interest in Entity D.

Relevant legislative provisions

Income Tax Assessment Act 1936 paragraph 128B(3)(n)

Income Tax Assessment Act 1997 section 880-105

Income Tax Assessment Act 1997 section 880-115

Income Tax Assessment Act 1997 subsection 840-805(9)

Reasons for decision

Question 1

Is the ordinary and statutory income derived by Entity A, Entity B and Entity C from its investment in Entity D, not assessable and not exempt income under section 880-105 of the ITAA 1997?

Summary

Ordinary and statutory income derived by Entity A, Entity B and Entity C as a return on the investments from Entity D 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 of the ITAA 1997 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) of the ITAA 1997:

(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.

Entity A, Entity B and Entity C are covered sovereign entities

Section 880-125 of the ITAA 1997 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.

Entity A, Entity B and Entity C are sovereign entities

For an entity to be covered by section 880-125 of the ITAA 1997, it must be a sovereign entity. Section 880-15 of the ITAA 1997 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.

Entity E is recognised under law as a government authority and has its own legal personality and an independent budget.

Entity E is operated in accordance with the annual general policies and budget. Entity E is managed by its own Board which consists of members appointed Country A.

Entity E has the power to establish subsidiaries that can hold its investments. In this case, Entity E has created, wholly owns and controls Entity A, Entity B and Entity C.

Based on the above facts, Entity R, Entity A, Entity B and Entity C are foreign government agencies as defined in subsection 995-1(1) of the ITAA 1997 and are therefore sovereign entities under paragraph 880-15(b) of the ITAA 1997.

Therefore this requirement is satisfied.

Entity A, Entity B and Entity C are 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 of the ITAA 1997, this phrase means monies raised by a foreign government (or part of a foreign government) for a public purpose which forms 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 and the proceeds of privatisations.

Entity A, Entity B and Entity C are wholly owned and funded by Entity E. Entity E, as noted above, is a sovereign entity and is a foreign government agency. Entity E's main purpose is to invest the funds of Country A assigned to it. Entity E has invested part of these funds in Entity D through its holding companies Entity A, Entity B and Entity C.

Entity A, Entity B and Entity C are therefore funded solely by public monies.

All returns on Entity A, Entity B and Entity C's investments are public monies

As Entity A, Entity B and Entity C are wholly owned by Entity E, all returns from Entity D investment are returned to Entity E. In accordance with the law, the funds once returned to Entity E can only be reinvested by Entity E or returned to the Government.

Therefore, all returns on Entity A, Entity B and Entity C's investments are public monies.

Entity A, Entity B and Entity C are not in a partnership

Entity A, Entity B and Entity C are wholly owned subsidiaries of Entity E and Entity E is a statutory created entity of Country A. It is not a partnership. As such, Entity A, Entity B and Entity C pass this condition.

Entity A, Entity B and Entity C are not a public non-financial entities or public financial entities

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

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) of the ITAA 1997 defines the term public financial entity as follows:

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.

It is noted that subparagraph 880-125(d)(ii) of the ITAA 1997 excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

Entity A, Entity B and Entity C were subsequently created by Entity E and are wholly owned by such in order to hold the units of Entity E's investment in Entity D.

Entity E, Entity A, Entity B and Entity C do not produce or trade non-financial goods and do not provide services that are not financial services. Entity E, Entity A, Entity B and Entity C have invested in Entity D - an Australian open-ended unit trust. Entity A, Entity B and Entity C's role consists of holding the trust units of Entity D. Neither Entity E, Entity A, Entity B and Entity C are trading in financial assets and liabilities, operating commercially in financial markets nor do they undertake the activities listed in paragraph 880-130(2)(c) of the ITAA 1997.

As such, Entity A, Entity B and Entity C are not public non-financial entities, nor public financial entities and pass the condition in paragraph 880-125(d) of the ITAA 1997.

As Entity A, Entity B and Entity C satisfy each of the requirements in paragraphs 880-125(a) through (d) of the ITAA 1997 they are considered sovereign entities that are covered by section 880-125 of the ITAA 1997 for the purposes of paragraph 880-105(1)(a) of the ITAA 1997.

Entity A, Entity B and Entity C'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) of the ITAA 1997, the income 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 membershipinterest for the purposes of paragraph 880-105(1)(b) of the ITAA 1997 will include:

1.    dividends - including non-share dividends and dividends that pass through a 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 entity for the purposes of this ruling is Entity D in which Entity A, Entity B and Entity C hold trust units. The trust units meet the requirements of being membership interests as defined by the interaction of sections 960-135 and 960-130 of the ITAA 1997. Entity A, Entity B and Entity C receive:

·         MIT fund payments, including interest components of trust distributions

·         capital gains, and

·         returns of capital.

As such, Entity A, Entity B and Entity C will receive amounts which satisfy the requirements of paragraph 880-105(1)(b) of the ITAA 1997.

Entity A, Entity B and Entity C '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) of the ITAA 1997, 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 entity is Entity D. It is an Australian resident registered managed investment scheme and is also a MIT for Australian tax purposes.

As such, Entity A, Entity B and Entity C receive income from Entity D which satisfy the requirements of paragraph 880-105(c) of the ITAA 1997.

Entity A, Entity B and Entity C 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) of the ITAA 1997, the sovereign entity and the sovereign entity group to which it belongs must satisfy the portfolio interest test in relation to the test entity 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 of the ITAA 1997 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.

Entity A, Entity B and Entity C WKIC each hold less than 10% of the total trust units available in the Entity D. Collectively, Entity E holds less than 10% of units in the Entity D.

As such, Entity A, Entity B and Entity C 's interest in the Test Entity satisfies the requirements of paragraph 880-105(d) of the ITAA 1997.

Entity A, Entity B and Entity C does not have influence of a kind described in subsection 880-105(6) of the ITAA 1997

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) of the ITAA 1997 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).

As such, 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) of the ITAA 1997, 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 entity.

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.

Sub-test 2 of the influence test, as contained in paragraph 880-105(6)(b) of the ITAA 1997, 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.

In relation to Entity A, Entity B and Entity C's investments in Entity D:

a.    Entity A, Entity B and Entity C have no involvement in the day to day management of the business.

b.    Entity A, Entity B and Entity C have no right to appoint a director to the Board of Directors of Entity D and has no right to appoint a director to the Board of Directors of Entity D.

c.     Entity A, Entity B and Entity C have no right to representation on any investor representative or advisory committee (or similar) of Entity D.

d.    Entity A, Entity B and Entity C has no ability to direct or influence the operation of the Entity D outside of the ordinary rights conferred by the unit interests held, and

e.    Entity A, Entity B and Entity C only holds rights to vote as a unitholder in proportion to its interest in the Entity D.

Based upon the above, the sovereign entity group of Entity A, Entity B and Entity C does not have influence of a kind described in subsection 880-105(6) of the ITAA 1997 and will, therefore, satisfy the requirements of paragraph 880-105(1)(f) of the ITAA 1997.

Conclusion

As all of the conditions listed in subsection 880-105(1) of the ITAA 1997 have been satisfied, section 880-105 of the ITAA 1997 will apply such that amounts of ordinary and statutory income derived by Entity A, Entity B and Entity C from their investment in Entity D are not assessable and not exempt income.

Question 2

Will any capital gain arising to Entity A, Entity B and Entity C in respect of their investment in Entity D, be disregarded pursuant to section 880-115 of the ITAA 1997?

Detailed Reasoning

Section 880-115 of the ITAA 1997 provides that a capital gain of a sovereign entity from a Capital Gains Tax (CGT) event that happens in relation to a CGT asset is disregarded if the following conditions are met:

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:

1.    the capital gain were an amount of ordinary income or statutory income; and

2.    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

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

These conditions are considered below.

1. Entity A, Entity B and Entity C are sovereign entities as covered by section 880-125

As noted in Question 1, Entity A, Entity B and Entity C are considered sovereign entities for the purposes of section 880-125 of the ITAA 1997.

Therefore, this requirement is satisfied.

2. CGT asset is a membership interest, non-share equity interest or debt interest in another entity

As noted in Question 1, the trust units Entity A, Entity B and Entity C hold in Entity D are membership interests in an Australian resident MIT.

Therefore, this requirement is satisfied.

3. The requirements of paragraphs 880-5(b) to (g) have been satisfied.

For the reasons outlined in the answer to Question 1, the requirements in paragraphs 880-105(c), (d) and (e) of the ITAA 1997 are satisfied.

Conclusion

All the requirements in section 880-115 of the ITAA 1997 are satisfied. Therefore, Entity A, Entity B and Entity C will be entitled to disregard the capital gain in respect to their investment in Entity D.

Question 3

Does paragraph 128B(3)(n) of the ITAA 1936 apply to exclude Entity A, Entity B and Entity C from liability to withholding tax on income that is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997?

Detailed reasoning

Section 128B of the ITAA 1936 imposes liability to withholding tax on income derived by a non-resident that consists of dividend income (subsection 128B(1) of the ITAA 1936), interest income (subsection 128B(2) of the ITAA 1936) as well as other income prescribed in that section.

Subsection 128B(3) of the ITAA 1936 notes that section 128B of the ITAA 1936 will not apply to prescribed categories of income. Relevantly, paragraph 128B(3)(n) of the ITAA 1936 states that this includes 'income that is non-assessable non-exempt income because of Division 880 of the ITAA 1997 or Division 880 of the IT(TP)A 1997.'

The income derived by Entity A, Entity B and Entity C as a return on their investments in the Entity D is considered non-assessable non-exempt income under Division 880 of the ITAA 1997.

Therefore, Entity A, Entity B and Entity C are excluded from liability to withholding tax on their interest and/or dividend income derived from the Entity D investments under paragraph 128B(3)(n) of the ITAA 1936.

Question 4

Does subsection 840-805(9) of the ITAA 1997 apply to exclude Entity A, Entity B and Entity C from liability to withholding tax on income that is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997?

Detailed reasoning

Subject to subsection 840-805(9) of the ITAA 1997, section 840-805(1) of the ITAA 1997 imposes a liability for MIT withholding tax on amounts paid in accordance with subsections 840-805(2), (3) and (4) of the ITAA 1997. Subsection 840-805(9) of the ITAA 1997 states that subsections 840-805(2), (3) and (4) of the ITAA 1997 do not apply to you if the payments made to you relate to an amount that is non-assessable non-exempt income because of Division 880 of the ITAA 1997, or Division 880 of the IT(TP)A 1997.

The income derived by Entity A, Entity B and Entity C as a return on its investments in the Entity D are considered non-assessable non-exempt income under Division 880 of the ITAA 1997. As such, Entity A, Entity B and Entity C are excluded from liability to withholding tax on amounts it receives under subsections 840-805(2), (3) and (4) of the ITAA 1997 in accordance with subsection 840-805(9) of the ITAA 1997.

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