Edited version of private advice

Authorisation Number: 1051757781177

Date of advice: 24 September 2020

Ruling

Subject: Sovereign immunity

Question 1

Is the ordinary and statutory income derived by the Entity A from its interests held in the entities listed in the Ruling (Test Entities) not assessable and not exempt income under section 880-105 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Entity A

Entity A is a foreign state. It is exempt from income tax in its own country.

The Treasurer of Entity A receives and invests all funds of Entity A except for pension funds. It must invest them in a manner that achieves the highest possible investment return consistent with appropriate risk and liquidity levels.

Entity A's funds are made up of amounts collected from State taxes, mining royalties, mineral taxes, and budgetary surpluses.

Entity A's funds are used for a variety of governmental purposes. Entity A invests the funds to make money to support those government programs.

Australian Investments

Entity A has investments in fixed income securities in Australia. It also owns membership interests in Australian resident companies and managed investment trusts (MITs) as listed in the Ruling.

The equity interests held by Entity A are all in Australian resident companies and MITs that have the following characteristics:

a.    Entity A and all members of its sovereign entity group hold collectively less than 10% of the total participation interests in each of the Test Entities.

b.    All Test Entities are Australian Stock Exchange (ASX) listed entities.

c.     Entity A and all members of its sovereign entity group would hold collectively less than 10% of the total participation interests in the Test Entities in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997.

d.    Neither Entity A, nor any members of its sovereign entity group, has involvement in the day to day management of the business of any of the Test Entities.

e.    Neither Entity A, nor any members of its sovereign entity group, has the right to appoint a director to the Board of Directors of any of the Test Entities.

f.      Neither Entity A, nor any members of its sovereign entity group, holds the right to representation on any investor representative or advisory committee (or similar) of the Test Entities.

g.    Neither Entity A, nor any members of its sovereign entity group, has the ability to direct or influence the operation of the Test Entities outside of the ordinary rights conferred by the interest held.

h.    Entity A's interests in the Test Entities do not provide it with an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations.

i.      Entity A's interests, when combined with the other interests held within its sovereign entity group, do not provide an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations.

j.      No person involved in the control and direction of the Test Entities' operations is accustomed or obliged to act in accordance with the directions, instructions or wishes of Entity A or members of Entity A's sovereign entity group.

Relevant legislative provisions

Division 880 of the Income Tax Assessment Act 1997

Section 880-105 of the Income Tax Assessment Act 1997

Section 880-125 of the Income Tax Assessment Act 1997

Section 880-130 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Is the ordinary and statutory income derived by Entity A from its interests held in the entities listed in Appendix 1 (the Test Entities) not assessable and not exempt income under section 880-105 of the ITAA 1997?

Answer

Yes.

Detailed reasoning

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.

Entity A 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.

Entity A 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.

Entity A is a foreign State.

As such, Entity A meets the requirement of being a sovereign entity in accordance with section 880-15 of the ITAA 1936.

Entity A 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.

Entity A receives its funds for investment from budgetary surpluses, mining royalties, mineral taxes, and other State taxes. It does not receive amounts related to a public pension or retirement system.

The monies therefore held and invested by Entity A are solely public monies.

All returns on Entity A's investments are public monies

Entity A uses the funds solely for the purpose of providing benefits to its residents. The funds are used for a variety of governmental purposes. The funds are not used to pay retirement benefits to public employees or similar.

The returns on investment therefore remain monies available to Entity A for a public purpose and are therefore public monies.

Entity A is not a partnership

Entity A is a foreign State. It is not a partnership. As such, it passes this condition.

Entity A is not a public non-financial entity or public financial entity

Subsection 880-130(1) 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.

Entity A is a foreign State itself. Its principal activities include the legislative, executive and judicial functions of a government or State. Its principal activity is not those outlined in subsections 880-130(1) or 880-130(2) of the ITAA 1997. Entity A is not a type of entity as listed in paragraphs 70 or 73 of the Draft Law Companion Ruling LCR 2019/D4 The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2019/D4).

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

Entity A'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, debt interest or non-share equity 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 are entities in which Entity A holds a membership interest and earns returns in the form of dividends, interest, and fund payments.

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

Entity A'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 ASX listed Australian resident companies and MITs at the relevant times.

As such, Entity A receives income from entities which satisfy the requirements of paragraph 880-105(1)(c).

Entity A's 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 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.

The portfolio interest test is outlined in subsection 880-105(4), 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.

Entity A is part of its own sovereign entity group. At the relevant times (as required by paragraph 880-105(1)(d)), Entity A's sovereign entity group collectively holds less than 10% of the total participation interests in each of the Test Entities and Entity A and its sovereign entity group collectively would hold less than 10% of the total participation interests in the Test Entities in the circumstances detailed in paragraph 880-105(4)(b).

Therefore the portfolio test is satisfied.

Entity A's sovereign entity group does not have influence of a kind described in subsection (6) in relation to the Test Entities at the income time

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).

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).

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), 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.

Entity A's interests in the Test Entities do not provide it with an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations. Furthermore, Entity A's interests, when combined with the other interests held within its sovereign entity group, do not provide an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations.

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.

No person involved in the control and direction of the Test Entities' operations is accustomed or obliged to act in accordance with the directions, instructions or wishes of Entity A or members of Entity A's sovereign entity group.

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

Conclusion

As all of the conditions listed in subsection 880-105(1) have been satisfied, section 880-105 will apply to the effect that amounts of ordinary and statutory income derived by Entity A from its equity interests held in the Test Entities are not assessable and not exempt income.

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