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Edited version of private advice

Authorisation Number: 1051806883195

Date of advice: 23 February 2021

Ruling

Subject: International issues - sovereign immunity

Question

Is ordinary or statutory income derived by the Foreign Entity, from its Australian investments listed in Appendix 1 of this Ruling (the Test Entities) not assessable and not exempt income under section 880-105 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Overview of the Foreign Entity

1. Foreign Entity was established by the Constitution (the Constitution) of the Foreign Country. (the Constitution).

2. The registered address of the Foreign Entity is in the Foreign Country.

3. The Foreign Entity is the central bank of the Foreign Country as per an Act of the Foreign Country (The Act).

4. Certain articles contained in the Act provide the nature and purpose of the Foreign Entity.

5. The Foreign Entity is a legal entity under the public law.

6. The Foreign Entity has the powers of an administrative authority in accordance with the Act.

7. As per the Act, the supreme governing body of The Foreign Entity is the Bank Board. The Bank Board will, among other things, be in charge of setting the monetary and macroprudential policy measures of the Foreign Entity, approving the budget of the Foreign Entity, and setting out the principles for the activities and transactions of the Foreign Entity.

Functions of the Foreign Entity

8. The primary objective of the Foreign Entity is the maintenance of price stability. In addition, the Foreign Entity works to ensure financial stability and the sound operation of the financial system in the Foreign Country.

9. In accordance with its primary objective as set out in the Act, the Foreign Entity shall:

a) set monetary policy

b) issue and manage the circulation of currency

c) supervise the activities of entities operating within the financial market

d) set macroprudential policy, and

e) carry on other activities pursuant to the Act.

10. The 'other activities' referred to in the Act are detailed by the Act and include:

a) the preparation and submission of draft legislation

b) the operation of payment systems

c) the registration of representative offices of foreign banks and financial institutions operating within the Foreign Country, and

d) engaging in investment and commercial activities insofar as is necessary to provide for its own operations.

Sovereign Entity Group

11. For the purpose of applying Division 880 of the ITAA 1997, the Foreign Entity is considered to form part of a sovereign entity group as set out in section 880-20 of the ITAA 1997.

12. The Foreign Entity, as the central bank of the Foreign Country, will form part of a sovereign entity group including the Foreign Country and any entities in which the Government of the Foreign Country either directly or indirectly holds 100% of the participation interests.

Australian Investments

13. The Foreign Entity invests the international reserves of the Foreign Country in accordance with the reserve management policy of the Foreign Entity.

14. The Foreign Entity invests into Australia through certain custodians and investment managers (the Investment Managers).

15. The Foreign Entity invests in publicly listed shares and AUD denominated bonds issued by the Commonwealth of Australia and other issuers.

16. The Investment Managers are contractually obliged to seek to maintain the publicly listed equity investments to reflect the S&P/ASX 200 index as closely as possible in accordance with the respective investment management agreements.

17. At all relevant times, the Foreign Entity is and has been, the beneficial owner of the Australian publicly listed equities. The publicly listed equities are held by a custodian or sub-custodian pursuant to an agreement and the Foreign Entity is therefore entitled to any and all dividend income from the holdings.

18. The Foreign Entity holds various equity interests in the Test Entities as listed in Appendix 1 of this Ruling.

19. The equity interests held by the Foreign Entity at the relevant date have the following characteristics:

a. The Foreign Entity 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. The Foreign Entity 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.

c. The Test Entities are all entities listed on the Australian Securities Exchange (ASX).

d. Neither the Foreign Entity, 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 the Foreign Entity, 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 the Foreign Entity, 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 the Foreign Entity, 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. The Foreign Entity'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. The Foreign Entity'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 the Foreign Entity or members of the Foreign Entity's sovereign entity group.

Relevant legislative provisions

Division 880 of the ITAA 1997

Reasons for decision

Question 1

Summary

Amounts of ordinary or statutory income derived by the Foreign Entity from its investments listed in Appendix 1 of this Ruling are not assessable and not exempt income as all conditions set out in subsection 880-105(1) of the ITAA 1997 have been satisfied and section 880-105 of the ITAA 1997 applies.

Detailed reasoning

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

(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.

The Foreign Entity is a sovereign entity covered by section 880-125 of the ITAA 1997

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;

(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.

The Foreign Entity is a sovereign entity

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;

(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) 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

Section 960-180 provides that an entity's total participation interest in another entity is the sum of:

(a) the entity's direct participation interest in the other entity at that time; and

(b) the entity's indirect participation interest in the other entity at that time.

The Foreign Country is a foreign country.

The Foreign Entity is the central bank of the Foreign Country, established by the Constitution, and is a 'public legal entity'. It performs a number of government functions including issuing currency, managing monetary policy, and managing the foreign reserves.

These activities are all done on behalf of the Foreign Country and the Foreign Entity is accountable to the government of the Foreign Country.

It can therefore be concluded that the Foreign Entity is an agency of the Foreign Country, having been established by the Foreign Country to undertake central banking activities.

The Foreign Entity is therefore considered to be 'an authority of the government of a foreign country' as per the definition outlined in paragraph 995-1(1)(b) of the ITAA 1997. Therefore, the Foreign Entity is a 'foreign government agency' under paragraph 880-15(b) of the ITAA 1997.

The Foreign Entity meets the requirement of being a sovereign entity in accordance with section 880-15 of the ITAA 1997.

The Foreign Entity 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 of the ITAA 1997, 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.

The Foreign Entity was endowed with government monies on its establishment

The Foreign Entity holdings of Australian assets constitute part of the official foreign exchange reserves.

The monies to make these investments in Australia originate from monies owned and controlled by the government of the Foreign Country.

It can therefore be concluded, that the Foreign Entity is funded solely by public monies.

All returns on the Foreign Entity's investments are public monies

The Act outlines what the Foreign Entity does with its profits.

The Foreign Entity uses its income to cover the necessary costs of its operations. The generated profit is allocated to its reserve fund and to other funds created from this profit, and for other uses within the Foreign Entity's budget. Any remaining profits are transferred by the Foreign Entity to the State budget.

All returns on investments are retained by the Foreign Entity in its reserves accounts or transferred to the general budget of the State. As a result, all returns on the Foreign Entity's investments can be considered public monies.

The Foreign Entity is not a partnership

The legal status of the Foreign Entity is defined by the Constitution and the Act as a public law entity. It is therefore not a partnership. As a result, it passes this condition.

The Foreign Entity is not a public non-financial entity or public financial entity (other than a public financial entity that only carries on central banking activities)

Subsection 880-130(1) of the 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) of the ITAA 1997 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;

(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.

The principal activity of the Foreign Entity is the maintenance of price stability. The Foreign Entity therefore does not meet the definition of a public non-financial entity in subsection 880-130(1) of the ITAA 1997.

The Foreign Entity does operate in financial markets, however these activities are not commercial in nature and their purpose is not for private profit but fulfilment of the Foreign Entity's function as the central bank of the Foreign Country. The Foreign Entity therefore does not meet the definition of a public financial entity in subsection 880-130(2) of the ITAA 1997.

However, even if the Foreign Entity was considered to undertake any of the activities in subsection 880-130(2) of the ITAA 1997, subparagraph 880-125(d)(ii) of the ITAA 1997 states that public financial entities that only carry on central banking activities are not excluded from being a covered sovereign entity.

Paragraph 81 of the Law Companion Ruling LCR 2020/3 The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2020/3) lists the following as being considered as 'central banking activities':

• monetary policy development

• issuing national currency

• acting as custodian of international reserves, and

• providing banking services to government.

Broadly, the Act outlines the functions of the Foreign Entity as:

• setting monetary policy

• issuing and managing the circulation of currency

• supervising the activities of entities operating within the financial market, and

• setting macroprudential policy.

The above activities are consistent with the Foreign Entity being an entity that only carries on central banking activities. As such, the Foreign Entity passes the condition in paragraph 880-125(d) of the ITAA 1997.

As the Foreign Entity satisfies each of the requirements in paragraphs 880-125(a) through (d) it is a sovereign entity that is covered by section 880-125 of the ITAA 1997 for the purposes of paragraph 880-105(1)(a) of the ITAA 1997.

The Foreign Entity'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, 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) of the ITAA 1997 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 the Foreign Entity holds an equity interest and earns returns in the form of dividends.

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

The Foreign Entity'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 Entities are ASX listed Australian resident companies at the relevant times.

As such, the Foreign Entity receives income from entities which satisfy the requirements of paragraph 880-105(1)(c) of the ITAA 1997.

The Foreign Entity'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) 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 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) 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.

The Foreign Entity is part of the sovereign entity group of the Foreign Country. To the best of the Foreign Entity's knowledge, at the relevant times (as required by paragraph 880-105(1)(d) of the ITAA 1997), the Foreign Entity, and its sovereign entity group collectively, holds less than 10% of the total participation interests in each of the Test Entities. In addition, the Foreign Entity 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) of the ITAA 1997.

Therefore, the portfolio interest test as found in subsection 880-105(4) of the ITAA 1997 is satisfied.

The Foreign Entity'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) of the ITAA 1997, 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.

The Foreign Entity'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, the Foreign Entity'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 makes 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) 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.

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 the Foreign Entity or members of the Foreign Entity's sovereign entity group.

Based upon the above, the sovereign entity group of the Foreign Entity 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 to the effect that amounts of ordinary and statutory income derived by the Foreign Entity from its equity interests held in the Test Entities are not assessable and not exempt income.

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