Edited version of private advice

Authorisation Number: 1051814274333

Date of advice: 19 March 2021

Ruling

Subject: International issues - sovereign immunity

Question

Is the ordinary and statutory income derived by Foreign Entity from its Australian investments, 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 period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Foreign Entity

1.    Under Foreign Law the Foreign Entity is a central bank.

2.    Under Foreign Law the capital of the Foreign Entity is owned by Foreign Government.

3.    The Foreign Entities board is appointed by Foreign Government.

4.    Under Foreign Law, Foreign Entity is required to coordinate its activities with the Foreign Government and must inform each other about prospective activities.

5.    Under Foreign Law, the Foreign Entity acts as an agent of the Foreign Government.

6.    The Foreign Entity is the beneficial owner of all its Australian investments.

7.    The Foreign Entity earns interest income from its investments in interest bearing securities but it does not invest in interest bearing securities for the purpose of supporting money lending activities.

The Foreign Fund

8.    The Foreign Fund was founded in accordance with Foreign Law.

9.    The assets of the Foreign Fund are under the trust management of the Foreign Entity.

10.  The Foreign Entity, being trust manager of the Foreign Fund, possesses the rights of holding, usage and disposal with respect to the assets of the Foreign Fund. The Foreign Entity is entitled to revenue from the Foreign Fund.

11.  The Foreign Government is the beneficial owner of the assets and income of the Foreign Fund.

12.  The source of the funds for the Foreign Fund are from the Foreign Government revenue and activities.

13.  Subject to Foreign Law, in respect to the assets given to the Foreign Entity, the Foreign Entity is responsible for the tax liabilities incurred from the asset's earnings.

14.  Under Foreign Law the funds from the Foreign Fund can only be spent as a transfer from the Foreign Fund to the Foreign Government Budget and on expenses for the Foreign Fund.

15.  The management is established under Foreign Law and develops proposals for the effective use of funds and its placement in financial instruments.

16.  The Foreign Entity has investments in Australian fixed income securities and Australian stocks.

Other relevant facts

17.  The Foreign Entity is a resident of Foreign Country.

The Foreign Entity's investments in Australia

18.  The Australian equity investments, held by the Foreign Entity include shares in Australian companies and units in Australian managed investment trusts (MITs) with the following characteristics:

a.    All investments are listed on the Australian Securities Exchange (ASX).

b.    The Foreign Entity holds less than 10% of the total equity interests on issue of each Australian company, MIT, or REIT.

c.     The Foreign Entity has no involvement in the day to day management of the business of any of the Australian company, MIT, or REIT.

d.    The Foreign Entity has no right to appoint a director to the Board of Directors of the Australian company or equivalent role in a MIT or REIT.

e.    The Foreign Entity has no right to representation on any investor's representative or advisory committee (or similar) of the Australian company, MIT, or REIT.

f.      The Foreign Entity has no ability to direct or influence the operation of the Australian company, MIT or REIT outside of the ordinary rights conferred by the equity interest held.

g.    The Foreign Entity only hold rights to vote in proportion to their equity interest in each Australian company, MIT or REIT.

19.  The Australian debt investments are made up of corporate, securitised, index linked and Government bonds and treasuries from which ordinary income is derived in the form of interest. The debt investments have the following characteristics:

a.    All investments are listed on the ASX.

b.    The investments are corporate, securitised, index linked and Government bonds and treasuries from which it ordinarily derives income in the form of interest.

c.     Foreign Entity have no involvement in the day to day management of the business of any the Australian debt issuers.

d.    Foreign Entity have not acquired the right to appoint a director to the Board of Directors of any issuing Australian debt issuer.

e.    Foreign Entity have not acquired the right to representation on any investor's representative or advisory committee (or similar) of the Australian Debt Issuer.

f.      Foreign Entity has no ability to direct or influence the operation of the Australian debt issuer outside of the ordinary rights conferred by the debt interest held.

g.    Foreign Entity has no voting rights in respect of the debt investments held.

h.    There are no special relationships or arrangements between Foreign Entity, and the issuers of the Australian debt investments held which affect the amount of interest income that is paid from those investments.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 880

Reasons for decision

Question 1

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

Summary

Ordinary and statutory income derived by the Foreign Entity as a return on its Australian investments is not assessable and not exempt income due to the operation of section 880-105 of the ITAA 1997.

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

(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.

Foreign Entity is a covered sovereign entity

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.

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;

(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.

Foreign Entity a central bank of Foreign Government. It is established by Foreign Law and is a resident of Foreign Country.

Foreign Law states that the Foreign Entity is a state body.

Foreign Entity's Executive Board was appointed by the Foreign Government.

The Foreign Fund was created by Foreign Law.

The assets of the Foreign Fund are under the trust management of the Foreign Entity in accordance with a trust agreement

The Foreign Entity, being trust manager of the Foreign Fund, has the right to hold, use and dispose of the assets of the Foreign Fund. The Foreign Entity is the legal and beneficial owner of the revenues and assets received on investments of the Foreign Fund.

Based on the above facts, Foreign Entity is a foreign government agency as defined in subsection 995-1(1) of the ITAA 1997 and is therefore a sovereign entity under paragraph 880-15(b) of the ITAA 1997.

Therefore, this requirement is satisfied.

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.

In accordance with the Foreign Law, the Foreign Entity is tasked with managing the Foreign Fund. Monies invested in the Foreign Fund are sourced from the Foreign Government's assets and activities.

Both the Foreign Entity and the Foreign Fund are therefore funded solely by public monies.

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

In accordance with the Foreign Law the Foreign Fund's assets and income are owned by Foreign Government. The Foreign Government is the stated beneficial owner of the funds in the Foreign Fund.

In regard to investments managed by external managers, the Foreign Entity is still beneficially entitled to these funds and as such they remain state funds in accordance with Foreign Law.

Therefore, all returns on the Foreign Entity's investments related to the Foreign Fund are public monies.

The Foreign Entity is not a partnership

The Foreign Entity is a state entity of Foreign Government. It is not a partnership. As such, it passes this condition.

The Foreign Entity is not a public non-financial entity or public financial entity

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 entityif 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.

The Foreign Entity was created by the Foreign Government through legislation, to conduct its central banking activities.

The Foreign Entity does not produce or trade non-financial goods and does not provide services that are not financial services. The Foreign Entity does not commercially trade in financial assets and liabilities, and undertakes the activities listed in paragraph 880-130(2)(c) of the ITAA 1997. Additionally, as a central bank it is excluded from being a public financial entity under subparagraph 880-125(d)(ii) of the ITAA 1997.

As such, the Foreign Entity is not a public non-financial entity nor a public financial entity and 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) of the ITAA 1997 it is considered 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 membershipinterest for the purposes of paragraph 880-105(1)(b) 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 entities for the purposes of this ruling are the publicly-traded companies and MITs in which the Foreign Entity holds shares and units respectively (which meet the requirements of being membership interests as defined by the interaction of sections 960-135 and 960-130 of the ITAA 1997) and pay to Foreign Entity:

•         MIT fund payments, including interest components of trust distributions, and

•         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 MITs

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 Australian resident companies and MITs.

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 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/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 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 holds less than 10% of the total shares on issue of each Australian company and less than 10% of the total units on issue of each Australian trust listed in Appendix 1.

As such, the Foreign Entity's interest in the test entities satisfy the requirements of paragraph 880-105(d) of the ITAA 1997.

The Foreign Entity 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) 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.

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 the Foreign Entity's investments in the Australian companies and trusts listed in Appendix 1:

(a)  The Foreign Entity has no involvement in the day to day management of the business of any of the Australian companies or trusts

(b)  The Foreign Entity has no right to appoint a director to the Board of Directors of any of the Australian companies and has no right to appoint a director to the Board of Directors of any of the trustee companies for the trusts.

(c)   The Foreign Entity has no right to representation on any investor representative or advisory committee (or similar) of any of the Australian companies or trusts.

(d)  The Foreign Entity has no ability to direct or influence the operation of the Australian company or trust outside of the ordinary rights conferred by the share or unit interest held.

(e)  The Foreign Entity only holds rights to vote as a shareholder or unitholder in proportion to its share interest in the Australian companies or trusts.

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)(e) 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 Australian investments are not assessable and not exempt income for the period from 1 July 2019 to 30 June 2024.

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