Edited version of private advice

Authorisation Number: 1051818061329

Date of advice: 25 March 2021

Ruling

Subject: Sovereign immunity

Question 1

Is the ordinary and statutory income derived by SubCo from the equity and debt interests it holds in the Aus Trust and Australian MIT (together the Australian Trusts) that were acquired on or before 27 March 20XX non-assessable non-exempt income under section 880-5 of the Income Tax (Transitional Provisions) Act 1997 (ITTPA 1997) up to 30 June 20XX?

Answer

Yes.

Question 2

Is the ordinary and statutory income derived by SubCo from the equity and debt interests in the Australian Trusts that were acquired after 27 March 20XX non-assessable non-exempt income under section 880-5 of the ITTPA 1997?

Answer

No.

Question 3

Is the ordinary and statutory income derived by SubCo from the less than 3% equity and debt interests in the Australian MIT non-assessable non-exempt income under section 880-105 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

The scheme commenced on:

1 July 2019

Relevant facts and circumstances

The entity is a corporation established in a foreign State to advance the objectives of the Government of the State.

The entity is a corporation without share capital and although it is not expressly an agent of the State, it is considered to be owned by the State and as a result is exempt from income tax in the foreign State.

No parties other than the State have any rights to acquire the capital of the entity.

The entity operates such that its only sources of revenue are premiums and investment returns. The only use of such funds is to meet the objectives of the State.

On a winding up or dissolution of the entity, the assets of the entity would be dealt with pursuant to the specific legislation enacted by the State at the time, thereby making the dealing with such assets under the control of the State. If no specific legislation was enacted to effect the dissolution or winding up of the entity, the assets of the entity would be distributed to the State.

The entity engages the Investment Manager to provide investment management services.

The Investment Manager makes investments and loans for a number of State-controlled entities.

The entity has a wholly owned subsidiary (SubCo) which has made an investment into Australia.

SubCo acquired prior to 27 March 20XX a less than 2% interest in Aus Trust, an Australian resident trust, and Australian MIT, an Australian resident managed investment trust (together the Australian Trusts). Aus Trust is not a MIT.

SubCo also acquired prior to 27 March 20XX less than 2% of the debt interests respectively issued by Australian Trusts.

After 27 March 20XX, SubCo acquired an additional less than 2% interest in the Australian Trusts, as well as a less than 2% interest in the debt interests issued by the Australian Trusts.

The Australian Trusts are the head of an ownership structure that holds Australian property and business interests.

SubCo has the right to cast a proportionate number of votes with respect to its interest on owner resolutions in respect of matters for the Australian Trusts and their Trustee Companies.

A deed sets out the voting thresholds for resolutions to be:

(i)    Reserved Matters Resolutions which require approval by 50% of the holders present (voting equivalent with their holdings) provided that such a resolution is not opposed by security holders with an aggregate holding equal to or greater than a prescribed amount.

(ii)   Special Reserved Matters Resolutions which require approval by 50% of the holders present (voting equivalent with their holdings) provided that such a resolution is not opposed by one or more holder that has greater than a prescribed holding amount.

The Reserved Matters are set out in the deed.

The Special Reserved Matters are set out in the deed.

SubCo will not enter into any agreement or arrangement which requires it to vote consistently with any other holder.

SubCo will not be a member of a pooled ownership group and will have no rights to appoint a director and no director will be eligible to cast votes in respect of the entity's interests.

SubCo received a private ruling confirming immunity from tax under the common law doctrine of sovereign immunity prior to 27 March 20XX with respect to its initial less than 2% investment in the Australian Trusts and the debt interests issued by the Australian Trusts.

Relevant legislative provisions

Division 880 of the Income Tax Assessment Act 1997

Division 880 of the Income Tax (Transitional Provisions) Act 1997

Reasons for decision

Question 1

Is the ordinary and statutory income derived by SubCo from the equity and debt interests it holds in the Aus Trust and Australian MIT (together the Australian Trusts) that were acquired on or before 27 March 20XX non-assessable non-exempt income under section 880-5 of the Income Tax (Transitional Provisions) Act 1997 (ITTPA 1997) up to 30 June 20XX?

Detailed reasoning

Section 880-5 of the ITTPA 1997 provides transitional relief for amounts of ordinary and statutory income derived by a sovereign entity by deeming such income to be not assessable and not exempt income if:

(a)  the amount is a return on an investment asset under a scheme

(b)  the sovereign entity acquired the investment asset on or before 27 March 20XX under the scheme; and

(c)   on or before 27 March 20XX, the sovereign entity applied for a private ruling in relation to the scheme; and

(d)  before 1 July 20XX, the Commissioner gave the entity a private ruling confirming that income from the investment asset was not subject to income tax, or withholding tax, because of the doctrine of sovereign immunity; and

(e)  the private ruling applied during at least part of the period:

(i)    starting on 27 March 20XX; and

(ii)   ending before 1 July 20XX;

regardless of whether the private ruling started to apply before 27 March 20XX, or ceased to apply before 1 July 20XX; and

(f)    the scheme carried out is not materially different to the scheme specified in the private ruling; and

(g)  the income year is

(i)    unless subparagraph (ii) applies - the 20XX-XX income year or an earlier income year; or

(ii)   if the last income year to which the private ruling relates is a later income year than the 20XX-XX income year- that later income year, or an earlier income year.

A preliminary requirement of the section is that irrespective of whether an entity has a private ruling in relation to sovereign immunity, the entity must be a 'sovereign entity.'

Sovereign entity is defined in section 880-15 of the ITAA 1997 as a foreign government agency or an entity in which a foreign government agency owns 100% of the participation interests.

SubCo is wholly owned by the entity.

The entity is a corporation established by the foreign State to advance the objectives of the government of the foreign state. The entity was formed without share capital and although it is not expressly an agent of the foreign State, it is considered to be owned by the foreign state and as a result is exempt from income tax in that State.

As such, the Commissioner accepts that the entity is an agency of the foreign State. Consequently SubCo, being a wholly owned subsidiary of the entity, is an entity in which a foreign government agency owns 100% of the participation interests.

With respect to the requirements of section 880-5 of the ITTPA 1997:

•         SubCo is paid dividends, interest, and trust distributions from its investment assets, being the units in and debt issued by the Australian Trusts. The holding of equity and debt interests in the Australian Trusts constitutes a scheme, as defined in 995-1 of the ITAA 1997. Paragraph 880-5(a) of the ITTPA 1997 is therefore satisfied.

•         SubCo acquired the equity and debt interests in the Australian Trusts constituting less than 2% of the equity and debt interests issued by the Australian Trusts prior to 27 March 20XX. As such, those interests satisfy paragraph 880-5(b) of the ITTPA 1997.

•         SubCo applied for a private ruling prior to 27 March 20XX, satisfying paragraph 880-5(c) of the ITTPA 1997.

•         SubCo was issued a private ruling prior to 27 March 20XX which concluded that the investment asset was not subject to income or withholding taxes because of the doctrine of sovereign immunity, satisfying 880-5(d) of the ITTPA 1997.

•         SubCo's private ruling satisfies 880-5(e) of the ITTPA 1997.

•         The only change with respect to the scheme described in the private ruling issued prior to 27 March 20XX is that SubCo increased its holding in the debt and equity interests of the Australian Trusts to less than 4% of the interests. Other than an increase in voting power with respect to securityholder matters, SubCo has no governance rights or ability to otherwise influence the Australian Trusts beyond that described in the previous private ruling. The acquisition of additional interests is not considered to make the current scheme materially different to the scheme described in the previous private ruling, satisfying paragraph 880-5(f) of the ITTPA 1997.

•         The income years in which SubCo will derive income from the Australian Trusts are from 1 July 2019 to 30 June 20XX. The income year is therefore 20XX-20XX and earlier income years, satisfying paragraph 880-5(g) of the ITTPA 1997.

All of the requirements in section 880-5 of the ITTPA 1997 are satisfied. As such, with respect to their initial acquisition of less than 2% of the debt and equity interests in the Australian Trusts, the transitional rules will apply such that all returns on those interests derived by SubCo will be non-assessable non-exempt income under section 880-5 of the ITTPA 1997 up to 30 June 20XX.

Question 2

Is the ordinary and statutory income derived by SubCo from the equity and debt interests in the Australian Trusts that were acquired after 27 March 20XX non-assessable non-exempt income under section 880-5 of the ITTPA 1997?

Detailed reasoning

As previously outlined, section 880-5 of the ITTPA 1997 provides transitional relief for amounts of ordinarily and statutory income derived by a sovereign entity by deeming such income to be non-assessable and not exempt income if they meet the requirements of that subsection.

Of relevance is the fact that the sovereign entity must have acquired the investment asset on or before 27 March 20XX. The investment asset is the asset on which the entity received a private ruling and is being paid the relevant return.

In this case, the investment assets are units and debt interests in the Australian Trusts. These were acquired from other holders of units in the Australian Trusts after 27 March 20XX. As such, the requirement in the transitional rules that the investment asset was acquired by SubCo before 27 March 20XX has not been satisfied.

As such, the ordinary and statutory income derived by SubCo from the equity and debt interests in the Australian Trusts acquired after 27 March 20XX is not to be treated as non-assessable non-exempt income as it does not meet the requirements for this treatment under section 880-5 of the ITTPA 1997.

Question 3

Is the ordinary and statutory income derived by SubCo from the less than 4% equity and debt interests in the Australian MIT non-assessable non-exempt income under section 880-105 of the Income Tax Assessment Act 1997 (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.

SubCo 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.

SubCo is a sovereign entity

As previously established, SubCo is a sovereign entity as defined in section 880-15 of the ITAA 1997.

SubCo 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 capital of the entity is contributed by, and considered to be owned by, the foreign State. On a winding up or dissolution of the entity, the assets would be dealt with either by specific legislation enacted by the foreign State, thus demonstrating the Province's control over the assets, or would be distributed to the foreign State.

SubCo is capitalised wholly with funds from the entity and its investment returns are generated for the benefit of the entity.

As such, SubCo is solely funded by public monies.

All returns on SubCo's investments are public monies

All returns on SubCo's investments are ultimately paid to the entity for it to exercise its functions on behalf of the foreign State.

On a winding up or dissolution of the entity, the assets would be dealt with either by specific legislation enacted by the foreign State, thus demonstrating the foreign State's control over the assets, or would be distributed to the foreign State.

The returns on monies invested by SubCo are therefore public monies.

SubCo is not a partnership

SubCo is a company incorporated in the foreign State under the relevant Act. It is not a partnership. As such, it passes this condition.

SubCo 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 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.

SubCo is a wholly owned subsidiary of the entity whose sole purpose is to hold the equity and debt interests in the Australian Trusts. Its principal activities are not those outlined in subsections 880-130(1) or 880-130(2) of the ITAA 1997. The Commissioner accepts that SubCo is not a public non-financial or public financial entity under either subsection 880-130(1) or 880-130(2) of the ITAA 1997.

As SubCo 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.

SubCo'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.

SubCo holds participation interests in the Australian resident MIT, and debt interests in the form of unitholder loans. It earns returns from those interests in the form of MIT fund payments and interest income.

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

SubCo'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.

Australian MIT is an Australian resident MIT at the relevant times. It should be noted that SubCo's holding in Aus Trust does not satisfy this requirement as Aus Trust is not a MIT.

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

SubCo'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.

SubCo's sovereign entity group will hold a combined less than 4% of interests in the relevant Test Entity (being the Australian MIT), which is substantially less than 10% of the total participation interests.

Therefore, the portfolio test in paragraph 880-105(4)(b) of the ITAA 1997 is satisfied.

SubCo'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.

SubCo's interests in Australian MIT does 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. SubCo's sovereign entity group also does not have such an entitlement in Australian MIT.

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 SubCo or members of SubCo's sovereign entity group.

As a securityholder, SubCo has the right to cast votes with respect to its less than 4% interest on securityholder resolutions in respect of certain limited matters for Australian MIT. Securityholder resolutions can only be approved by Securityholders who together hold more than 50% of the total number of securities held by Securityholders eligible to vote on the resolution. SubCo's voting power is such as it cannot affect the outcome of a vote to approve a Securityholder resolution. Further, SubCo will not enter into any agreement or arrangement which requires it to vote consistently with any other Securityholder.

Based upon the above, the sovereign entity group of SubCo 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) 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 SubCo from its equity and debt interests held in the Australian MIT are non assessable and non exempt income.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).