Edited version of private advice

Authorisation Number: 1051819405578

Date of advice: 31 March 2021

Ruling

Subject: International issues - sovereign immunity

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 Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will any capital gain arising to the Foreign Entity in respect of the Australian equity investment assets, 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 the Foreign Entity 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:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Foreign Fund

The Foreign Entity and the Foreign Fund were established by the Foreign Government. The Foreign Council controls the Foreign Entity. The Foreign Fund is under the direct supervision of the Foreign Entity.

Relevantly, the Foreign Fund is responsible for the supervision and management of the foreign exchange market of the Foreign Country, to undertake supervision and management of the settlement, the sale of foreign exchange and to cultivate and develop the foreign exchange market and to undertake operations and management of foreign exchange reserves, gold reserves, and other foreign exchange assets of the Foreign Country.

In connection with the management of the foreign exchange reserves of the Foreign Country, the Foreign Fund acts as an agent of Foreign Entity in making investments with such foreign exchange reserves.

The beneficial owner of all the accounts opened or transactions entered for the purpose of investment with such foreign exchange reserves is Foreign Entity and all the income arising from such activities belongs to Foreign Entity, rather than Foreign Fund.

The Foreign Entity is governed by Foreign Law. The relevant articles of the Foreign Law are outlined below.

Foreign Law states the Foreign Entity is the central bank of the Foreign Country. Foreign Entity under the leadership of the Foreign Government formulates and implements monetary policy, prevents and mitigates financial risks, and maintains the financial stability.

The objective of the monetary policy is as, to maintain the stability of the value of the currency and thereby promote economic growth.

The Foreign Entity undertakes central banking activities.

The Foreign Entity reports to the Foreign Government its decisions concerning annual monetary supply, interest rates, exchange rate and other important issues specified by the Foreign Government for approval before they are implemented.

In accordance with Foreign Law, all of the capital of the Foreign Entity is funded and owned by the Foreign Government.

In accordance with Foreign Law, the Foreign Entity's management is nominated and appointed by Foreign Government.

The Foreign Entity may deal in Foreign Government bonds, other government bonds, financial bonds and foreign exchange on the open market in order to implement monetary policies.

The Foreign Entity will also manage the Foreign Government treasury in accordance with the laws and administrative rules and regulations.

The Foreign Entity exercises independent control over its budget. Once the budget has been examined and verified by the financial department under the Foreign Government it is incorporated into the budget.

The Foreign Entity, after withdrawing funds for its general reserve will turn over to the Foreign Government the entire net profit from its income in an accounting year minus expenses.

Other relevant facts

Foreign Entity is not in the business of trading securities.

Foreign Entity's resides in Foreign Country.

Foreign Entity is not aware of any other members of its sovereign entity group which hold investments in its Australian investments.

Foreign Entity's sovereign entity group does not hold a total participation interest in its Australian investments of greater than 10%.

Foreign Entity's investments in Australia

In performing its official responsibilities as a central bank of the Foreign Country, the Foreign Entity via the Foreign Fund invests a portion of the foreign exchange reserves of the Foreign Country in Australian investments.

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.

c.     The Foreign Entity has no involvement in the day to day management of the business of any of the Australian companies / MITs.

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.

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

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

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

The Foreign Entity also holds Australian debt investments. The 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.     The Foreign Entity holds less than 10% of the total equity interests on issue of each Australian debt issuer.

d.    The Foreign Entity has no involvement in the day to day management of the business of any the Australian debt issuers.

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

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

a.    The 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.

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

c.     There are no special relationships or arrangements between the 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 the 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.

The 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.

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;

(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 Law establishes the Foreign Entity as the central bank of Foreign Country. Under the Foreign Law, the Foreign Entity among other central banking activities holds, administers and manages the Foreign Country's foreign exchange reserves. This includes supervising the Foreign Fund.

The Foreign Entity is under the leadership of, and reports its activities to, the Foreign Government. Specifically, it reports its decisions concerning the money supply, exchange rates and other important issues specified by the Foreign Government for approval before they are implemented.

The Foreign Entity's high-level management is nominated and appointed by the Foreign Government.

Based on the above facts, the 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 Foreign Law, all the capital of the Foreign Entity is funded and owned by the Foreign Government.

The Foreign Entity is therefore funded solely by public monies.

All returns on Foreign Entity's investments are public monies

In accordance with Foreign Law, the Foreign Entity's budget is reviewed by the Foreign Government and becomes part of the budget and is executed by the Foreign Government. Under Foreign Law, the Foreign Entity surrenders to the Foreign Government budget its net profit each accounting year after the Foreign Government makes provisions for the Foreign Entity. Losses of the Foreign Entity are covered by fiscal appropriation from the budget.

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

The Foreign Entity is not a partnership

The Foreign Entity was established through Foreign Law and is under the leadership of the Foreign Government. It is not a partnership. As such, it satisfies this requirement.

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 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.

The Foreign Entity was established by the Foreign Law, to conduct the Foreign Government's central banking activities.

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

Therefore, 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) 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 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) or debt interests and pay to the Foreign Entity:

•         MIT fund payments, including interest components of trust distributions

•         Dividends

•         Interest.

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.

Foreign Entity is unaware of any entity in its sovereign entity group that holds interests in its Australian investments.

The Foreign Entity and its sovereign entity group 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.

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), 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:

(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, and

(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.

In relation to the Foreign Entity's investments in the debt investments:

(a)  the Foreign Entity has no involvement in the day to day management of the business of any the Australian debt issuers

(b)  the Foreign Entity has not acquired the right to appoint a director to the Board of Directors of any issuing Australian debt issuer

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

(d)  the 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

(e)  the Foreign Entity has no voting rights in respect of the debt investments held, and

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

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 so that amounts of ordinary and statutory income derived by the Foreign Entity's from its investments in its Australian investments are not assessable and not exempt income for the period from 1 July 2019 to 30 June 2024.

Question 2

Will any capital gain arising to the Foreign Entity in respect of the equity investment assets, 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:

(i)    the capital gain were an amount of ordinary income or statutory income; and

(ii)   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

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

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

As noted in Question 1, the Foreign Entity is considered a sovereign entity for the purposes of section 880-125 of the ITAA 1997.

Therefore, this requirement is satisfied.

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

As noted in Question 1, the Foreign Entity's Australian investments are membership interests in Australian resident companies and MITs.

Therefore, this requirement is satisfied.

The requirements of paragraphs 880-105(c) to (e) of the ITAA 1997 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

As all the requirements in section 880-115 of the ITAA 1997 are satisfied, the Foreign Entity will be entitled to disregard the capital gain in respect to its Australian investments.

Question 3

Does paragraph 128B(3)(n) of the ITAA 1936 apply to exclude the Foreign Entity 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 Income Tax (Transitional Provisions) Act 1997.'

The income derived by the Foreign Entity as a return on its Australian investment assets is considered non-assessable non-exempt income under Division 880 of the ITAA 1997.

Therefore, the Foreign Entity is excluded from liability to withholding tax on its interest and/or dividend income under paragraph 128B(3)(n) of the ITAA 1936.

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