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Edited version of private advice

Authorisation Number: 1051821414010

Date of advice: 9 April 2021

Ruling

Subject: Sovereign immunity

Question 1

Is ordinary or statutory income derived by Entity One 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.

Question 2

Is any capital gain or loss made by Entity One in respect of its Australian investments listed in Appendix 1 of this Ruling, disregarded under section 880-115 and section 880-120 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 Entity One from liability to withholding tax on income derived from Australian investments listed in Appendix 1 of this Ruling that is not assessable and not exempt income due to the operation of Division 880 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

The scheme commenced on:

1 July 20XX to 30 June 20XX

Relevant facts and circumstances

Entity One

Entity One was established by amendment of the Constitution of the State of the Foreign State (the Constitution).

Entity One does not have its own legal identity.

Entity One consists of a portion of taxation revenue received by the State.

The purpose of Entity One is to conserve and invest the portion of taxation revenue for the benefit of the State.

Entity Two

Entity Two is a resident of the State and was created under the Laws of the State.

Entity Two's purpose is to manage and invest the assets of Entity One and other funds designated by law in accordance with the Laws of the State.

Entity Two is managed by its board of trustees (the Board). Investment authority over Entity One's assets is vested in the Board.

Taxation

Entity One and Entity Two are exempt from all taxes in the State and in the Foreign Country.

Investments

Entity One, through Entity Two, invests in a wide range of both public and private assets including real estate, bonds, public and private equities, infrastructure and hedge funds.

Entity One does not trade in financial assets or operate commercially in the financial markets.

Appropriation of Entity One's income

Calculation of Entity One's income is governed by the Laws of the State.

The operating budget of Entity Two is to be funded from the revenue generated from Entity One's investments.

Entity Two will transfer an amount to Entity One to offset the effect of inflation during that year.

Sovereign entity group

Entity One and Entity Two will form part of a sovereign entity group including the State and any entities in which the government of the State either directly or indirectly holds 100% of the participation interests.

No other entities in the sovereign entity group hold investments in Australia.

Investment in the Test Entities

Entity Two holds a portfolio of equity investments in Australian companies and managed investment trusts (MITs) on behalf of Entity One.

The equity interests held by Entity One as the relevant time have the following characteristics:

a. Entity One 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. Each of the Test Entities is listed on the Australian Stock Exchange (ASX).

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

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

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

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

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

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

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

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

Relevant legislative provisions

Income Tax Assessment Act 1997 section 880-105

Income Tax Assessment Act 1997 section 880-115

Income Tax Assessment Act 1997 section 880-120

Income Tax Assessment Act 1936 section 128B

Reasons for decision

Question 1

Summary

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

Detailed Reasoning

All legislative references in Question 1 refer to the ITAA 1997 unless otherwise specified.

Section 880-105 provides that amounts of ordinary and statutory income derived by a sovereign entity are not assessable and not exempt income if certain conditions are met. Those conditions are listed in subsection 880-105(1):

(a) the sovereign entity is covered by section 880-125; and

(b) the amount is a return on any of the following kinds of interest that the sovereign entity holds in another entity (the test entity):

(i) a *membership interest;

(ii) a *debt interest;

(iii) a *non-share equity interest; and

(i) a company that is an Australian resident at the time (the income time) when the amount becomes ordinary or statutory income of the sovereign entity; or

(ii) a *managed investment trust in relation to the income year in which the income time occurs; and

(d) the *sovereign entity group of which the sovereign entity is a member satisfies the portfolio interest test in subsection (4) in relation to the test entity:

(i) at the income time; and

(ii) throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time; and

(e) the sovereign entity group of which the sovereign entity is a member does not have influence of a kind described in subsection (6) in relation to the test entity at the income time.

These conditions are considered below.

Entity One is a covered sovereign entity

Section 880-125 states:

A *sovereign entity is covered by this section if it satisfies all of the following requirements:

(a) the entity is funded solely by public monies;

(b) all returns on the entity's investments are public monies;

(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 requirements are considered below.

Entity One is a sovereign entity

For an entity to be covered by section 880-125, it must be a sovereign entity. Section 880-15 defines a sovereign entity to be any of the following:

(a) a body politic of a foreign country, or a part of a foreign country;

(b) a *foreign government agency;

(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

Entity One was established by amendment of the Constitution of the State without its own legal identity. Entity One consists of a portion of taxation revenue received by the State. The purpose of Entity One is to conserve and invest the portion of taxation revenue for the benefit of the State. Entity One is managed by Entity Two which is another State entity.

Entity One is therefore considered to be a foreign government agency under paragraph 880-15(b) as it is an authority of the State.

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

Entity One is funded solely by public monies

The phrase 'public monies' is not defined and as such takes its ordinary meaning. In the context of Division 880, this phrase essentially means monies raised by a foreign government (or part of a foreign government) for a public purpose which will often form part of the foreign government's (or part of the foreign government's) equivalent to Australia's Consolidated Revenue Fund (Roy Morgan Research Pty Ltd v FC of T & Anor [2011] HCA 35). This would ordinarily include general tax revenue, proceeds from the issue of government bonds, the proceeds of privatisations etc

Entity One consists of a portion of taxation revenue received by the State. Entity One does not have its own legal identity. The operating budget of Entity Two is to be funded from the revenue generated from Entity One's investments. Entity Two will transfer an amount to Entity One to offset the effect of inflation during that year.

Therefore, Entity One is funded solely by public monies.

All returns on Entity One's investments are public monies

All income and gains arising on the investments of Entity One are for the sole and exclusive benefit of the State. No person other than the State has the right to use, enjoy or dispose of the income and gains which arise on such investments. The operating budget of Entity Two is to be funded from the revenue generated from Entity One's investments. Entity Two will transfer an amount to Entity One to offset the effect of inflation during that year.

All of the uses for Entity One's funds are for a public purpose.

Therefore, all of Entity One's returns are public monies.

Entity One is not a partnership

Entity One is not a partnership. As such, it passes this condition.

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

Subsection 880-130(1) defines the term public non-financial entity:

An entity is a public non-financial entity if its principal activity is either or both of the following:

(a) producing or trading non-financial goods;

(b) providing services that are not financial services.

Subsection 880-130(2) defines the term public financial entity:

An entity is a public financial entity if any of the following requirements are satisfied:

(a) it trades in financial assets and liabilities;

(b) it operates commercially in the financial markets;

(i) financial intermediary services, including deposit-taking and insurance services;

(ii) financial auxiliary services, including brokerage, foreign exchange and investment management services;

(iii) capital financial institution services, including financial services in relation to assets or liabilities that are not available on open financial markets.

Entity One consists of a portion of taxation revenue received by the State. The purpose and principal activity of Entity One is to conserve and invest the portion of taxation revenue for the benefit of the State.

Entity One's principal activity is not producing or trading non-financial goods, nor is it providing services that are not financial services. Therefore, Entity One is not a public non-financial entity.

Entity One does not trade in financial assets or operate commercially in the financial markets. Entity One's principal activities do not include financial intermediary services, financial auxiliary services or capital financial institution services. Additionally, Entity One is not a type of entity listed in paragraphs 76 or 79 of LCR 2020/3. Therefore, the Commissioner accepts that Entity One is not a public financial entity.

Conclusion

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

Entity One's return is received on a relevant interest in the Test Entities

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(b), it must be a 'return on' a membership interest, debt interest or non-share equity interest held by the sovereign entity in the test entities.

As detailed in paragraph 4.37 of the Explanatory Memorandum to the Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Act 2019 ('the EM'), a 'return on' a membership interest, debt interest or non-share equity interest for the purposes of paragraph 880-105(1)(b) will include:

1. dividends - including non-share dividends and dividends that pass through a managed investment trust (MIT)

2. interest - including interest that passes through a MIT

3. fund payments made by a MIT (other than fund payments that are attributable to non-concessional MIT income), and

4. revenue gains made on the disposal of an interest in the test entity - including revenue gains that pass through a MIT.

The Test Entities comprise a portfolio of equity investments held by Entity Two on behalf of Entity One. These equity investments are membership interests in Australian resident companies and MITs. Entity One earns returns in the form of interest, dividends and/or fund payments.

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

Entity One's income is received from Australian resident companies or managed investment trusts

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(c), it must be received from an entity that is either:

(i) a company that is an Australian resident at the time (the income time) when the amount becomes ordinary or statutory income of the sovereign entity; or

(ii) a *managed investment trust in relation to the income year in which the income time occurs.

At the relevant times, each of the Test Entities listed in Appendix 1 of this Ruling was an Australian resident company or a MIT.

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

Entity One's sovereign entity group satisfies the portfolio interest test

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(d), the sovereign entity and the sovereign entity group to which it belongs must satisfy the portfolio interest test in relation to the test entities at both the income time and throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time.

The portfolio interest test is outlined in subsection 880-105(4), which states:

A *sovereign entity group satisfies the portfolio interest test in this subsection in relation to the test entity at a time if, at that time, the sum of the *total participation interests that each *member of the group holds in the test entity:

(a) is less than 10%; and

(b) would be less than 10% if, in working out the *direct participation interest that any entity holds in a company:

(i) an *equity holder were treated as a shareholder; and

(ii) the total amount contributed to the company in respect of *non-share equity interests were included in the total paid-up share capital of the company.

Section 880-20 provides the definition of sovereign entity group. Broadly, sovereign entities of the same foreign government will be members of the same sovereign entity group and sovereign entities of the same part of a foreign government will be members of the same sovereign entity group.

Entity One will form part of a sovereign entity group including the State and any entities in which the State either directly or indirectly holds 100% of the participation interests.

Entity One holds less than 10 per cent of the total participation interests in each of the Test Entities. No other entities in the sovereign entity group hold investments in Australia.

Therefore, at the relevant times (as required by paragraph 880-105(1)(d)), Entity One and its sovereign entity group collectively hold less than 10% of the total participation interests in each of the Test Entities. In addition, Entity One and its sovereign entity group collectively hold less than 10% of the total participation interests in the Test Entities in the circumstances detailed in paragraph 880-105(4)(b).

Therefore, the portfolio interest test is satisfied.

Entity One's sovereign entity group does not have influence of a kind described in subsection 880-105(6) in relation to the Test Entities at the income time

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(e), at the income time the sovereign entity group to which the sovereign entity belongs must not have influence over the test entity of a kind described in subsection 880-105(6).

Subsection 880-105(6) states:

A *sovereign entity group has influence of a kind described in this subsection in relation to the test entity at a time if any of the following requirements are satisfied at that time:

(a) a *member of the group:

(i) is directly or indirectly able to determine; or

(ii) in acting in concert with others, is directly or indirectly able to determine;

the identity of at least one of the persons who, individually or together with others, make (or might reasonably be expected to make) the decisions that comprise the control and direction of the test entity's operations;

(b) at least one of those persons is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of a member of the group (whether those directions, instructions or wishes are expressed directly or indirectly, or through the member acting in concert with others).

As such, there are two distinct sub-tests within the influence test.

Sub-test 1 of the influence test, as contained in paragraph 880-105(6)(a), assesses whether the sovereign entity group is able to determine the identity of at least one of the persons who, individually or together with others, makes or is reasonably expected to make, decisions comprising the control and direction of the test entity's operations. This includes situations where the sovereign entity group is able to act in concert with others to determine the identity of a relevant decision-maker in the test entity.

Sub-test 1 also extends to situations where the sovereign entity group, in its own right, holds the ability to approve or veto decisions which go to the control or direction of the test entity.

Entity One's interests in the Test Entities have the characteristics outlined in fact 17. Entity One's interests do not provide it with an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations. Furthermore, Entity One's interests, when combined with the other interests held within its sovereign entity group, do not provide an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations.

Sub-test 2 of the influence test, as contained in paragraph 880-105(6)(b), assesses whether at least one of the relevant decision-making persons of the test entity is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of the sovereign entity group.

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

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

Conclusion

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

Question 2

Is any capital gain or loss made by Entity One, in respect of its Australian investments listed in Appendix 1 of this Ruling, disregarded under section 880-115 and section 880-120 of the ITAA 1997?

Summary

Entity One will be required to disregard any capital gain or loss made in respect of its ownership interests in the Test Entities under sections 880-115 and 880-120 of the ITAA 1997.

Detailed Reasoning

All legislative references in Question 2 refer to the ITAA 1997 unless otherwise specified.

Section 880-115 provides that a sovereign entity disregards a capital gain from a CGT event that happens in relation to a CGT asset if:

(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

(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.

Section 880-120 provides that a sovereign entity disregards a capital loss from a CGT event if, on the assumption that the loss were a capital gain, the capital gain would be disregarded because of section 880-115.

As established in Question 1, Entity One:

• is covered by section 880-125,

• holds membership interests in the Test Entities, and

• satisfies the requirements in paragraphs 880-105(1)(c), (d) and (e) in relation to ordinary or statutory income that it will derive from the Test Entities.

Therefore, Entity One will be required to disregard any capital gain or loss made in respect of its ownership interests in the Test Entities.

Question 3

Does paragraph 128B(3)(n) of the ITAA 1936 apply to exclude Entity One from liability to withholding tax on income derived from Australian investments listed in Appendix 1 of this Ruling, that is not assessable and not exempt income due to the operation of Division 880 of the ITAA 1997?

Summary

The exclusion to liability under subsection 128B(3)(n) of the ITAA 1936 will apply to the income derived by Entity One from the investments listed in Appendix 1 of this Ruling, to the same extent that Division 880 of the ITAA 1997 applies.

Detailed Reasoning

All legislative references in Question 3 refer to the ITAA 1936 unless otherwise specified.

Paragraph 128B(3)(n) provides an exclusion from withholding tax on income that is non-assessable non-exempt income because of Division 880 of the ITAA 1997or Division 880 of the Income Tax (Transitional Provisions) Act 1997.

As stated in Question 1, income derived from investments listed in Appendix 1 of this Ruling is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997.

Therefore, to the extent that Division 880 of the ITAA 1997 applies to income derived by Entity One from its investments listed in Appendix 1, so will the exclusion from liability under subsection 128B(3)(n).

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