Edited version of private advice

Authorisation Number: 1051841629100

Date of advice: 11 June 2021

Ruling

Subject: Taxability of investment gains

Question 1

Will gains derived by the Bank from the disposal or redemption of its Commonwealth Bonds be non-assessable non-exempt income under subsection 842-215(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Does subparagraph 128B(3)(h)(iv) of Income Tax Assessment Act 1936 (ITAA 1936) apply to exclude the Bank from liability to withholding tax on interest income from its Commonwealth Bonds?

Answer

Yes

This ruling applied for the following periods:

1 July 20XX to 30 June XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

The Bank is the central bank of Country A.

The Bank receives all Government revenues and pays out funds in accordance with the Government's instructions.

The Bank does not have share capital and must repay its entire capital to the Government.

The Bank is not a partnership.

The Bank is controlled by a board of directors.

The Bank's objectives and functions align with it only carrying out activities that are consistent with the Bank being an entity that only carries on central banking activities.

The Bank's activities are conducted primarily using funds belonging to the Government and/or its constituent entities, as well as funding from financial institutions licenced by the Bank, funds are received in the course of it carrying out functions of the Government Bank. The Bank's activities are not financed by any funds or assets belonging to or held for the benefit of any private individual or entity.

The Bank is not a resident for the purposes of subsection 6(1) of the ITAA 1936.

The Bank does not have a permanent establishment in Australia, and it does not carry on a trading business in Australia.

The Bank has appointed persons to facilitate trading in Australia listed debt and equity securities issued by Australian resident companies or managed investment trusts (MITs). Relevantly, the Bank also owns Australian Government Bonds issued by the Commonwealth of Australia (Commonwealth Bonds).

Reasons for Decision

Question 1

Will gains derived by the Bank from the disposal or redemption of its Commonwealth Bonds be non-assessable non-exempt income under subsection 842-215(1) of the ITAA 1997?

Detailed reasoning

Subdivision 842-I of the ITAA 1997 sets out the rules regarding the taxation of some foreign residents (known as IMR entities) that invest into or through Australia.

Subsection 842-215(1) of the ITAA 1997 relevantly states that where an entity is an 'IMR entity' relation to an 'IMR financial arrangement' for an income year, what would otherwise be the entity's assessable income for the year is non-assessable non-exempt income to the extent that it is attributable to a return or gain from the entity disposing of, ceasing to own or otherwise realising the IMR financial arrangement, provided that the requirements in subsection 842-215(3) of the ITAA 1997 are satisfied for that year.

The Bank's gains from the disposal or redemption of its Commonwealth Bonds will be non-assessable non-exempt income pursuant to section 842-215(1) of the ITAA 1997 if it meets the relevant requirements.

IMR Entity

Section 842-220 of the ITAA 1997 provides the meaning of the term 'IMR entity'. An entity will be an 'IMR entity' for an income year if the entity (i) is not an Australian resident at all times during the income year, and (ii) is not a resident trust for CGT purpose for the income year. As the Bank is not an Australian resident, and is also not a trust, it will be an IMR entity at all relevant times.

IMR Financial Arrangement

An 'IMR financial arrangement' is defined in section 842-225 of the ITTA 1997 to be 'financial arrangement' (as defined in section 230-45 of the ITAA 1997) that is not and does not relate to 'taxable Australian real property' (being broadly Australian land or an Australian mining quarrying or prospecting right) or an 'indirect Australian real property interest' (being a membership interest in certain entities).

Subsection 842-215(3) requirements

The Bank must also meet the requirements of subsection 842-215(3) of the ITAA 1997 as stated below:

The requirements of this subsection in relation to the year are that:

(a)  During the whole of the year, the IMR entity is an IMR widely held entity; and

(b)  During the whole of the year, the interest of the entity in the issuer of, or counterparty to, IMR financial arrangement does not pass the non-portfolio interest test (see section 960-195); and

(c)   None of the return, gains or losses for the year from the arrangement are attributable to:

i.      If the entity is a resident of a country that has entered into an international tax agreement with Australia containing a permanent establishment article - a permanent establishment (within the meaning of the relevant international tax agreement) of the entity in Australia; or

ii.     Otherwise - a permanent establishment of the entity in Australia; and

(d)  The IMR entity does not, during the year, carry on in Australia a trading business (within the meaning of section 102M of the Income Tax Assessment Act 1936) that relates (directly or indirectly) to the arrangement; and

(e)  Subsection 842-225(2) does not apply to the IMR financial arrangement.

Requirement (a) - IMR widely held entity

An 'IMR widely held entity' is relevantly defined in section 842-230 of ITAA 1997 to include an entity that is covered by paragraph 275-20(4)(h) of the ITAA 1997.

Below considers whether the Bank is an entity under paragraph 275-20(4)(h) of the ITAA 1997, being:

An investment entity that satisfies all of these requirements:

i.              The entity is wholly-owned by one or more foreign government agencies, or is wholly-owned subsidiary of one or more foreign government agencies;

ii.             The entity is established using only the public money or the public property of the foreign government concerned;

iii.            All economic benefits obtained by the entity have passed, or are expected to pass, to the foreign government concerned.

Each of these requirements are considered below:

An Investment Entity

Subsection 960-100(1) of the ITAA 1997 defines the term 'entity' as follows:

(1)  Entity means any of the following:

a.    An individual;

b.    A body corporate;

c.     A body politics;

d.    A partnership;

e.    Any other unincorporated associated or body persons;

f.      A trust;

g.    A superannuation fund;

The Bank is the central bank of the foreign country. The Bank satisfied the definition in subsection 960-100(1) of the ITAA 1997. The Bank is engaged in investment activities and it is therefore considered an investment entity for the purposes of paragraph 275-20(4)(h) of the ITAA 1997.

Wholly Owned by Foreign Government Agencies

Subsection 995-1(1) of the ITAA 1997 states:

Foreign government agency means:

(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.

The Bank is created and governed by law. The Bank was incorporated pursuant to its Charter. The Government of Country A satisfies paragraph (a) of the definition of foreign government agency. The Bank receives all Government revenues and pays out funds in accordance with the Government's instructions. The Bank does not have share capital and it must repay its entire capital to the Government.

Therefore, the Bank is considered wholly owned by a foreign government agency and satisfies subparagraph 275-20(4)(h)(i) of the ITAA 1997.

Public Monies

The public monies condition requires that the entity must be established by using only public, or governmental, monies or property of the foreign government, rather than private money or property, or money or property accruing to the benefit of individuals or other entities in a private capacity.

The Bank does not have share capital and must repay its entire capital to the Government.

Therefore, all economic benefits obtained by the Bank are established using only the public money or the public property of the government and satisfies subparagraph 275-20(4)(h)(ii) of the ITAA 1997.

Economic benefits pass to foreign government

The Bank does not have share capital and must repay its entire capital to the Government. Therefore, all economic benefits obtained by the Bank will pass or are expected to pass, to the Government. Subparagraph 275-20(4)(h)(iii) of the ITAA 1997 is satisfied.

The Bank is therefore an entity that is covered by paragraph 275-20(4)(h) of the ITAA 1997 and is an 'IMR widely held entity' as defined in section 842-230 of ITAA 1997.

The Bank is considered an IMR widely held entity for the relevant income year, it satisfies paragraph 842-215(3)(a) of the ITAA 1997.

Requirement (b) - it is not possible for either the Bank or its associates to hold a direct or indirect participation interest in the Commonwealth therefore it satisfies paragraph 842-15(3)(b) of the ITAA 1997.

Requirement (c) - The Bank does not have a fixed place at or through which it carries on business in Australia, nor does it have an agent in Australia with the general authority to negotiate or conclude contracts on its behalf. The Bank does not have a permanent establishment in Australia so none of the returns, gains or losses from the arrangement are attributable to permanent establishment. It therefore satisfies paragraph 842-215(3)(c) of the ITAA 1997.

Requirement (d) - The bank does not carry on trading business within the meaning of section 102M of ITAA 1936. The Bank is not carrying on a business that relates to the Commonwealth Bonds. It therefore satisfies paragraph 842-215(3)(d) of the ITAA 1997.

Requirement (e) - the requirement in subsection 842-225(2) of the ITAA 1997 concerns whether certain underwriting arrangements that are not financial arrangements are considered to be 'IMR financial arrangements'. Paragraph 842-215(3)(e) of the ITAA 1997 does not apply to the Bank as the Commonwealth Bonds are not sub-underwriting arrangements.

As the requirements of subsection 842-215(3) of the ITAA 1997 are satisfied, any gain the Bank makes from the disposal or redemption of its Commonwealth Bonds that would otherwise be assessable income, will not be non-assessable non-exempt income pursuant to subsection 842-215(1) of the ITAA 1997.

Taxation of Financial Arrangements (TOFA)

Section 230-15 of the ITAA 1997 operates to make gains from financial arrangements assessable income and losses from financial arrangements deductible. In respect of section 230-15 of the ITAA 1997, it is noted that there is an explicit exemption from its operation in section 230-30 of the ITAA 1997. For completeness, it is noted that section 230-30 of the ITAA 1997 applies if the gain on disposal or redemption of the Commonwealth Bonds are non-assessable and non-exempt income.

As the gain on disposal or redemption of the Commonwealth Bonds would be treated or reasonably expected to be treated, as non-assessable non-exempt income under a provision of the Act, that being section 842-215 of ITAA 1997, the gain is not assessable under section 230-15 of the ITAA 1997 due to the operation of section 230-30 of the ITAA 1997.

Conclusion

As the requirements of subsection 842-215(3) are satisfied, any gains the Bank makes from the disposal or redemption of its Commonwealth Bonds that would otherwise be assessable income under the ITAA 1936 or ITAA 1997, such as pursuant to section 230-15 of the ITAA 1997 or section 26BB of the ITAA 1936, will instead be non-assessable non-exempt income pursuant to subsection 842-215(1) of the ITAA 1997.

Question 2

Does subparagraph 128B(3)(h)(iv) of the ITAA 1936 apply to exclude the Bank from liability to withholding tax on interest income from its Commonwealth Bonds?

Answer

Yes

Detailed Reasoning

All legislative references in Question 2 refer to the ITAA 1936 unless otherwise specified.

Section 128B deals with liability to withholding tax for certain income including income that consists of interest paid by Australian residents to non-residents. Subsection 128B(3) lists certain types of income to which liability to withholding tax under section 128B does not apply. Subparagraph 128B(h)(iv) provides that section 128B does not apply to interest income that applies to which section 128F applies.

Section 128F provides an exemption from withholding tax for certain publicly offered company debentures or debt interests. The exemption applies if the conditions in subsection 128F(1) are satisfied and subsections (5) and (6) do not apply.

Subsection 128F(1) provides that section 128F applies to interest to paid by a company in respect of certain publicly offered debentures and debt interests if:

a.    The company was a resident of Australia when it issued the debenture or debt interest; and

b.    The company is a resident of Australia when the interest is paid; and

c.     For a debt interest other than a debenture - the debt interest:

                      i.        Is a non-equity share; or

                     ii.        Consists of two or more related schemes (within the meaning of the Income Tax Assessment Act 1997) where one or more of them is a non-equity share; or

                    iii.        Is a syndicated loan; or

                   iv.        Is prescribed by the regulations of this section and

d.    Either

                      i.        The issue of the debenture or dent interest satisfied the public offer test set out in subsection (3) or (4); or

                     ii.        For a syndicated loan - the invitation to become a lender under the relevant syndicated loan facility satisfied the public offer test set out in subsection (3A).

Subsection 6(1) defines a debenture as:

'debenture' in relation to a company, includes debenture stock, bonds, notes and any other securities of the company, whether constituting a charge on the assets of the company or not.

The Commonwealth Bonds held by the Bank are debentures for the purposes of section 128F.

Subsection 128F(7) treats the Commonwealth or an authority of the Commonwealth as if the Commonwealth or authority were a company and a resident of Australia. Pursuant to subsection 128F(7), the Commonwealth Bonds held by the Bank will be deemed to be issued by, and interest on the Commonwealth Bonds will be deemed to be paid by, an Australian resident company.

It is assumed that all the Commonwealth Bonds held by the Bank are issued in accordance with 128F(3) and or 128F(4). Additionally it is assumed that subsection 128F(5) does not apply.

The Bank is not an 'associate', as defined by subsection 128F(9), of the Commonwealth for the purposes of 128F(6). That is, the Bank nor any of its associates have influence or have a majority voting interest in the Commonwealth. The Commonwealth nor any of its associates have influence or have a majority voting interest in the Bank.

Conclusion

As subsection 128F(1) is satisfied and subsection (5) and (6) do not apply, section 128F applies to the interest paid to the Bank in respect of the Commonwealth Bonds. Therefore, no tax is payable under Division 11A pursuant to subsection 128F(2).

Therefore, the Bank is excluded from liability to withholding tax on interest that is paid to it from the Commonwealth Bonds pursuant to subparagraph 128B(3)(h)(iv).

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