Edited version of private advice

Authorisation Number: 1051844185136

Date of advice: 9 June 2021

Ruling

Subject: Sovereign immunity

Question

Is the ordinary and statutory income derived by Govsub Co in its capacity holding assets on trust for the Government of Country A (Gov Trust) from the Loan Notes it holds that were issued by AusCo on XX/XX/XXXX not assessable and not exempt income under section 880-105 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If

your circumstances are materially different from these facts, this ruling has no effect and you

cannot rely on it. The fact sheet has more information about relying on your private ruling.

Statutory Body of Country A

1.    Statutory Body was established under statute in Country A to own and administer assets of the government of Country A (the Government). It is a corporation and a legal person capable of suing and being sued and has the ability to hold title to movable and immovable property.

2.    Statutory Body owns 100% of the shares in a number of entities, including GovCo.

3.    GovCo is a company incorporated in Country A and is a resident of Country A for income tax purposes.

4.    GovCo owns 100% of the shares in Govsub Co

Gov Trust

5.    Govsub Co is a company incorporated in Country A and is a resident of Country A for tax purposes.

6.    Govsub Co's business activity is to hold the AusCo Loan Notes. Govsub Co holds these assets on trust for the Government (Gov Trust). A Declaration of Trust provides that all the rights and interests in any and all assets of Govsub Co shall be held by Govsub Co on trust for the Government and that Govsub Co has no beneficial interest in the assets.

7.    Gov Trust (i.e. the trust created by Govsub Co holding loan notes on trust for the Government and not Govsub Co in its capacity as a company) is an entity under paragraph 960-100 of the ITAA 1997 (i.e. a trust) and is not a resident of Australia for income tax purposes, is not a resident trust estate as defined in Part III of the Income Tax Assessment Act 1936 (ITAA 1936) and is not a partnership under section 6 of the ITAA 1936.

8.    Gov Trust does not actively trade in financial assets and liabilities or operate commercially in financial markets or provide services listed in paragraph 880-130(2)(c) of the ITAA 1997.

9.    Gov Trust is wholly funded by the Government. The sources of the Government funds are sourced from public monies.

10.  The moneys invested, and the returns on those moneys are, and will remain, funds beneficially owned by the Government.

11.  There are no third-party borrowings entered into by the above entities.

12.  The Government is beneficially entitled to all of the income from the assets which Gov Trust holds on trust for the Government.

AusCo Loan Notes

13.  Gov Trust has acquired and is proposing to acquire a further interest in Loan Notes issued by AusCo.

14.  AusCo is wholly owned by the trustee of AusParent Trust.

15.  The terms of the AusCo Loan Notes include:

a.    Interest accrues daily;

b.    If the notes are not repaid, AusCo agrees to pay interest on the unpaid amount at the then applicable Default rate;

16.  Gov Trust will receive an interest return which is based on the Australian Bank Bill swap rate.

17.  Gov Trust will receive a principal amount of the Loan Notes at the maturity date.

18.  The Loan Notes do not give Gov Trust or any other entity within the sovereign entity group of Gov Trust the right to appoint a person to a board, committee or similar, of AusCo or AusParent Trust, either directly or indirectly.

19.  Neither Gov Trust, nor, to the best of Gov Trust's knowledge, any member of the same sovereign entity group, entered into or received any side letters, arrangements or agreements with AusCo.

20.  Gov Trust can only vote on issues that materially and adversely affects the rights or interests of Gov Trust in relation to the terms of the Loan Notes themselves. These issues are typical debt security holder rights as opposed to rights comprising the control and direction of the operations of AusCo and AusParent Trust.

21.  Neither Gov Trust, nor any member of the same sovereign entity group, hold any other influence potentially of a kind described in subsection 880-105(6) of the ITAA 1997 over AusCo.

22.  Govsub Co also holds, on trust for the Government, another set of loan notes issued by an unrelated Australian Issuer.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 880

Reasons for Decision

Question 1

Is the ordinary and statutory income derived by Gov Trust from the loan notes it holds that were issued by AusCo on XX/XX/XXXX not assessable and not exempt income under section 880-105 of the ITAA 1997?

Summary

All of the conditions listed in subsection 880-105(1) have been satisfied in relation to Gov Trust's investments in the AusCo Loan Notes. As such, subsection 880-105(1) will apply to the effect that amounts of ordinary and statutory income derived by Gov Trust from its investments in AusCo Loan Notes are not assessable and not exempt income.

Detailed reasoning

All legislative references are to the ITAA 1997 unless stated otherwise.

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

(c)   the test entity is:

i.      a company that is an Australia 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.

Gov Trust 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;

(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

Gov Trust 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 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.

Section 960-180 provides than 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.

Section 960-190 provides that as Gov Trust is a trust (within the meaning of Part X of the ITAA 1936), the direct control interest (within the meaning of section 351 of the ITAA 1936) is relevant to determine the direct participation interest that the government of Country A holds in Gov Trust.

Section 351 of the ITAA 1936 provides that an entity that is a beneficiary in a trust holds a direct control interest in the trust at a particular time equal to the percentage of the income or corpus of the trust represented by the share of the income or corpus to which the beneficiary is entitled, of that the beneficiary is entitled to acquire.

The government of Country A is a body politic of a foreign country.

As the sole beneficiary of the trust with rights to all its income and corpus, the Government, has a 100% direct control interest in Gov Trust and therefore holds a participation interest of 100% in Gov Trust.

Gov Trust is not an Australian resident and is not a resident trust estate for the purposes of Division 6 of Part III of the ITAA 1936.

As such, Gov Trust meets the requirements of being a sovereign entity in accordance with paragraph 880-15(c)

Gov Trust is funded solely by public monies

The phrase 'public monies' is not defined and as such take 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 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.

Gov Trust receives its funds from the Government. The sources of funds include proceeds from Government securities, budget surpluses and proceeds from Government asset sales.

As such, Gov Trust is funded solely by public monies.

All returns on Gov Trust's investments are public monies

The government of Country A is beneficially entitled to all of the income from the assets which Gov Trust holds on trust for Country A, including AusCo Loan Notes. As such, all returns on Gov Trust's investments will be paid to the government of Country A, making them public monies.

Gov Trust is not a partnership

Gov Trust is a trust. It is not a partnership under subsection 6(1) of the ITAA 1936. Gov Trust therefore satisfies this requirement.

Gov Trust 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;

(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 services in relation to assets or liabilities that are not available on open financial markets.

It is noted that subparagraph 880-125(d)(ii) excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

While Govsub Co holds, on trust for Country A, another set of residential mortgage backed securities issued by an unrelated Australian issuer, it is considered that neither Govsub Co, nor Gov Trust as a trust entity, produces or trades non-financial goods and does not provide services that are not financial services. Gov Trust does not actively trade in financial assets and liabilities, operate commercially in financial markets or provide services listed is paragraph 880-130(2)(c).

As such, Gov Trust does not meet either definition of being a public non-financial or financial entity satisfying the condition 880-125(d).

As Gov Trust satisfied 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).

Gov Trust's return is received on 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.

AusCo, being the test entity, is a company which has issued loan notes, (a debt interest), to investors including Gov Trust. Gov Trust receives interest income as a return on this debt interest.

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

Gov Trust'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.

AusCo, as the issuer of the loan notes, pays interest to Gov Trust. AusCo is an Australian resident company.

As such, Gov Trust receives income from an entity which satisfied the requirements of paragraph 880-105(1)(c).

Gov Trust'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 entity 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 the 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 an 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.

Neither Gov Trust nor any members of its sovereign entity group hold any direct or indirect participation interests in AusCo. As such, paragraph 880-105(1)(d) is satisfied.

Gov Trust's sovereign entity group does not have influence of a kind described in subsection (6)

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 the 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 88-105(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 directions, instructions or wishes of the sovereign entity group.

The holding of the AusCo Loan Notes do not give Gov Trust, directly or indirectly, or acting in concert with others, any ability to appoint, control or influence any person that has the ability to participate in or influence decisions that comprise the control and direction of AusCo. There are no rights to appoint a person to a board, committee or similar, either directly or indirectly to AusCo. Additionally, Gov Trust had not entered into or received any side letters, arrangements or agreements involving their investment into AusCo loan notes. All of the above points regarding influence are true with respect to all members of Gov Trust's sovereign entity group. The voting rights that Gov Trust does hold relate to the terms of the loan notes themselves and do not relate to the management of the operations of any entity.

Based upon the above, the sovereign entity group of Gov Trust 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 interest income derived by Gov Trust from its investments in the AusCo loan notes issued on XX/XX/XXXX are not assessable and not exempt income.

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