Edited version of private advice

Authorisation Number: 1052150267728

Date of advice: 2 August 2023

Ruling

Subject: International issues - sovereign immunity

Question 1

Is the ordinary and statutory income derived by Foreign Bank from its Australian investments (the Test Entities) not assessable income and not exempt income under section 880-105 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20YY

Year ended 30 June 20YY

Year ended 30 June 20YY

Year ended 30 June 20YY

Year ended 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

1.    Foreign Bank is the central bank of Country A established under the Foreign Bank Act (the Act) and the Constitution of Country A (the Constitution).

2.    Foreign Bank has legal personality, the right to use a seal bearing the national emblem and is not subject to entry into the register of state enterprises. The activity of Foreign Bank is conducted in Country A. The registered office of Foreign Bank is in Country A.

3.    Foreign Bank is exempt from taxes and stamp duty in Country A.

4.    The basic objective of the activity of Foreign Bank is to maintain price stability, while supporting the economic policy of the Government of Country A. Foreign Bank's role is to formulate and implement monetary policy and is responsible for issuing and protecting the value of the currency of Country A.

5.    The activities of Foreign Bank include managing the foreign exchange reserves, conducting foreign exchange activities, providing banking services to the state budget and regulating the liquidity of the banks and providing them with refinancing facilities.

6.    Foreign Bank has the exclusive right to issue the currency of Country A.

Foreign Bank finances

7.    Foreign Bank is funded solely by public monies.

8.    Foreign Bank cannot be declared bankrupt.

9.    A portion of the annual profit of Foreign Bank shall be remitted to the Government of Country A.

Foreign Bank Australian investments

10.  Foreign Bank proposes to hold membership interests in the Test Entities. These interests will be beneficially owned by Foreign Bank.These membership interests have the following characteristics:

(a)  All Test Entities in which Foreign Bank proposes to make invests into are listed on the Australian Securities Exchange (ASX).

(b)  Foreign Bank, and, to the best of Foreign Bank's knowledge, its sovereign entity group, will hold collectively less than 10% of the total participation interests in each of the Test Entities.

(c)   Foreign Bank, and, to the best of Foreign Bank's knowledge, its sovereign entity group, will hold collectively less than 10% of the total participation interests in each of the Test Entities in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997.

(d)  Neither Foreign Bank nor, to the best of the Foreign Bank's knowledge, any members of its sovereign entity group will have involvement in the day to day management of the business of any of the Test Entities.

(e)  Neither Foreign Bank nor, to the best of the Foreign Bank's knowledge, any members of its sovereign entity group will have the right to appoint a director to the Board of Directors of any of the Test Entities.

(f)    Neither Foreign Bank nor, to the best of the Foreign Bank's knowledge, any members of its sovereign entity group will hold the right to representation on any investor representative or advisory committee (or similar) of the Test Entities.

(g)  Neither Foreign Bank nor, to the best of Foreign Bank's knowledge, any members of its sovereign entity group will have the ability to direct or influence the operation of the Test Entities outside of the ordinary rights conferred by the membership interest held.

(h)  Foreign Bank will only hold rights to vote in proportion of its membership interest in the investment.

(i)    To the best of Foreign Bank's knowledge, when combined with the other interests held within its sovereign entity group, its interests will not provide it or the sovereign entity group 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 will be accustomed or obliged to act in accordance with the directions, instructions or wishes of Foreign Bank, or, to the best of the Foreign Bank's knowledge, Foreign Bank's sovereign entity group.

11.  The Test Entities are managed investment trusts (MITs).

12.  Foreign Bank's interest in the Test Entities may give rise to Australian dividend income, interest income and/or other types of income, including fund payments made by a MIT.

13.  The returns achieved by Foreign Bank from investing in the Test Entities will not belong to the Government of Country A per se. The invested funds will belong to Foreign Bank as the beneficial owner. Achieving these returns results from pursuing public tasks which are imposed on the Foreign Bank under the Constitution and the Act.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 880-105

Reasons for decision

Section 880-105 of the ITAA 1997 provides that amounts of ordinary and statutory income derived by a sovereign entity are not assessable income 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 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.

Foreign Bank 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.

Foreign Bank 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.

Relevantly, 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.

The term 'authority' is not defined and therefore takes its ordinary meaning. The Macquarie Dictionary states that 'authority' means:

noun (plural authorities)

1. the right to determine, adjudicate, or otherwise settle issues or disputes; the right to control, command, or determine.

2. a person or body with such rights.

Foreign Bank was established as the central bank of Country A under the Act and the Constitution. Foreign Bank's mandated objective under the Act and the Constitution is to maintain price stability, while supporting the economic policy of the Government of Country A. Foreign Bank's role is to formulate and implement monetary policy and is responsible for issuing and protecting the value of the currency of County A.

Foreign Bank has legal personality, the right to use a seal bearing the national emblem and is not subject to entry into the register of state enterprises. The activity of Foreign Bank is conducted in Country A. The registered office of Foreign Bank is in Country A

Therefore, Foreign Bank meets the requirements of being a sovereign entity in accordance with paragraph 880-15(b) of the ITAA 1997 as an authority of the government of a foreign country.

Foreign Bank is funded solely by public monies

Law Companion Ruling LCR 2020/3 - The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2020/3) provides guidance on the term 'public monies'.

In the context of Division 880 of the ITAA 1997, LCR 2020/3 provides at paragraph 54, that this phrase essentially means monies of a foreign government (or part of a foreign government) held 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.

Foreign Bank is funded solely by public monies.

Therefore, Foreign Bank is funded solely by public monies and satisfies this requirement.

All returns on Foreign Bank's investments are public monies

The returns achieved by Foreign Bank from investing in the Test Entities will not belong to the Government of Country A per se. The invested funds will belong to Foreign Bank as the beneficial owner (which may be used for re-investment purposes). Achieving these returns results from pursuing public tasks which are imposed on the Foreign Bank under the Constitution and the Act and are conducted to ensure the safety of foreign exchange operations.

Therefore, the monies that are invested by Foreign Bank are and will remain public monies. Foreign Bank satisfies this requirement.

Foreign Bank is not a partnership

Foreign Bank is the central bank of Country A established with its own legal personality under the Act and is not a partnership.

Therefore, Foreign Bank satisfies this requirement.

Foreign Bank 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.

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.

Paragraph 79 of LCR 2020/3 lists common examples of public financial entities which includes banks and deposit taking corporations. As Foreign Bank is the central bank of Country A established under the Act, it is a public financial entity. However subparagraph 880-125(d)(ii) excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

Paragraph 81 of LCR 2020/3 lists inclusively the following as 'central banking activities':

•         monetary policy development

•         issuing national currency

•         acting as custodian of international reserves, and

•         providing banking services to government.

Foreign Bank's mandated objective under the Act and the Constitution is to maintain price stability, while supporting the economic policy of the Government of Country A. Foreign Bank's role is to formulate and implement monetary policy and is responsible for issuing and protecting the value of the currency of Country A.

It is considered that all of the activities of Foreign Bank are consistent with Foreign Bank being an entity that only carries on central banking activities. Therefore, Foreign Bank satisfies the requirement in paragraph 880-125(d) of the ITAA 1997.

As Foreign Bank satisfies each of the requirements in paragraphs 880-125(a) through (d) of the ITAA 1997, Foreign Bank is a sovereign entity that is covered by section 880-125 for the purposes of section 880-105 of the ITAA 1997.

Foreign Bank's return will be received on a relevant interest in the Test Entity

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) 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.

Foreign Bank proposes to acquire membership interests in the Test Entities from which it will likely receive Australian dividend income, interest income and/or other types of income, including fund payments made by a MIT as a return on its interests in the Test Entities.

Therefore, amounts received by Foreign Bank satisfy the requirements of paragraph 880-105(1)(b) of the ITAA 1997.

Foreign Bank's income will be 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 all MITs listed on the ASX.

Therefore, Foreign Bank will receive income from an entity which satisfies the requirements of paragraph 880-105(1)(c) of the ITAA 1997.

Foreign Bank'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 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) 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 Bank is part of the sovereign entity group of the Government of Country A. At the relevant times (as required by paragraph 880-105(1)(d) of the ITAA 1997), Foreign Bank and its sovereign entity group collectively, will hold less than 10% of the total participation interests in each of the Test Entities and will hold 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.

Therefore, the requirements of paragraph 880-105(d) of the ITAA 1997 are satisfied.

Foreign Bank's sovereign entity group will not have influence of a kind described in subsection (6) in relation to the Test Entity 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 is contained in paragraph 880-105(6)(a) of the ITAA 1997 and assesses whether the sovereign entity group is able to directly or indirectly 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. 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.

Foreign Bank's proposed interests in the Test Entities will not provide it with an entitlement to either directly or indirectly determine the identity of any person who makes decisions that comprise the control and direction of the Test Entity's operations. Furthermore, Foreign Bank's interest, when combined with those of its sovereign entity group, will not provide its sovereign entity group with an entitlement to either directly or indirectly determine the identity of any person who makes decisions that comprise the control and direction of the Test Entity's operations.

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 each of the Test Entities operations will be accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of Foreign Bank or its sovereign entity group.

Based upon the above, the sovereign entity group of Foreign Bank 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 such that amounts of ordinary and statutory income derived by Foreign Bank from its investments in the Test Entities are not assessable income and not exempt income.

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