Edited version of private advice

Authorisation Number: 1052230900839

Date of advice: 12 March 2024

Ruling

Subject: International issues ~ Sovereign immunity

Question

Is the ordinary and statutory income derived by Company A from its interests held in the Test Entities not assessable income and not exempt income under section 880-105 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

Relevant facts and circumstances

The scheme that is the subject of this Ruling is described below.

Company A

1.    Company A is a public institution owned, established and supervised by the Government of Country X ('the Government'). It is an independent government investment institution created by law.

2.    Company A is established as an independent legal identity.

3.    Company A manages a global investment portfolio in a wide range of asset classes.

4.    Company A's international investment portfolio is professionally managed with a majority of Company A funds being managed by external investment managers and the balance managed internally.

5.    Company A's primary objective is to invest funds and deliver sustained long-term financial returns so the government can provide for Country X's current and future welfare. Company A receives its funds from the Government's financial surplus to its budgetary and other funding requirements. Company A is responsible for receiving the funds of the Government earmarked for investment under law.

6.    Company A carries out its investment program independently and without reference to the Government or other entities that also invest funds on the Government's behalf.

7.    Any reference in this Ruling to a related party of Company A is to exclude any other government-owned entity and any entities owned by such entity that invest funds on behalf of the Government where the investment program of those entities is carried out independently to Company A, its subsidiaries or any entity Company A holds an interest in.

8.    Company A's Board of Directors' decisions are made on a majority of votes, with the chairman having the deciding vote.

9.    The Board of Directors approves Company A's budget.

10. The Managing Director implements the Board of Directors' directions and proposes investment strategies and policies for their approval. The Investment Committee advises the Managing Director.

11. No Director may have a direct or indirect interest in contracts, projects and transactions entered into by Company A.

12. Any monies given to Company A, or income made by Company A, are ultimately owned by the Government. The Government is able to recall any monies of Company A or its subsidiaries at any time. In the event Company A is liquidated or dissolved, all assets and monies will flow back to the Government.

13. Company A is to have full power to act and carry out a number of actions, including:

a.            Formulating and implementing Country X's investment policy.

b.            Appointing investment managers and determining the scope of their powers.

c.             Exercising all its voting rights regarding any investments.

14. Company A has reporting requirements to the Government.

15. Company A is not a partnership.

16. Company A is not a resident of Australia for Australian income tax purposes.

17. Company A and all its establishments and companies are exempt from taxes in Country X.

18. Company A is not in the business of trading in equity and debt securities with the intent of deriving profits from the buying and selling of securities.

19. Company A does not produce or trade non-financial goods. Investments made by Company A in Australia are principally equity interests, debt interests and derivatives.

20. Company A does not provide non-financial services.

21. Company A does not provide services or undertake any other activities.

Australian investments

22. The majority of Company A's international investments are small stakes in companies and trusts that involve no control rights, no board seats and no involvement in the management or direction of the entities in which they invest. Company A manages a substantial global diversified portfolio of holdings across sectors, geographies and asset classes including public listed equities, fixed income, real estate, infrastructure, alternative investments and private equity.

23. Company A's investment decisions are based solely on economic objectives. This includes delivering sustained long-term fixed returns. Company A's international investment portfolio is professionally managed with a majority of Company A's funds being managed by external investment managers and the balance managed internally.

24. Company A currently holds a number of direct equity investments in Australia including interests in Australian listed companies. Company A also directly holds a number of Commonwealth and State government bonds, corporate debt securities, and derivatives.

25. The equity interests held by Company A are all in Australian resident companies or managed investment trusts.

26. The equity interests held by Company A all have the following characteristics:

a)            All securities are listed on the Australian Securities Exchange ('ASX') or another recognised stock exchange

b)            Company A and all members of its sovereign entity group, to the best of its knowledge, hold collectively less than 10% of the total participation interests in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997

c)            Neither Company A, nor any members of its sovereign entity group, has any involvement in the day to day management of the Test Entity

d)            Neither Company A, nor any members of its sovereign entity group, has any right to representation on the board of directors of any of the Test Entities

e)            Neither Company A, nor any members of its sovereign entity group, has any right to representation on any investor representative or advisory committee (or similar) of any Test Entity, and

f)             Neither Company A, 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

g)            Company A's interests in the Test Entities do 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 Entities' operations

h)            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 Company A or members of Company A's sovereign entity group.

27. The debt investments Company A hold are a mixture of bonds, deposit certificates, and commercial papers.

28. These debt interests that Company A hold in Australian Test Entities have the following characteristics:

a)            The debt securities provide no rights to representation, no voting rights, and no ability to influence the Test Entity

b)            The debt securities have broad financial covenants, and do not allow Company A or its sovereign entity group to have any influence or control over the debt issuer's management. The covenants are in accordance with industry standard

c)            The debt securities do not provide any right or option for conversion to equity at any time, and

d)            The debt interests do not otherwise give Company A or its sovereign entity group any other influence in the Test Entities potentially of a kind described in subsection 880-105(6) of the ITAA 1997.

29. Financial derivatives are held in the form of Australian Treasury bond futures and ASX Index futures. The purpose of the derivative investments is to obtain market exposure through exchanged traded futures.

30. Company A is currently in receipt of the following types of Australian source income:

a)            Interest income

b)            Franked dividend income

c)            Unfranked dividend income, and

d)            Australian sourced capital gains income.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Division 880

Reasons for decision

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

Question

Is the ordinary and statutory income derived by Company A from its interests held in the Test Entities not assessable income and not exempt income under section 880-105 of the ITAA 1997?

Summary

The ordinary and statutory income derived by Company A derived from its interests held in each Test Entity is not assessable and not exempt income due to the operation of section 880-105 of the ITAA 1997.

Detailed reasoning

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 (thetest 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.

Company A 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.

Company A 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;

(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.

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.

Country X is an independent, sovereign state.

Company A is the investment authority of the Government. It is an independent legal entity that acts autonomously in attaining its objectives, discharging its functions and exercising its powers. It is wholly owned and supervised by the Government.

On the basis that Company A:

•                    is the investment authority of part of a foreign country;

•                    is supervised by Country X;

•                    was established by, capitalised, and funded by the Government;

•                    has its primary objective as investing funds and delivering sustained long-term financial returns so the government can provide for Country X's current and future welfare; and

•                    is not an Australian resident or a resident trust estate;

Company A meets the requirements of being a sovereign entity as defined in section 880-15.

Company A 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 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.

Company A's primary objective is to invest funds and deliver sustained long-term financial returns so the Government can provide for Country X's current and future welfare. Company A receives its funds from the Government's financial surplus to its budgetary and other funding requirements. Company A shall be responsible for receiving the Government's funds earmarked for investment.

As such, Company A is funded solely by public monies.

All returns on Company A's investments are public monies

Company A manages and administers the Government's investments.

Any monies given to Company A, or income made by Company A, are ultimately owned by the Government. The Government is able to recall any monies of Company A or its subsidiaries at any time. In the event Company A is liquidated or dissolved, all assets and monies will flow back to the Government.

Therefore, all returns on Company A's investments are public monies.

Company A is not a public non-financial or 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 financial services in relation to assets or liabilities that are not available on open financial markets.

IsCompany A a public non-financial entity?

Law Companion Ruling 2020/3 The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2020/3) provides that a public non-financial entity is determined by:

76. Whether an entity is producing or trading non-financial goods and/or providing services that are not financial services is a question of fact...

Company A does not produce or trade in non-financial goods or provide non-financial services. As such, it is not a public non-financial entity as defined in subsection 880-130(1).

Is Company A a public financial entity?

Company A was established to be a sovereign wealth fund so the Government can provide for the Country X's current and future welfare. All monies and income gained by Company A are ultimately returned to the Government for this purpose.

Whether Company A operates commercially in the financial market above requires an examination of its principal purpose. Company A manages the Government's investments - it does not act as a business or in a commercial manner when acting on behalf of the Government.

As a sovereign wealth fund, it is not a public financial entity that charges an economically significant price for its principal activities.

Based on the circumstances, the Commissioner accepts that Company A is not either a public non-financial entity or a public financial entity under subsection 880-130(2), being a part of the State and not engaging in the relevant activities outlined in subsection 880-130(1) or paragraph 880-130(2).

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

Company A'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.

Company A invests in the Test Entities and they are Australian resident companies or managed investment trusts. Company A holds both shares and debt interests in the Test Entities. Company A receives income from these interests.

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

Company A'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.

As previously outlined, the Test Entities from which Company A derives its ordinary and statutory income are all Australian resident companies or managed investment trusts.

As such, Company A receives income from an entity which satisfies the requirements of paragraph 880-105(1)(c).

Company A 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.

Company A's sovereign entity group consists of all entities that are wholly owned by Country X.

With respect to the equity interests in the Test Entities, Company A holds significantly less than 10% of the participation interests in the Test Entity. To the best of Company A's knowledge, its sovereign entity group as a whole holds less than 10% of the participation interests in the Test Entity.

As such, Company A's sovereign entity group satisfies the requirements of paragraph 880-105(d) with respect to each Test Entity.

Company A'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 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), 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.

Company A's interests in the Test Entities do 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 Entities' operations. Furthermore, Company A's interests, when combined with the other interests held by members of its sovereign entity group, do not provide 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 Entities' operations.

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 Company A or members of Company A's sovereign entity group.

Based upon the above, the sovereign entity group of Company A does not have influence of a kind described in subsection 880-105(6) and, therefore, satisfies the requirements of paragraph 880-105(1)(f).

Conclusion

As all of the conditions listed in subsection 880-105(1) have been satisfied, section 880-105 will apply such that amounts of ordinary and statutory income derived by Company A from its investments in the Test Entities are not assessable and not exempt income.

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