Edited version of private advice

Authorisation Number: 1052274393914

Date of advice: 15 July 2024

Ruling

Subject: Sovereign immunity

Question 1

For the entities listed in Appendix 1 of this Ruling that satisfy the requirements of paragraph 880-105(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) (referred to in this Ruling collectively as 'the Eligible Entities'), is an amount of ordinary or statutory income that is a return on the interest that Entity One holds in any of the Eligible Entities not assessable income and not exempt income under section 880-105 of the ITAA 1997?

Answer

Yes.

Question 2

Is any capital gain or loss made by Entity One from a CGT event that happens in relation to a CGT asset that is a membership interest, non-share equity interest or debt interest in any of the Eligible Entities disregarded under section 880-115 or 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) (for interest and dividends) and subsection 840-805(9) of the ITAA 1997 (for fund payments from MITs) apply to exclude Entity One from liability to withholding tax on income from the Eligible Entities that is not assessable income and is not exempt income due to the operation of Division 880 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Entity One

1. Entity One was established by amendment of the Constitution of the State of the Foreign State ('the Constitution').
2. Entity One does not have its own legal identity.
3. Entity One consists of a portion of taxation revenue received by the State.
4. The purpose of Entity One is to conserve and invest the portion of taxation revenue for the benefit of the State.
5. 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.

Entity Two

6. Entity Two is a resident of the State and was created under the Laws of the State.
7. 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.
8. Entity Two is managed by its board of trustees (the Board). Investment authority over Entity One's assets is vested in the Board.

Distribution & Appropriation of Entity One Income

9. All income and gains arising on the investments of Entity One are for the sole and exclusive benefit of the State.
10. Income from Entity One is reinvested.
11. The operating budget of Entity Two is to be funded from the revenue generated from Entity One's investments.
12. Entity Two will transfer an amount to Entity One to offset the effect of inflation during that year.
13. Certain income of Entity One is transferred to the State via appropriation.

Taxation

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

Investments

15. 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.
16. No other entities in the sovereign entity group hold investments in Australia.
17. Entity One does not trade in financial assets or operate commercially in the financial markets.
18. Entity Two holds an Australian portfolio of equity and debt investments on behalf of Entity One.
19. Entity One's interests in the Eligible Entities at 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 Eligible Entities.

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

c.     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 Eligible Entities.

d.    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 Eligible Entities.

e.    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 Eligible Entities.

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

g.    Entity One's interests in the Eligible Entities 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 Eligible Entities' operations.

h.    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 Eligible Entities' operations.

i.      No person involved in the control and direction of the Eligible 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 1997 section 840-805

Income Tax Assessment Act 1936 section 128B

Reasons for decision

Question 1

For the entities listed in Appendix 1 of this Ruling that satisfy the requirements of paragraph 880-105(1)(c) of the ITAA 1997 (referred to in this Ruling collectively as 'the Eligible Entities'), is an amount of ordinary or statutory income that is a return on the interest that Entity One holds in any of the Eligible Entities not assessable income and not exempt income under section 880-105 of the ITAA 1997?

Summary

An amount of ordinary income that is a return on an interest that Entity One holds in the Eligible Entities is not assessable and not exempt income under section 880-105 of the ITAA 1997.

Detailed reasoning

Section 880-105 of the ITAA 1997 provides that an amount of ordinary or statutory income that a sovereign entity receives as a return on an interest in another entity is not assessable income and is not exempt income if certain conditions are met. Those conditions are listed in subsection 880-105(1) of the ITAA 1997:

(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.

Entity One 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 requirements are considered below.

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.

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

(c) an authority of the government of part of a foreign country.

Section 960-180 of the ITAA 1997 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 considered to be a foreign government agency under paragraph 880-15(b) as it is an authority of the government of the State.

As such, Entity One meets meet the definition of a 'sovereign entity' in accordance with section 880-15.

Entity One is funded solely by public monies and all returns on Entity One's investment are 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, 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.

Entity One consists of a portion of taxation revenue received by the State. All income and gains arising on the investments of Entity One are for the sole and exclusive benefit of the State.

Therefore, Entity One is funded solely by public monies.

Therefore, this requirement is satisfied.

Entity One is not a partnership

Entity One is not a partnership.

Therefore, this requirement is satisfied.

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.

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.

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.

Entity One does not trade in financial assets and liabilities, nor does it operate commercially in the financial markets. Entity One's principal activities are not 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 (which detail common examples of public financial entities and public non-financial entities). 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 Eligible 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 Eligible Entities comprise a portfolio of equity and debt investments held by Entity Two on behalf of Entity One. These investments are membership, debt or non-share equity 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 MITs

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(c), it must be a return on an interest held in 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 specified in the question, this Ruling only applies to an amount of ordinary or statutory income that is a return on the interest that Entity One holds in the entities listed in Appendix 1 of the Ruling that are either a company that is an Australian resident at the time when the amount becomes ordinary or statutory income of Entity One or a managed investment trust in relation to the income year when the amount becomes ordinary or statutory income of Entity One (i.e. the Eligible Entities).

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

It is noted that where an amount of ordinary or statutory income received by Entity One from its Australian investments is a return on an entity that is neither a company or MIT at the above times specified in paragraph 880-105(1)(c), the amount is not covered by this Ruling or Division 880 of the ITAA 1997.

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 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 Eligible Entities. No other State entities 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 Eligible Entities. In addition, Entity One and its sovereign entity group collectively hold less than 10% of the total participation interests in the Eligible 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) of the ITAA 1997

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(e), 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) at the income time.

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

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 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 Eligible 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 Eligible Entities' operations.

Sub-test 2

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 Eligible 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) at the income time in the Eligible Entities 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 such that an amount of ordinary or statutory income that is a return on the interest that Entity One holds in any of the Eligible Entities, is not assessable income and is not exempt income.

Question 2

Is any capital gain or loss made by Entity One from a CGT event that happens in relation to a CGT asset that is a membership interest, non-share equity interest or debt interest in any of the Eligible Entities, disregarded under section 880-115 or section 880-120 of the ITAA 1997?

Summary

Any capital gain or loss made by Entity One from a CGT event that happens in relation to a CGT asset that is a membership interest, non-share equity interest or debt interest in any of the Eligible Entities will be disregarded under section 880-115 or section 880-120 of the ITAA 1997.

Detailed reasoning

Section 880-115 the ITAA 1997 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

(c) the requirements in paragraphs 880-105(1)(c), (d) and (e) would be satisfied, on the assumptions that:

(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 the ITAA 1997 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 the ITAA 1997.

As established in Question 1, Entity One:

a.    is covered by section 880-125,

b.    holds a membership interest, non-share equity interest or debt interest in the Eligible Entities, and

c.     satisfies the requirements in paragraphs 880-105(1)(c), (d) and (e) in relation to ordinary or statutory income that it is a return on an interest in the Eligible Entities.

Therefore, any capital gain or loss made by Entity One from a CGT event that happens in relation to a CGT asset that is a membership interest, non-share equity interest or debt interest in any of the Eligible Entities, is disregarded under section 880-115 (for capital gains) or section 880-120 (for capital losses) of the ITAA 1997.

Question 3

Does paragraph 128B(3)(n) of the ITAA 1936 (for interest and dividends) and subsection 840-805(9) of the ITAA 1997 (for fund payments from MITs) apply to exclude Entity One from liability to withholding tax on income from the Eligible Entities that is not assessable income and is not exempt income due to the operation of Division 880 of the ITAA 1997?

Summary

Paragraph 128B(3)(n) of the ITAA 1936 (for interest and dividends) and subsection 840-805(9) of the ITAA 1997 (for fund payments from MITs) apply to exclude Entity One from liability to withholding tax on income from the Eligible Entities that is not assessable income and is not exempt income due to the operation of Division 880 of the ITAA 1997.

Detailed reasoning

Paragraph 128B(3)(n) of the ITAA 1936 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.

Further, subsection 840-805(9) of the ITAA 1997 provides an exclusion from managed investment trust withholding tax on income that is non-assessable non-exempt income because of Division 880 of the ITAA 1997 or Division 880 of the Income Tax (Transitional Provisions) Act 1997.

Section 6-23 of the ITAA 1997 provides that an amount of ordinary income or statutory income is non-assessable non-exempt income if a provision of the ITAA 1997 or of another Commonwealth law states that it is not assessable income and is not exempt income.

As stated in Question 1, an amount of ordinary or statutory income that is a return on the interest that Entity One holds in any of the Eligible Entities is not assessable income and is not 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 of Entity One from its investments listed in Appendix 1, so will the exclusion from liability under paragraph 128B(3)(n) of the ITAA 1936 and subsection 840-805(9) of the ITAA 1997.

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