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Authorisation Number: 1011660624652

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Ruling

Subject: Sovereign Immunity

A special purpose vehicle (SPV) non-resident company was established by the Government of the non-resident company to hold investments.

The immediate holding and parent company of the SPV non-resident company is an investment corporation incorporated in the country of the SPV non-resident company. It typically establishes wholly-owned special purpose vehicles to hold its investments.

The SPV non-resident company, and the immediate holding and parent company of the SPV non-resident company, are wholly owned by a body corporate established under an enactment of the Government of the country of the SPV non-resident company to own and administer assets of the Government of the SPV non-resident company.

The SPV non-resident company acts as a holding company for investments in Australia and outside Australia that are made in the management of the foreign reserves of the country of the SPV non-resident company.

The only Australian investment, asset and activity of the SPV non-resident company, is its passive debt investment in an Australian company.

Pursuant to a loan agreement between the SPV non-resident company and the Australian company and group companies of the Australian company, the SPV non-resident company is to provide debt to the Australian company to fund some of its capital costs and expenses.

The term of the debt is X years less one day from the date of execution of the loan agreement.

Income to be derived by the SPV non-resident company from the loan agreement will consist of interest payable or capitalised each month and various fees, including an arrangement fee, commitment fee and agent fees. No other fees will be paid by the Australian company to the SPV non-resident company.

The Australian company must also reimburse the SPV non-resident company of all reasonably incurred expenses in connection with the negotiation, preparation, execution, enforcement or preservation of certain documents, and provide payment and indemnity against any stamp duty or GST payable by the SPV non-resident company.

The loan agreement will be secured by effectively a proportional interest in various security assets of the Australian company, which are shared with other creditors of the Australian company.

The funds of the foreign reserves of the country of the SPV non-resident company that are used by the SPV non-resident company to make the debt investments are generated from sustained balance of payments surpluses and accumulated national savings.

The funds from the SPV non-resident company will flow back to its immediate holding and parent company, generally in the form of a dividend which is paid as and when required.

Pursuant to the loan agreement:

§ the Australian company must supply the SPV non-resident company information in relation to its financial status and expansion project;

§ the SPV non-resident company must give prior consent or approval to the Australian company over certain actions, including entering into new material contracts, corporate restructures or transactions to dispose of any assets;

§ the SPV non-resident company is entitled to appoint a delegate to attend board meetings of the Australian company as an observer, and will not have any voting rights at the board meetings;

§ the Australian company has various rights as a warrant holder.

As a condition of the provision of the debt, a warrant deed was executed between an Australian resident company which wholly owns the group of companies of which the Australian company is a part of, and the SPV non-resident company, whereby the SPV non-resident company was granted warrants, giving it the right to receive a cash settlement amount following the issue of a call notice within a certain period. The warrants do not confer on the SPV non-resident company the right to participate in new issues of stapled securities, or the right to participate in distributions, by the Australian resident company which wholly owns the group of companies of which the Australian company is a part of.

Question 1

Will income derived in Australia by an SPV non-resident company from its loan agreement and warrant deed, entered into with an Australian company and certain group entities of the Australian company, and the responsible entity of the Australian resident company which wholly owns the group of companies of which the Australian company is a part of, be exempt from Australian income and withholding tax under the international law doctrine of sovereign immunity?

Answer

Yes.

Reasons for Decision

Certain income derived from within Australia by foreign governments from the performance of governmental functions within Australia will be exempt from Australian tax under the doctrine of sovereign immunity.

An activity undertaken by a foreign government will generally be accepted as the performance of governmental functions provided that the agencies are owned and controlled by the government and do not engage in ordinary commercial activities. This approach is consistent with the decision of the British House of Lords in the case I Congreso del Partido [1981] 2 All ER 1064 which held that activities of a trading, commercial or other private law character were not governmental functions.

In order to establish whether sovereign immunity applies to exempt income from withholding tax, the current practice of the ATO requires satisfying the following requirements under ATO ID 2002/45:

§ Requirement 1: That the person making the investment (and therefore deriving the income) is a foreign government or an agency of a foreign government;

§ Requirement 2: That the moneys being invested are and will remain government moneys; and

§ Requirement 3: That the income is being derived from a non-commercial activity.

Consideration will be given to each of these requirements pursuant to ATO ID 2002/45.

Requirement 1: That the person making the investment (and therefore deriving the income) is a foreign government or an agency of a foreign government

The SPV non-resident company, itself, is not a foreign government. Therefore, it will be necessary to consider whether the SPV non-resident company is an 'agency of a foreign government'.

An 'agency of a foreign government' is not defined in ATO ID 2002/45. However, the definition of a 'foreign government agency' in the Income Tax Assessment Act 1997 (ITAA 1997) is an appropriate definition in the context of ATO ID 2002/45.

Subsection 995-1(1) of the ITAA 1997 provides that a foreign government agency is:

a) the government of a foreign country or part of a foreign country;

b) an authority of the government of a foreign country; or

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

Further, the explanatory memorandum to Tax Law Improvement Act (No 1) 1998 confirms that 'foreign government agency' will cover foreign governments, and foreign government agencies and authorities of foreign governments.

As the SPV non-resident company is not a 'government', it is necessary to consider whether it is an 'authority' of the body corporate established under an enactment of the Government of the country of the SPV non-resident company. In the context of sovereign immunity, the ATO practice is to include an entity that is wholly-owned by a foreign government as an 'authority' where that entity is performing a function for the public advantage or executes a function in the public interest and not a private body established exclusively for private profit. This is consistent with judicial decisions that consider the term 'authority' in the context of a State such as Commissioner of Taxation v. Bank of Western Australia; State Bank of New South Wales (1995) 61 FCR 407; (1995) 32 ATR 380; (1995) 96 ATC 4009 and SGH Ltd v. Commissioner of Taxation [2002] HCA 18; (2002) 49 ATR 521; 2002 ATC 4336.

The SPV non-resident company, wholly-owned by the body corporate established under an enactment of the Government of the country of the SPV non-resident company, acts as a holding company and SPV for investments in Australia through its immediate holding and parent company, in the management of the foreign reserves of the country of the SPV non-resident company. The management of the foreign reserves of a country is a function for the public advantage or public interest and is not a function exclusively for private profit. Therefore, the SPV non-resident company acts as an 'authority' of the body corporate established under an enactment of the Government of the country of the SPV non-resident company. Accordingly, the SPV non-resident company is considered to be an 'agency of a foreign government' and satisfies Requirement 1 of ATO ID 2002/45.

Requirement 2: That the moneys being invested are and will remain government moneys

To be 'government moneys', the moneys must be available as part of the general funds of the foreign government, used for general government functions as required.

A report from the SPV non-resident company's immediate holding and parent company states that the funds of the foreign reserves of the country of the SPV non-resident company that are used by the SPV non-resident company to make the debt investments are generated from sustained balance of payments surpluses and accumulated national savings.

Further, funds from the SPV non-resident company will flow back to its immediate holding and parent company, generally in the form of dividend which is paid as and when required. The SPV non-resident company's immediate holding and parent company is 100% fully owned by the body corporate established under an enactment of the Government of the country of the SPV non-resident company.

As the money being invested by the SPV non-resident company represents only government money, Requirement 2 of ATO ID 2002/45 is satisfied.

Requirement 3: That the income is being derived from a non-commercial activity

ATO ID 2002/45 states that the question of whether an operation or activity is commercial in nature will depend on the facts of each particular case. However, it provides that commercial activity is generally concerned with the trading of goods and services or the carrying on of a business. In contrast, income from interest bearing investments or investments in equities is generally not considered to be income derived from commercial activities.

As a guide, ATO ID 2002/45 states that a portfolio holding in a company (that is, a holding of 10 per cent or less of the equity in a company) will generally be accepted as non-commercial activity and any dividends received from such a holding would be exempt from tax (provided the other requirements of sovereign immunity are also satisfied). The SPV non-resident company is not involved in a shareholding of the Australian company. Income is derived solely by the SPV non-resident company in Australia from its passive debt investment, which includes the loan notes and the warrants in the Australian company.

ATO ID 2002/45 states that 'a commercial activity is generally an activity concerned with the trading of goods and services, such as buying, selling, barter and transportation, and includes the carrying on of a business.' The SPV non-resident company does not engage in any activities of this nature in Australia in relation to its investment in the Australian company.

However, all of the particular facts and circumstances need to be considered when determining whether an investment is a non-commercial activity. This includes determining whether the SPV non-resident company has a sufficient level of influence over the Australian company, such that it can be said that it is involved in carrying on the commercial activity of the Australian company. Therefore, consideration needs to be given to the relationship between the SPV non-resident company and the Australian company.

The loan agreement provides that the Australian company must supply the SPV non-resident company information in relation to its financial status and expansion project. Although the SPV non-resident company will have the right to receive and review such information, it does not have the ability to amend or alter the information. Therefore, this will be a passive oversight role, and will not cause the investment to be considered non-passive and commercial.

The loan agreement provides that the SPV non-resident company must give prior consent or approval to the Australian company over certain actions, including entering into new material contracts, corporate restructures or transactions to dispose of any assets. It is accepted that these undertakings are in place to protect and preserve the secured property, and ensure the ability of the Australian company to repay the debt is not adversely impacted. None of these undertakings relate to the day-to-day business activities that are conducted by the Australian company.

The loan agreement provides that the SPV non-resident company is entitled to appoint a delegate to attend board meetings of the Australian company as an observer, and will not have any voting rights at the board meetings. As such, as there is no right to vote or influence board meetings, the involvement is passive.

Further, the holding of rights by the SPV non-resident company as a warrant holder does not adversely impact on its debt investment such that it is considered to be non-passive and commercial.

For the aforementioned reasons, the SPV non-resident company's debt investment and warrant deed is a non-commercial and passive investment. As such, Requirement 3 of ATO ID 2002/45 is satisfied.