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Subject: Sovereign immunity

Question 1

Is the income derived in Australia by the Trust from its debt investment exempt from Australian income and withholding tax under the international law doctrine of sovereign immunity?

Answer

Yes.

This ruling applies for the following periods:

n Year ending 30 June 2012

n Year ending 30 June 2013

n Year ending 30 June 2014

The scheme commences on:

1 July 2011

Relevant facts and circumstances

Structure of relevant entities

1. MCo is the sole legal and beneficial holder of the units in a unit trust (the Trust) and FCo is the trustee of the Trust. The Trust was established to hold investments in Australia.

2. MCo, FCo, their holding company, and their ultimate holding company, TCo, are resident companies of the same foreign country. These entities are wholly owned by a statutory body corporate established under an enactment of the foreign country to own and administer assets of the Government of that foreign country.

3. TCo acts as a holding company for global real estate investments that are made in the management of the foreign reserves of the foreign country.

4. The trust deed of the Trust is governed by Australian law.

Investment Arrangement

5. The Trust has entered into a co-investment agreement with an unrelated Australian entity for the purposes of making debt investments secured to Australian real estate investment assets.

6. Under the co-investment agreement, the Trust will contribute three quarter of the total debt investments.

7. The Trust has appointed an unrelated Australian investment management firm to act as its investment manager for the debt investment. The terms of this arrangement are set out in an investment management agreement (IMA).

8. The loans issued as part of the debt investment will meet the criteria specified in the investment mandate and investment guidelines of the IMA.

9. The investment manager is responsible for sourcing borrowers that meet the criteria set out in the investment guidelines. The investment manager also provides other services to the Trust such as giving investment advice, taking action in relation to the debt investment, keeping records and accounts, furnishing reports on the debt investment values, interest and fees paid and receivable, capital repaid, etc.

10. The term of the Trust's investment in the debt investment is from the date of the IMA until the last day of the calendar month following the date that the last loan is fully repaid or otherwise resolved.

11. Any loan that the investment manager sources will be allocated between the Trust and the other Australian investor pro-rata to their commitment amounts. Either the Trust or the Australian investor can decline an investment in which case the Trust can either invest alongside the investment manager's other client accounts or decide to invest alone.

12. The terms of the loans issued as part of the debt investment will be determined on a loan by loan basis. Each loan will be governed by one loan agreement under which the different investors will each fund a proportion. The loan agreement will clearly indicate the amount to be contributed by each investor.

13. Income to be derived by the Trust from the debt investment will predominantly consist of interest income but may also include fee income (e.g. upfront fees, prepayment fees and extension fees).

14. All income derived by the Trust from the debt investment will be used to fund and support governmental functions of the Government of the foreign country.

15. The Trust, the Australian co-investor and the investment manager will not have any degree of control or influence over or be represented on the board of directors of any borrowing entities.

Other activities and investments

16. The Trust does not engage in commercial activities such as trading of goods and services, buying, selling, bartering and transportation or carrying on a business.

17. The Trust does not hold any other investments at present.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 995-1(1).

Reasons for decision

Summary

Income derived in Australia by the Trust from its debt investment will be treated as exempt from Australian income and withholding tax under the international law doctrine of sovereign immunity.

Detailed reasoning

While the Australian taxation legislation itself does not provide an exemption specifically for foreign government agencies, the Australian government recognises the international law doctrine of sovereign immunity and will treat as "exempt" certain income derived by foreign governments. In accordance with that doctrine, the Australian government accepts that any income derived by a foreign government from the performance of governmental functions within Australia is exempt from Australian tax.

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

ATO Interpretive Decision ATO ID 2002/45 discusses the conditions that must be satisfied for the doctrine of sovereign immunity to apply to treat interest and dividend income as being exempt from Australian income and withholding taxes. These conditions are:

1. that the person making the investment (and therefore deriving the income) is a foreign government or an agency of a foreign government;

2. that the moneys being invested are and will remain government moneys; and

3. that the income is being derived from a non-commercial activity.

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

The Trust, itself, is not a foreign government. Therefore, it will be necessary to consider whether the Trust is an 'agency of a foreign government'.

An 'agency of a foreign government' is not defined in ATO ID 2002/45. However, subsection 995-1(1) of the Income Tax Assessment Act 1997 provides that a foreign government agency is:

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

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

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

In the context of sovereign immunity, we consider that an entity that is wholly owned by a foreign government is an 'authority' where that entity is performing a function for the public advantage and executes a function in the public interest and not a private body established exclusively for private profit.

The Trust, which is indirectly wholly owned by the body corporate established under an enactment of the Government of the foreign country, acts as a special purpose vehicle for investments in Australia in the management of the foreign reserves of the foreign country. 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 Trust acts as an 'authority' of that body corporate. Accordingly, the Trust is considered to be an 'agency of a foreign government' and satisfies condition 1 of ATO ID 2002/45.

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

The funds used by the Trust to make the debt investment are sourced from the foreign reserves of the foreign country and will remain so for the period that the Trust holds the investment.

The money is being invested for the purpose of preserving and enhancing the foreign reserves of the foreign country. All income derived from the debt investment will be used to fund and support governmental functions of the Government of the foreign country.

Accordingly, the moneys being invested by the Trust are, and will remain, government moneys.

Condition 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.

The Trust has entered into an arrangement with an unrelated Australian entity to jointly invest in certain secured loans that satisfy its investment guidelines. Income to be derived from the Trust from the debt investment will consist mainly of interest and fees. The Trust will not acquire any control or voting rights over the borrowing entities as a result of the debt investment. The Trust does not carry on a business nor does it engage in the trading of goods and services.

Based on the above factors, the Trust's debt investment will constitute a passive, non-commercial investment.

Conclusion

The three conditions outlined in ATO ID 2002/45 are satisfied. Accordingly, the interest income derived by the Trust in Australia in respect of its debt investment will be treated as exempt from Australian income and withholding tax under the common law doctrine of sovereign immunity.

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