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Ruling

Subject: Sovereign immunity and International Agreement

Questions

Is the foreign government entity entitled to an exemption from liability to dividend withholding tax under the common law principle of sovereign immunity in respect of its passive portfolio investments (i.e. investments in which the entity holds less than 10% of the total interests)?

Answer

Yes

Is the foreign government entity entitled to an exemption from liability to income tax under the common law principle of sovereign immunity in respect of distributions from passive investments in widely held management investment trusts in which the entity holds less than 10% of the total fund?

Answer:

Yes

Is the foreign government entity entitled to an exemption from liability to interest withholding tax under the International Agreement on its income from interest in Australia?

Answer:

Yes

This ruling applies for the following periods:

1 July 2011 to 30 June 2015

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The entity is part of the pay-as-you-go component of the pension system where the basic principle is that current pension benefits are financed by contributions.

The entity is regulated by legislation which also contains rules stipulating how the assets of the funds may be invested.

The performance of the entity is evaluated yearly by the government and the results are presented in a communication to the parliament. Pension benefits in the new system are financed by contributions paid in over the working life of the contributors. This is a so called defined contribution system, where the pension benefits are indexed for annual growth in the average income, the income index.

The entity is a government entity and its operations are regulated only by law and not by directive. The entity has its own board of directors and external auditors, all of which are appointed by the government.

Relevant legislative provisions

International Agreement

Subsection 15-5(2) of the Taxation Administration Act 1953

Reasons for decision

The Agreement

In the Agreement, paragraph (3) of Article 11 requires each country to exempt interest derived by the government or any other body exercising governmental functions in, the other country or by the central bank of the other country.

Accordingly, an exemption from withholding tax on the entity's interest income is available under the Agreement.

Sovereign immunity

As the Agreement does not have a similar article in respect of ordinary income including dividends, the question of an exemption from income tax including dividend withholding tax is addressed by the common law principle of sovereign immunity.

Certain income derived from within Australia by foreign governments is exempt from Australian tax under the international law doctrine of sovereign immunity. In accordance with that doctrine, Australia 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 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.

When determining whether sovereign immunity applies to a particular operation or activity, it is necessary to establish whether the operation or activity is commercial in nature. Whether an operation or activity is commercial in nature will depend on the facts of each particular case. However, as a guide, a commercial activity is generally an activity concerned with the trading of goods and services, such as buying, selling, bartering and transportation, and includes the carrying on of a business.

Income derived by a foreign government or by any other body exercising governmental functions from interest bearing investments or investments in equities is generally not considered to be income derived from a commercial operation or activity. Accordingly, provided the funds used to make such investments are and remain government moneys, the income is accepted as being exempt from tax under the common law doctrine of sovereign immunity.

In relation to a holding of shares in a company, there would be instances where the extent of the holding gives rise to questions as to whether it constitutes a passive investment or the carrying on of a business, but this would depend on the particular circumstances. A portfolio holding in a company (that is, a holding of 10% or less of the equity in a company) will generally be accepted as a non-commercial activity and any dividends received from such a holding would be exempt from tax.

In summary, to establish that sovereign immunity applies to exempt dividend and interest income from withholding tax, it is necessary to establish the following:

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

· that the moneys being invested are and will remain government moneys; and

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

If these three conditions are satisfied, then the Australian income including dividend and interest income will not be subject to Australian income taxes, including withholding taxes.

Condition 1

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

The entity has provided evidence in its annual reports and its legislation that it is a government controlled investment fund and that it is the beneficial owner of the assets and therefore it is beneficially entitled to the income. All board members are appointed by the government.

Condition 2

That the moneys being invested are and will remain government moneys.

The entity has provided in its legislation that the moneys invested are and will remain government moneys. The entity is responsible to the government for the control and management of all funds invested. The unfunded liabilities are met by the government as per the Annual Report

Condition 3

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

In accordance with the facts provided the entity's investments in Australia are considered to be of a passive and non-commercial nature.

Accordingly, an exemption under the principles of sovereign immunity for Australian income tax including dividend withholding tax is available.