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Ruling

Subject: Sovereign immunity

Question

Is the foreign central bank eligible for exemption from withholding tax on dividend and interest derived in Australia under the principles of sovereign immunity?

Answer

Yes. The foreign central bank is eligible for exemption from withholding tax on dividends and interest derived in Australia under the principles of sovereign immunity

This ruling applies for the following periods:

1 April 2012 to 31 March 2015

The scheme commences on:

1 April 2012

Relevant facts and circumstances

The foreign central bank was established by the foreign country legislation with the power to invest in equities, interest bearing bonds and other securities amongst the other functions listed below. Some of these investments are in Australia.

The functions and powers of the foreign central bank are:

· developing and implementing the state's monetary policy

· supporting functional operation of payment systems

· carrying out foreign exchange regulation and foreign exchange control

· helping to support the financial system's stability.

· being the sole entity allowed to issue banknotes coins and securities

· servicing the public debt

· having the right to grant credits to banks and also to legal entities that have opened bank accounts

· being the lender of last resort for banks

· issuing an opinion to the authorized state body for the regulation and supervision of the financial market and financial organizations

· having the right to impose restrictions on lending and bank fees

· establishing regulations on providing electronic banking services in the performance of banking operations

· issuing licenses for operations involving the use of foreign exchange valuables

· issuing licenses to organizations engaging in certain kinds of banking operations to engage in exchange operations with foreign exchange and to carry out operations concerned with the collection and shipment of banknotes, coins, and valuables, and interbank clearing

· performing the rediscounting of bills of exchange in accordance with regulation

· setting aside resources of banks for the purposes of regulating the volume of credits granted by banks in order to lower the risk of default by banks under their obligations, and to protect the interests of the depositors and shareholders of banks.

Relevant legislative provisions

Taxation Administration Act 1953 subsection 15-15(2).

Reasons for decision

While the taxation legislation itself does not provide an exemption specifically for foreign governments, the international law doctrine of sovereign immunity is recognised as providing an exemption on investments of foreign governments and monetary authorities of foreign governments where the monies being invested are and will remain government monies (that is, investment of foreign reserve assets) and are invested in passive (that is non-commercial) type investments. This is usually regarded as meaning investments at interest in traditional instruments such as bonds or a portfolio (that is a holding of 10% or less of the equity in a company) holding of shares.

Other prudential and statutory requirements (for example clearance through the Reserve Bank) may also need to be satisfied, though these do not directly impact on the tax position of the investment.

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, 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 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 dividend and interest income will not be subject to Australian income taxes which include 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 foreign central bank is a government controlled central bank and is the beneficial owner of the assets and therefore it is beneficially entitled to the income.

Condition 2

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

The foreign central bank has established that the moneys being invested remain government moneys.

Condition 3

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

In accordance with the facts provided, the foreign central bank's future investments in Australia will be considered to be of a passive and non-commercial nature.

The foreign central bank therefore clearly fits into the government agency definition through its function as a central monetary depository and the managing of the country's currency reserves and other foreign assets.

Accordingly, an exemption under the principles of sovereign immunity for interest and dividend withholding tax is available.