Edited version of your private ruling

Authorisation Number: 1012447795046

Ruling

Subject: Sovereign immunity exemption

Question 1

i. Is the foreign entity (the Entity) exempt from Australian income tax and withholding tax on its interest income, rental income, trust distributions, managed investment distributions and any other income including capital gains derived for its passive portfolio investments or non-commercial activities in Funds A, B and C in Australia, under the principle of sovereign immunity?

ii. Is the Entity exempt from Australian income tax and withholding tax on its interest income, rental income, trust distributions, managed investment distributions and any other income, excluding capital gains tax, for its passive portfolio investment in Fund D, under the principle of sovereign immunity?

Answer

i. Yes. Provided the income is not derived from investments funded by third party debt, the Entity is exempt from Australian income tax and withholding tax on its interest income, rental income, trust distributions, managed investment distributions and any other income including capital gains derived for its passive portfolio investments or non-commercial activities in Funds A, B and C in Australia, under the principle of sovereign immunity.

ii. Yes. Provided the income is not derived from investments funded by third party debt, the Entity is exempt from Australian income tax and withholding tax on its interest income, rental income, trust distributions, managed investment distributions and any other income, excluding capital gains tax, for its passive portfolio investment in Fund D, under the principle of sovereign immunity.

Question 2

Is the Entity exempt from Australian income tax and withholding tax on income or gains arising from Loans A and B in Australia, under the principle of sovereign immunity?

Answer

Yes. Provided the income is not derived from investments funded by third party debt, the Entity is exempt from Australian income tax and withholding tax on income or gains arising from its investment in Loans A and B in Australia under the principle of sovereign immunity.

Question 3

In circumstances where one or more investments of the Entity do not qualify for the sovereign immunity exemption, will the exempt status of other passive investments of the entity to which this ruling applies be unaffected?

Answer

Yes. In circumstances where one or more investments of the Entity do not qualify for the sovereign immunity exemption, the exempt status of the other passive investments of the company which are covered by this ruling will be unaffected.

This ruling applies for the following periods:

Various income years

The scheme commences on:

During the 2007 income year

Relevant facts and circumstances

The Entity has applied for an exemption from Australian income tax and withholding tax based on the principle of sovereign immunity.

The Entity has supplied the following documents in support of its private ruling application:

· The founding law of the foreign government institution (the Law)

· Bye-Laws of the Entity;

· The Entity's annual financial statements for 2 years; and

· Response to request for further information.

The Entity is a subsidiary of the foreign government institution (the Institution), which is wholly owned by the government of the foreign country. The Institution was established to receive and invest funds of the government for the public interest of the foreign country. The Institution has independent legal authority and full capacity, with the right to form subsidiaries under the Law.

While the Institution itself does not direct the day-to-day management of the affairs of the Entity, the directors that it designates have the responsibility, acting in their capacity as directors of the Entity, to ensure that the Entity conducts its activities in a manner consistent with the guiding purposes of the Institution as set forth in the Law.

The Entity is not a resident of Australia as defined in section 6 of the Income Tax Assessment Act 1936 (ITAA 1936) and acts as a holding company for investments in Australia that are funded primarily by the deployment of the foreign reserves of the foreign government. The Entity currently owns various investments in Australia.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 6

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

Reasons for decision

Question 1

As stated by ATO Interpretative Decision ATO ID 2002/45, certain income derived from within Australia by foreign governments is exempt from Australian tax under the international law doctrine of sovereign immunity.

While the taxation legislation itself does not provide an exemption specifically for foreign governments, the Australian Government recognises the international law doctrine of sovereign immunity. In recognition of the doctrine, the practice is to refrain from seeking to tax gains from non-commercial activities of foreign governments. As such, 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 agency will generally be accepted as the performance of governmental functions provided that 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 British House of Lords in the case I Congreso del Partido 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 (i.e., a holding of 10 per cent 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.

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 relevant income will not be subject to Australian income taxes.

Condition 1

Is the person making the investment (and therefore deriving the income) a foreign government or an agency of a foreign government?

As the Entity is not a foreign government, it is required to be an agency of a foreign government to fulfil Condition 1. While the term 'agency of a foreign government' is not defined, subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a 'foreign government agency' is:

(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.

According to the information provided, the Entity acting as an 'authority' of the government of the foreign country. Accordingly, it is considered to be an 'agency of a foreign government', making investments and deriving income for the purpose of applying for sovereign immunity.

Condition 2

Are the moneys being invested government moneys and will they remain government moneys?

Although the Entity may have the option of leveraging its investments using third party finance, all funding for Funds A, B, C & D has been ultimately provided by the Institution. It is noted for completeness however that if third party finance was accessed to fund any of these investments, this would lead to a failure to comply with Condition 2.

In accordance with the facts provided, the funds invested by the Entity in respect of Funds A, B and C are government moneys of the foreign country and will remain government moneys of the foreign country.

In the case of the Entity's investment in Fund D, proceeds from the redemption of the Entity's interest in Fund D were used to repay a portion of a loan from a third party. This loan is considered to be third party debt and any capital gains made from the redemption would not be exempt from Australian income tax. Despite this, as funding for the investment in Fund D originated from the government of the foreign country, all interest income, rental income, trust distributions, managed investment distributions and any other income earned prior to the disposal remain eligible for exemption under the principle of sovereign immunity.

Condition 3

Is the income derived from non-commercial activity?

In accordance with the information provided, the Entity's investment in Funds A, B, C and D are accepted as passive and non-commercial in nature.

Conclusion

Any interest income, rental income, trust distributions, managed investment distributions and any other income including capital gains from the Entity's holdings in Funds A, B and C will be exempt from tax under the common law principle of sovereign immunity, provided the income is not derived from investments funded by third party debt.

The Entity is also exempt from Australian income tax and withholding tax on its interest income, rental income, trust distributions, managed investment distributions and any other income, excluding capital gains tax, from its investment in the Fund D, provided the income is not derived from investments funded by third party debt.

Question 2

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.

Condition 1

Is the person making the investment (and therefore deriving the income) a foreign government or an agency of a foreign government?

The Entity is an 'agency of a foreign government', making investments and deriving income for the purpose of applying for sovereign immunity.

Condition 2

Are the moneys being invested government moneys and will they remain government moneys?

The Entity's investment in Loans A and B are ultimately funded by government moneys of the foreign country and will remain government moneys of the foreign country.

Condition 3

Is the income derived from non-commercial activity?

Based on the facts provided, the Entity's investments in Loan A and B are considered to be of a passive and non-commercial nature.

Conclusion

As Loans A and B satisfy all three conditions, the Entity is exempt from Australian income tax and withholding tax on income or gains arising from these financial arrangements under the principle of sovereign immunity, provided the income or gains are not derived from investments funded by third party debt.

Question 3

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. When applying the doctrine of sovereign immunity, the investments of a foreign government entity has in Australia may constitute more than one operation or activity.

An 'operation or activity' of a foreign government entity is not necessarily considered together with all the investments a foreign government agency may have in Australia. The doctrine of sovereign immunity is applied on an activity-by-activity basis.

This approach is consistent with the international common law doctrine relating to sovereign immunity. In considering whether sovereign immunity applied to the commercial activities of a foreign government, the House of Lords stated in I Congresso del Partido 2 All ER 1064 at 1071, per Lord Wilberforce,

that:

If a trader is always a trader, a state remains a state and is capable at any time of acts of sovereignty. The question arises, therefore, what the position is where the act on which the claim is founded is quite outside the commercial, or private law, activity in which the state has engaged, and has the character of an act done jure imperii. The restrictive theory does not and could not deny capability of a state to resort to sovereign, or governmental, action: it merely asserts that acts done within the trading or commercial activity are not immune. The inquiry still has to be made whether they were within or outside that activity

With regard to the specific circumstances of the case, the non-exempt activities are considered to be activities that are separate to the government entity's exempt investments. Consequently, an investment of the foreign government entity which does not qualify for the sovereign immunity exception will not affect the tax status of the exempt investments of the government entity covered by this ruling.