Edited version of private advice

Authorisation Number: 1012622927344

Ruling

Subject: Sovereign Immunity

Question

Will the Australian Taxation Office (ATO) impose liability to income tax or withholding tax on a foreign government entity on income derived from its investment in units in two Australian trusts?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

The scheme commenced on:

Year ended 30 June 2008

Relevant facts and circumstances

1. The non-resident entity is a separate entity of a foreign state.

2. The non-resident entity receives funds for investment purposes from its foreign government.

3. The non-resident entity invests in two Australian trusts.

4. The non-resident entity will derive income from its investment.

5. The interest in the investment is more than 10%, but less than 20%.

6. The investment is made on a long-term basis.

7. The day to day running of the activity which the non-resident entity has invested in is carried out by an independent manager.

8. The non-resident entity is not represented or involved in the Board of the manager.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1997 section 4-1

Reasons for decision

Question

Will the ATO impose liability to income tax or withholding tax on a foreign government entity on income derived from its investment in units in two Australian trusts?

Detailed reasoning

Non-resident taxpayers will generally be liable to pay income tax under section 4-1 of the Income Tax Assessment Act 1997 or withholding tax under section 128B of the ITAA 1936 on Australian-sourced income, unless an exemption or exclusion applies.

Further, a non-resident taxpayer will be liable to income tax including withholding taxes from distributions from Australian managed investment trusts under Subdivision 12-H of Schedule 1 to the Tax Administration Act 1953.

While the taxation legislation does not provide an exemption or exclusion for foreign governments or entities of foreign governments, liability to income tax and withholding tax may not be imposed under the common law doctrine of sovereign immunity.

Sovereign immunity background

The common law doctrine of sovereign immunity can be traced back to early English law. It originated from the historic principle that 'no court has power to command the King' (Ulen & Co v. Bank Gospodarstwa Krajowego (National Economic Bank) (1940) 24 NYS 2d 201, 204). Until the twentieth century, sovereign immunity from the jurisdiction of foreign courts had very few exceptions; it was a rule of absolute immunity.

The Foreign States Immunities Act 1985 (Immunities Act) is an Australian Commonwealth Act which reflects a more restrictive view of the common law doctrine of sovereign immunity. The legislation followed recommendations from the Australian Law Reform Commission Report No. 24 1984, Foreign State Immunity which identified a more restrictive view of the doctrine that had been taken and adopted into legislation by several other countries.

It has been long-standing practice for the ATO to use the principles delineated in the Immunities Act to apply the more restrictive view of the doctrine of sovereign immunity when considering taxation matters.

Section 9 of the Immunities Act states that a foreign state is immune from the jurisdiction of the courts of Australia in a proceeding, subject to a number of exceptions. In the High Court case of PT Garuda Indonesia Ltd v. Australian Competition & Consumer Commission [2012] HCA 33 (PT Garuda Case), it was stated at paragraph 8, that section 9 of the Immunities Act 'is exhaustive of the common law and indicates that statute provides the sole basis for foreign state immunity in Australian courts.'

The comment confirms that the rule of absolute immunity in regard to the common law doctrine has been effectively replaced by the principles outlined in the Act.

The ATO follows the principles delineated in the Immunities Act which represents Australia's restrictive approach when considering sovereign immunity claims to taxation matters.

Pursuant to this approach, an entity claiming sovereign immunity must satisfy three conditions:

1. the entity must be a foreign state, or a separate entity of a foreign state

2. the scheme to which the claim applies must not be a commercial transaction, and

3. the monies being invested in the scheme are and will remain government monies.

If these three conditions are satisfied, it has been the long-standing practice of the ATO to not impose the entity's liability to income tax and withholding tax in respect of ordinary income and statutory income on the basis that the entity has satisfied the common law doctrine of sovereign immunity.

Condition 1: a 'foreign state' or 'separate entity' of a foreign state

A claim for sovereign immunity may only be made by a 'foreign state' (section 9 of the Immunities Act).

A foreign state is defined in section 3 of the Immunities Act to be a country outside of Australia that is either:

• an independent sovereign state, or

• a separate territory (whether or not it is self-governing) that is not part of an independent sovereign state.

Sovereign immunity also extends to a 'separate entity' of a foreign state pursuant to section 22 of the Immunities Act.

A separate entity of a foreign state is defined in section 3 of the Immunities Act to be a natural person, body corporate or corporation sole that:

• is an agency or instrumentality of the foreign state, and

• is not a department or organ of the executive government of the foreign state.

The lower court decision of the PT Garuda Case (PT Garuda Indonesia Ltd v. Australian Competition and Consumer Commission [2011] FCAFC 52) considered when an entity may be an agency or instrumentality of the foreign state.

The court decided (at paragraph 128), that the correct approach is to consider, on the whole of the evidence, whether the person is acting for, or being used by, the foreign state as its means to achieve some purpose or end of that state in the relevant circumstances.

Is the non-resident entity a 'foreign state' or 'separate entity' of a foreign state?

In carrying out its duties, the non-resident entity is considered to be an agency or instrumentality of a foreign state and consequently a separate entity of a foreign state.

Condition 2: commercial transaction

Under section 11 of the Immunities Act, a foreign state does not enjoy sovereign immunity in so far as the proceeding concerns a commercial transaction.

As suggested by the High Court in the PT Garuda Case at paragraph 5, the necessity for sovereign immunity to be excluded from commercial transactions came about as a result of governments increasingly becoming engaged in various commercial activities and that immunity of governments involved in commercial activities was inconsistent with international law and it was undesirable.

As a result, Australia accepts that foreign states performing only governmental functions, rather than undertaking commercial transactions, may claim sovereign immunity.

This approach is consistent with the decision of the British House of Lords in 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.

Whether an operation or activity is a commercial transaction will depend on the facts of each particular case. As a guide, a commercial transaction 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.

In relation to the 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 a commercial investment, but this would depend on the particular circumstances. A portfolio holding in a company or fund (that is, a holding of 10% or less of the equity in a company) will generally be accepted as a non-commercial transaction.

Is the non-resident entity's investment a commercial transaction?

Despite an interest of over 10% in the two Australian trusts, the lack of influence in the day to day running of the investment activity, the long-term nature of the investment and the lack of representation or involvement on the Board of the manager illustrates the investment's passive nature.

Therefore, the scheme to which the non-resident entity's claim for sovereign immunity applies is not a commercial transaction.

Condition 3: monies are and will remain government monies

In line with the principle that sovereign immunity applies to foreign states performing only governmental functions, an entity claiming sovereign immunity must establish that the monies being invested in the scheme are and will remain government monies.

The monies that are invested by the non-resident entity are and will remain government monies.

Conclusion

Since the three conditions are satisfied, the non-resident entity's claim for sovereign immunity on its investment in two Australian trusts has been established. In line with long-standing practice, the ATO will not impose liability to income tax and withholding tax on income derived from its investment.