Edited version of private advice

Authorisation Number: 1012656161965

Ruling

Subject: Sovereign Immunity

Question

Will the ATO impose liability to income tax or withholding tax on the non-resident entity on its interest income and capital gains derived from its investment in Australian government securities?

Answer

No.

This ruling applies for the following periods:

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:

1 July 2014

Relevant facts and circumstances

1. The non-resident entity is the central bank of a State.

2. The objectives of the entity are to control inflation, to support the stability of the financial system, and to support the implementation of government economic and social policy.

3. The entity's functions include the holding and managing of the foreign reserves of the State.

4. The entity's board of directors is appointed by the foreign government.

5. The entity reports to the foreign government on its performance, governance and the state of the economy.

6. The entity is exempt from tax in the state in which it resides.

7. The entity distributes its profits annually to the foreign government.

8. The entity proposes to invest in Australian government bonds as part of managing the foreign reserves of the State.

9. The entity will hold these investments on a long-term basis.

10. The entity will derive interest income and capital gains from these investments.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1997 section 4-1, and

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

Reasons for decision

Unless an exemption or exclusion applies, a non-resident taxpayer that derives Australian sourced income 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 Income Tax Assessment Act 1936.

While the taxation legislation does not provide an exemption or exclusion for foreign governments, liability to income tax and withholding tax may not be imposed on foreign governments or entities of foreign governments 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, subject to a number of exceptions, a foreign state is immune from the jurisdiction of the courts of Australia in a proceeding.

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 entity a foreign state or separate entity of a foreign state?

The entity satisfies this condition for the following reasons:

• the entity manages the foreign reserves of the State

• the entity's objectives support the implementation of government policy

• the foreign government has significant influence over the entity's management

• the entity reports to the foreign government, and

• the entity distributes its profits to the foreign government.

All these factors show the close relationship between the entity and its foreign government, and its satisfaction of this condition.

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.

Are the entity's investments commercial transactions?

The entity invests in Australian government bonds as part of managing the State's foreign reserves. The investments are held on a long-term basis to derive interest income and capital gains. The income is used to fund the exercising of government functions. The instruments involve no participation rights in a business or entity.

The investments are therefore non-commercial transactions.

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 entity manages the State's foreign reserves, which are government monies. The investments are made while managing these reserves. The income derived from the investments is used to implement monetary policy, improve the State's credit rating and economic standing, and is distributed back to the foreign government to exercise other governmental functions. Accordingly, the monies invested are and will remain government monies.

Conclusion

As the conditions for sovereign immunity are satisfied, the ATO will not impose liability to income tax or withholding tax on the non-resident entity on its interest income and capital gains derived from its Australian investments.