Edited version of your written advice

Authorisation Number: 1012864361791

Date of advice: 21 August 2015

Ruling

Subject: Sovereign immunity

Question

Is the investment entity immune from income tax or withholding tax on interest income, dividend income, rental income, trust distributions, managed investment trust distributions and any other income derived from its investment in an Australian entity under the common law doctrine of sovereign immunity?

Answer

Yes.

Relevant facts and circumstances

Government entity

1. The government entity was established under an Act.

2. The government entity forms part of the government of the country and is responsible for managing the nation's economic policy, finances, fiscal strategies and tax system.

Investment entity

3. The investment entity is a wholly owned subsidiary of the government entity. The investment entity was established under an Act to manage assets entrusted by the government and the central bank.

4. The investment entity was established with share capital contributed by the government.

5. The investment entity manages the assets entrusted by the government and the central bank.

6. The investment entity entered into an agreement with the government entity. Under the agreement, the government entity entrusts the foreign exchange reserves of the government (the Assets) to the investment entity. The investment entity manages the Assets for the government entity and is the legal owner of these Assets while the government entity is the beneficial owner of the Assets.

7. Profits from the management of the Assets by the investment entity belong to the government entity. The profits includes all income and gains derived from the entrusted assets including interest, dividends, fund payments, capital gains and foreign exchanges gains.

8. The Assets managed by the investment entity on behalf of the government entity are to be accounted for separately from the assets that the investment entity holds in its own right and the assets entrusted by other government ministries and agencies. Accordingly, the annual report of investment entity does not include the Assets or income, gains and losses from management of those Assets held on trust for the government entity.

9. Under the agreement, the government entity may demand payment of the profits from asset management by giving prior notice to investment entity. If the government entity does not make a demand for payment, the profits from asset management are reinvested by investment entity on behalf of the government entity.

10. There is no trust deed between the investment entity and the government entity.

Investment in the Australian entity

11. The investment entity has a less than 10% interest in the Australian entity.

12. The investment entity expects to derive income from its investment in the Australian entity.

13. The income and gains from the investment in the Australian entity will be used to fund and support governmental functions of the government.

14. The government entity, investment entity, and members of their steering committees, board of directors and employees currently do not hold a seat on the board of directors of the Australian entity and will not hold a seat as a result of the investment entity's investment in the Australian entity.

15. The investment entity has no other investment in the Australian entity and has no intention of increasing its investment in the Australian entity (directly or indirectly).

Relevant legislative provisions

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1997 section 4-1

Reasons for decision

Question

Is the investment entity immune from income tax or withholding tax on interest income, dividend income, rental income, trust distributions, managed investment trust distributions and any other income derived from its investment in an Australian entity under the common law doctrine of sovereign immunity?

Detailed reasoning

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

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

The government entity forms part of the government and is responsible for managing the nation's economic policy, finances, fiscal strategies and tax system.

The investment entity is a wholly owned subsidiary of the government entity and was established under an Act with share capital contributed by the government. The investment entity was established to manage assets entrusted by the government.

The investment entity entered into an agreement with the government entity, whereby the government entity entrusts the Assets to the investment entity. The investment entity acts as a trustee of the Assets and manages the Assets beneficially for the government entity.

Accordingly, the investment entity is 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 investment entity's investment in the Australian entity a commercial transaction?

ATO Interpretative Decision ATOID 2002/45 states that a holding of 10% or less of the equity in a company will generally be accepted as a passive investment, and therefore a non-commercial activity. Although the Commissioner only refers to shares in a company, there is no reason why this view would be any different in the event that the investments are held in trust.

The government entity, through the investment entity, has a less than 10% interest in the Australian entity. The government entity, investment entity, and members of their steering committees, board of directors and employees currently do not hold a seat, and will not hold a seat, on the board of directors of the Australian entity.

Accordingly, the government entity's investment in the Australian entity through the investment entity will constitute a passive investment, and therefore a non-commercial activity. The relatively small interest in the Australian entity and the inability for the investment entity to control, influence or potentially control or influence not only the day to day management of the Australian entity, but also key business, strategic, and financial decisions relating to the Australian entity was decisive in reaching this conclusion.

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 investment company manages the Assets for the government entity and is the legal owner of these Assets while the government entity is the beneficial owner of the Assets.

Profits from the management of the Assets by the investment entity belong to the government entity. The profits include all income and gains derived from the entrusted assets including interest, dividends, fund payments, capital gains and foreign exchanges gains.

The Assets managed by the investment entity on behalf of the government entity are to be accounted for separately from the assets that the investment entity holds in its own right and the assets entrusted by other government ministries and agencies. Accordingly, the annual report of the investment entity does not include the Assets or income, gains and losses from management of those Assets held on trust for the government entity.

Under the agreement, the government entity may demand payment of the profits from asset management by giving prior notice to investment entity. If the government entity does not make a demand for payment, the profits from asset management are reinvested by the investment entity on behalf of the government entity.

Accordingly, the monies that are invested by the government entity via the investment entity in the Australian entity are and will remain government monies.

Conclusion

As the three conditions have been satisfied, the investment entity will be immune from income tax or withholding tax with respect to income derived from the investment in the Australian entity under the common law doctrine of sovereign immunity.