Edited version of your written advice

Authorisation Number: 1013001704031

Date of advice: 15 June 2016

Ruling

Subject: Sovereign Immunity

Question 1

Is the non-resident entity exempt from liability to income tax and withholding tax on interest income derived from its investment in a managed investment fund (Managed Fund) under a double tax agreement?

Answer

Yes.

Question 2

Will the non-resident entity be immune from income tax and withholding tax on any ordinary income or statutory income derived from its investment in the Managed Fund under the common law doctrine of sovereign immunity?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

The scheme commenced on:

1 July 2012

Relevant facts and circumstances

1. The non-resident entity was established and capitalised by a foreign government.

2. The non-resident entity is in a country that has a double tax agreement (DTA) with Australia.

3. Any contracts or agreements entered into by the non-resident entity are binding on the foreign government.

4. The non-resident entity's purpose is to invest funds for the purpose of funding a social security pension scheme.

5. The non-resident entity's board is appointed by the foreign government.

6. The non-resident entity receives its funds from the foreign government.

7. The non-resident entity's investments, assets, and all income and gains derived from them are beneficially owned by the government, which reserves the right to use the money for other governmental functions.

8. The non-resident entity currently holds approximately X% of the units in the Managed Fund. By extension, it also holds approximately X% of the voting rights.

9. The non-resident entity will be paid trust distributions from the Managed Fund. This distribution will be made primarily of capital gains, ordinary income, rental income, and interest income. The non-resident entity may also in the future receive capital gains from the disposal of its units in the Managed Fund.

10. By virtue of a distribution reinvestment plan, the non-resident entity's percentage holding will change but not exceed 4% of the units in the Managed Fund.

11. The non-resident entity will have no control rights, no position on the Managed Fund's unitholder committee, no representation on the board of directors, and no involvement in the Managed Fund's operations.

12. There is no relationship between the non-resident entity and the Managed Fund other than the X% unit holding that the non-resident entity has in the Managed Fund.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1997 section 4-1

Income Tax Assessment Act 1997 section 995-1

International Tax Agreements Act 1953 section 3AAA

International Tax Agreements Act 1953 section 4

Double Tax Agreement

Reasons for decision

Question 1

Is the non-resident entity exempt from liability to income tax and withholding tax on interest income derived from its investment in a managed investment fund (Managed Fund) under a double tax agreement?

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 (ITAA 1936) on Australian-sourced income, unless an exemption or exclusion applies.

In determining liability to tax on Australian income derived by a foreign resident, it is necessary to also consider the applicable agreement as defined in section 3AAA or section 3AAB of the International Tax Agreements Act 1953 (the Agreements Act).

Subsection 4(1) of the Agreements Act incorporates the ITAA 1936 and the ITAA 1997 so that those Acts are read as one with the Agreements Act.

Subsection 4(2) of the Agreements Act, provides that the Agreements Act effectively overrides the ITAA 1936 and the ITAA 1997 where there are inconsistent provisions (except for some limited provisions).

Tax agreement

There is a double tax agreement between Australia and the country in which the non-resident entity resides. The agreement provides that interest income derived by a government of a contracting state be exempt from tax in the other contracting state. The non-resident entity derives interest income as part of its interest in the Managed Fund.

Is the non-resident entity a part of the government of a contracting state?

The non-resident entity is a part of the government of a foreign state because;

• it was established by, funded by, and is part of the foreign government with whom Australia has a tax agreement

• any contracts or agreements the non-resident entity enters are binding on the state

• its board of directors, chairman, and deputy chairman are all appointed by the foreign government

• it is evaluated and audited by the foreign government and the auditors it appoints, and

• its assets are all beneficially owned by the foreign government.

As the non-resident entity satisfies this condition, it is exempt from liability to withholding and income taxes on interest income derived from its investment in the Managed Fund.

Question 2

Will the non-resident entity be immune from income tax and withholding tax on any ordinary income or statutory income derived from its investment in the Managed Fund under the common law doctrine of sovereign immunity?

Detailed reasoning

Sovereign Immunity

For Australian income tax and withholding tax purposes it is accepted that the doctrine of sovereign immunity applies to a foreign government or an agency of a foreign government that engages in governmental functions. 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.

In determining whether the doctrine of sovereign immunity applies to Australian income tax and/or withholding tax, it is necessary to establish the following:

1. that the person making the investment (and therefore deriving the income) is a foreign government or an agency of a foreign government

2. that the moneys invested are and will remain government moneys, and

3. that the income or gain is being derived from a non-commercial activity.

If these three conditions are satisfied, then the income or gains will not be subject to Australian income tax and/or withholding tax.

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

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

For the reasons outlined previously, the non-resident entity is a part of a foreign government satisfying this requirement.

Condition 2: The monies invested 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.

Are the contributions received by the non-resident entity government monies?

The non-resident entity was established by, and received its initial capital from, a foreign government. It receives all of its funds for investment from the foreign government. The money is invested by the non-resident entity, and called upon by the foreign government when it needs to exercise governmental functions, including funding the social security pension scheme.

Accordingly, the money the subject of this scheme is and will remain government monies, satisfying this requirement with respect to sovereign immunity.

Condition 3: Non-commercial transaction

Whether an operation or activity is a commercial transaction will depend on the facts of each case. As a guide, a commercial transaction is generally considered to be an activity concerned with the trading of goods and services, such as buying, selling, bartering, transportation, and includes the carrying on of a business.

In relation to the ownership of shares in a company or other similar equity interests, there would be instances where the extent of the holding gives rise to questions as to whether the interests constitute a passive investment or a commercial investment. A determination of commerciality will depend on the particular circumstances.

Importantly, consideration will be given to factors relating to the influence and control that is exercised by the investor in relation to the acquired company or similar equity investment, particularly in relation to its influence on day to day management and key business, strategy and financial decisions.

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

The non-resident entity currently holds approximately X% of the units in the Managed Fund. It has held these units since 20XX.

The factors relevant to determining whether this investment by the non-resident entity is reflective of a commercial transaction are as follows;

• the investment has been held since 20XX to derive distribution income.

• the non-resident entity has no influence or involvement in the board, the unitholder committee or operations of the Managed Fund. The non-resident entity has no right to appoint a director, and its unit holding does not entitle it to appoint a representative to the unitholder committee of the Managed Fund.

• The non-resident entity holds approximately X% of the units, and by extension, approximately X% of the voting rights in the Managed Fund. The extent of the holding is not considered to be indicative of a commercial transaction.

• The non-resident entity participates in the Managed Fund's distribution reinvestment plan. The non-resident entity's interest will not exceed 4% of the units in the Managed Fund even with participation in the plan. The extent of the holding and associated voting rights would not be considered to be indicative of a commercial transaction.

Together, the above factors indicate that the non-resident entity's investment into the Managed Fund is a passive holding, and therefore non-commercial transaction, satisfying this condition.

Conclusion

As the three conditions have been satisfied, the non-resident entity is immune from income tax and withholding tax on income derived from its investment into the Managed Fund under the common law doctrine of sovereign immunity.