Edited version of private advice

Authorisation Number: 1051713152412

Date of advice: 10 July 2020

Ruling

Subject: Sovereign immunity

Question 1

Is the ordinary and statutory income derived by the Bank from its debt interests held in the entities listed in Appendix 1 (the Test Entities) not assessable and not exempt income under section 880-105 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Does section 880-110 of the ITAA 1997 operate to deny the Bank a deduction for any loss it incurs in respect of its debt interests in the Test Entities?

Answer

Yes.

Question 3

Is any capital gain or capital loss made by the Bank with respect to its debt interests in the Test Entities disregarded under sections 880-115 and 880-120 of the ITAA 1997 respectively?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.    The Bank is a central bank of the foreign government of Country A.

2.    The purpose of the Bank is to preserve the monetary stability of the foreign country. Its functions are stipulated by various laws.

3.    The Bank is charged with carrying out activities including issuing currency, prudential bank supervision, banking licencing, foreign exchange regulation and monetary policy.

4.    The activity of the Bank in the Australian markets as well as any other market is solely for the performance of functions of the Bank as a central bank.

5.    The Bank is a legal, independent entity and it is taxed at zero rate in its country.

6.    The Bank is not a body of state power, but its powers are in effect, the functions of a body of state power because their implementation implies the use of that state power.

7.    For the purpose of correct tax qualification, the Bank is deemed to be wholly owned by the Government. The authorised capital (money of the bank) and other property of the Bank shall be in federal ownership.

8.    The Bank is the central bank of issue exercising operations in financial markets in the course of management of foreign exchange reserves.

9.    Profits of the Bank are transferred to the federal budget or reserves and various funds.

10.  The Bank invests in bonds issued by the Commonwealth of Australia; states and territories of Australia and in money market instruments in Australian banks.

11.  The Bank expects to derive the following forms of income in Australia on its Australian investments:

interest income on its bank deposits, money market instruments and balances of bank accounts held with Australian banks,

coupon income (interest income) on its Australian Government debt securities or debt securities issued by the financial authorities of Australian States, and

capital gains when it disposes of Australian Government debt securities or debt securities issued by financial authorities of Australian States.

12.  The Bank holds various debt interests in the Test Entities listed in Appendix 1.

13.  The debt interests have the following characteristics:

a.    The Bank and all members of its sovereign entity group hold collectively less than 10% of the total participation interests in each of the Test Entities.

b.    The Bank and all members of its sovereign entity group would hold collectively less than 10% of the total participation interests in the Test Entities in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997.

c.     Neither the Bank, nor any members of its sovereign entity group, has involvement in the day to day management of the business of any of the Test Entities.

d.    Neither the Bank, nor any members of its sovereign entity group, has the right to appoint a director to the Board of Directors of any of the Test Entities.

e.    Neither the Bank, nor any members of its sovereign entity group, holds the right to representation on any investor representative or advisory committee (or similar) of the Test Entities.

f.      Neither the Bank, nor any members of its sovereign entity group, has the ability to direct or influence the operation of the Test Entities outside of the ordinary rights conferred by the interest held.

g.    The Bank's interests in the Test Entities do not provide it with an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations.

h.    The Bank's interests, when combined with the other interests held within its sovereign entity group, do not provide an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations.

i.      No person involved in the control and direction of the Test Entities' operations is accustomed or obliged to act in accordance with the directions, instructions or wishes of the Bank or members of the Bank's sovereign entity group.

Appendix 1 - List of Relevant Test Entities as at 1 July 20XX

Reasons for decision

Question 1

Is the ordinary and statutory income derived by the Bank from its debt interests held in the entities listed in Appendix 1 (the Test Entities) not assessable and not exempt income under section 880-105 of the ITAA 1997?

Answer

Yes.

Detailed reasoning

Section 880-105 provides that amounts of ordinary and statutory income derived by a sovereign entity are not assessable and not exempt income if certain conditions are met. Those conditions are listed in subsection 880-105(1):

(a) the sovereign entity is covered by section 880-125; and

(b) the amount is a return on any of the following kinds of interest that the sovereign entity holds in another entity (the test entity):

(i) a *membership interest;

(ii) a *debt interest;

(iii) a *non share equity interest; and

(c) the test entity is:

(i) a company that is an Australian resident at the time (the income time) when the amount becomes ordinary or statutory income of the sovereign entity; or

(ii) a *managed investment trust in relation to the income year in which the income time occurs; and

(d) the *sovereign entity group of which the sovereign entity is a member satisfies the portfolio interest test in subsection (4) in relation to the test entity:

(i) at the income time; and

(ii) throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time; and

(e) the sovereign entity group of which the sovereign entity is a member does not have influence of a kind described in subsection (6) in relation to the test entity at the income time.

These conditions are considered below.

The Bank is a covered sovereign entity

Section 880-125 states:

A *sovereign entity is covered by this section if it satisfies all of the following requirements:

(a) the entity is funded solely by public monies;

(b) all returns on the entity's investments are public monies;

(c) the entity is not a partnership;

(d) the entity is not any of the following:

(i) a *public non-financial entity;

(ii) a *public financial entity (other than a public financial entity that only carries on central banking activities).

These conditions are considered below.

The Bank is a sovereign entity

For an entity to be covered by section 880-125, it must be a sovereign entity. Section 880-15 defines a sovereign entity to be any of the following:

(a) a body politic of a foreign country, or a part of a foreign country;

(b) a *foreign government agency;

(c) an entity:

(i) in which an entity covered by paragraph (a) or (b) holds a *total participation interest of 100%; and

(ii) that is not an Australian resident; and

(iii) that is not a resident trust estate for the purposes of Division 6 of Part III of the Income Tax Assessment Act 1936.

Country A is a foreign country.

The Bank is the central bank of Country A. It was established by statute and is a legal entity. It performs a number of government functions including issuing currency, managing monetary policy, and managing the foreign reserves. It is taxed at a zero rate in Country A.

As an agency or instrumentality of Country A, the Bank undertakes its activities in accordance with the relevant laws. Accordingly, the Bank would constitute a body corporate (not being a natural person or corporation sole) that is an entity. That is, it is an agency or instrumentality of Country A.

As such, the Bank meets the requirements of being a sovereign entity in accordance with section 880-15 of the ITAA 1936.

The Bank is funded solely by public monies

The phrase 'public monies' is not defined and as such takes its ordinary meaning. In the context of Division 880, this phrase essentially means monies raised by a foreign government (or part of a foreign government) for a public purpose which form part of the foreign government's (or part of the foreign government's) equivalent to Australia's Consolidated Revenue Fund (Roy Morgan Research Pty Ltd v FC of T & Anor [2011] HCA 35). This would ordinarily include general tax revenue, proceeds from the issue of government bonds, the proceeds of privatisations etc.

The authorised capital (money of the bank) and other property of the Bank shall be in federal ownership.

The Australian investments are made when managing and administering the foreign reserves. This money is held by the Bank to provide liquidity in foreign currency for the State. This money may be used to finance the repayments of the country's debt, to pay for exceptional government expenditure on imports at times of emergency, or to provide liquidity in a financial crisis.

The source of the monies to make these investments in Australia originates in monies owned and controlled by the government of Country A.

As such, the Bank is funded solely by public monies.

All returns on the Bank's investments are public monies

The profits made by the Bank are distributed to the federal budget or transferred to reserves and various funds of Country A.

As such, all returns on the Bank's investments are public monies.

The Bank is not a partnership

The Bank is a public law entity and is not a partnership. As such, it passes this condition.

The Bank is not a public non-financial entity or public financial entity

Subsection 880-130(1) defines the term public non-financial entity:

An entity is a public non financial entity if its principal activity is either or both of the following:

(a) producing or trading non financial goods;

(b) providing services that are not financial services.

Subsection 880-130(2) defines the term public financial entity:

An entity is a public financial entity if any of the following requirements are satisfied:

(a) it trades in financial assets and liabilities;

(b) it operates commercially in the financial markets;

(c) its principal activities include providing any of the following financial services:

(i) financial intermediary services, including deposit taking and insurance services;

(ii) financial auxiliary services, including brokerage, foreign exchange and investment management services;

(iii) capital financial institution services, including financial services in relation to assets or liabilities that are not available on open financial markets.

It is noted that subparagraph 880-125(d)(ii) excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

The Bank was established for the purpose of carrying on the business of central banking. The Bank satisfies the definition of a public financial entity provided for in subsection 880-130(2). However subparagraph 880-125(d)(ii) excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

Paragraph 75 of the Draft Law Companion Ruling LCR 2019/D4 The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2019/D4) lists the following as being considered as 'central banking activities':

• monetary policy development
• issuing national currency
• acting as custodian of international reserves, and
• providing banking services to government.

It is considered that the activities of the Bank are consistent with the Bank only being an entity that only carries on central banking activities. As such, the Bank passes the condition in paragraph 880-125(d).

As the Bank satisfies each of the requirements in paragraphs 880-125(a) through (d) it is a sovereign entity that is covered by section 880-125 for the purposes of paragraph 880-105(1)(a).

The Bank's return is received on a relevant interest in the Test Entities

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(b), it must be a 'return on' a membership interest, debt interest or non-share equity interest held by the sovereign entity in the test entities.

As detailed in paragraph 4.37 of the Explanatory Memorandum to the Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Act 2019 ('the EM'), a 'return on' a membership interest, debt interest or non-share equity interest for the purposes of paragraph 880-105(1)(b) will include:

1.            dividends - including non-share dividends and dividends that pass through a managed investment trust (MIT)

2.            interest - including interest that passes through a MIT

3.            fund payments made by a MIT (other than fund payments that are attributable to non-concessional MIT income), and

4.            revenue gains made on the disposal of an interest in the test entity - including revenue gains that pass through a MIT.

The Test Entities are entities of which the Bank holds a debt interest and earns returns in the form of interest

As such, the Bank will receive amounts which satisfy the requirements of paragraph 880-105(1)(b).

The Bank's income is received from Australian resident companies or managed investment trusts

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(c), it must be received from an entity that is either:

(i) a company that is an Australian resident at the time (the income time) when the amount becomes ordinary or statutory income of the sovereign entity; or

(ii) a *managed investment trust in relation to the income year in which the income time occurs.

The Test Entities are Australian resident companies at the relevant times.

As such, the Bank receives income from entities which satisfy the requirements of paragraph 880-105(1)(c).

The Bank's sovereign entity group satisfies the portfolio interest test

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(d), the sovereign entity and the sovereign entity group to which it belongs must satisfy the portfolio interest test in relation to the test entities at both the income time and throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time.

The portfolio interest test is outlined in subsection 880-105(4), which states:

A *sovereign entity group satisfies the portfolio interest test in this subsection in relation to the test entity at a time if, at that time, the sum of the *total participation interests that each *member of the group holds in the test entity:

(a) is less than 10%; and

(b) would be less than 10% if, in working out the *direct participation interest that any entity holds in a company:

(i) an *equity holder were treated as a shareholder; and

(ii) the total amount contributed to the company in respect of *non-share equity interests were included in the total paid-up share capital of the company.

Section 880-20 provides the definition of sovereign entity group. Broadly, sovereign entities of the same foreign government will be members of the same sovereign entity group and sovereign entities of the same part of a foreign government will be members of the same sovereign entity group.

The Bank is part of the sovereign entity group of Country A. At the relevant times (as required by paragraph 880-105(1)(d)), the Bank, and its sovereign entity group collectively, holds less than 10% of the total participation interests in each of the Test Entities and the Bank and its sovereign entity group collectively, would hold less than 10% of the total participation interests in the Test Entities in the circumstances detailed in paragraph 880-105(4)(b).

Therefore the portfolio test is satisfied.

The Bank's sovereign entity group does not have influence of a kind described in subsection (6) in relation to the Test Entities at the income time

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(e), at the income time the sovereign entity group to which the sovereign entity belongs must not have influence over the test entity of a kind described in subsection 880-105(6).

Subsection 880-105(6) states:

A *sovereign entity group has influence of a kind described in this subsection in relation to the test entity at a time if any of the following requirements are satisfied at that time:

(a) a *member of the group:

(i) is directly or indirectly able to determine; or

(ii) in acting in concert with others, is directly or indirectly able to determine;

the identity of at least one of the persons who, individually or together with others, make (or might reasonably be expected to make) the decisions that comprise the control and direction of the test entity's operations;

(b) at least one of those persons is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of a member of the group (whether those directions, instructions or wishes are expressed directly or indirectly, or through the member acting in concert with others).

As such, there are two distinct sub-tests within the influence test.

Sub-test 1 of the influence test, as contained in paragraph 880-105(6)(a), assesses whether the sovereign entity group is able to determine the identity of at least one of the persons who, individually or together with others, makes or is reasonably expected to make, decisions comprising the control and direction of the test entity's operations. This includes situations where the sovereign entity group is able to act in concert with others to determine the identity of a relevant decision-maker in the test entity.

Sub-test 1 also extends to situations where the sovereign entity group, in its own right holds the ability to approve or veto decisions which go to the control or direction of the test entity.

The Bank's interests in the Test Entities do not provide it with an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations. Furthermore, the Bank's interests, when combined with the other interests held within its sovereign entity group, do not provide an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations.

Sub-test 2 of the influence test, as contained in paragraph 880-105(6)(b), assesses whether at least one of the relevant decision-making persons of the test entity is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of the sovereign entity group.

No person involved in the control and direction of the Test Entities' operations is accustomed or obliged to act in accordance with the directions, instructions or wishes of the Bank or members of the Bank's sovereign entity group.

Based upon the above, the sovereign entity group of the Bank does not have influence of a kind described in subsection 880-105(6) and will, therefore, satisfy the requirements of paragraph 880-105(1)(f).

Conclusion

As all of the conditions listed in subsection 880-105(1) have been satisfied, section 880-105 will apply to the effect that amounts of ordinary and statutory income derived by the Bank from its debt interests held in the Test Entities are not assessable and not exempt income.

Question 2

Does section 880-110 of the ITAA 1997 operate to deny the Bank a deduction for any loss it incurs in respect of its debt interests in the Test Entities?

Answer

Yes.

Detailed reasoning

Section 880-110 provides that a sovereign entity cannot deduct an amount if:

(a) the sovereign entity is covered by section 880-125; and

(b) the amount is a loss in respect of any of the following kinds of interest that the sovereign entity holds in another entity:

(i) a membership interest;

(ii) a debt interest;

(iii) a non-share equity interest; and

(c) the requirements in paragraphs 880-105(1)(c), (d) and (e) would be satisfied, on the assumptions that:

(i) the amount were ordinary income or statutory income; and

(ii) the amount became ordinary income or statutory income of the sovereign entity at the time it arose; and

(iii) references in those paragraphs to the test entity were references to the other entity mentioned in paragraph (b) of this section.

As established in Question 1, the Bank:

(a) is covered by section 880-125

(b) holds debt interests in the Test Entities, and

(c) satisfied the requirements in paragraphs 880-105(1)(c), (d) and (e) in relation to ordinary or statutory income that it will derive from the Test Entities.

Therefore, the Bank cannot deduct an amount if it is a loss in respect of its debt interests in the Test Entities.

Question 3

Is any capital gain or capital loss made by the Bank with respect to its debt interests in the Test Entities disregarded under sections 880-115 and 880-120 of the ITAA 1997 respectively?

Answer

Yes.

Detailed reasoning

Section 880-115 provides that a sovereign entity disregards a capital gain from a CGT event that happens in relation to a CGT asset if:

(a) the sovereign entity is covered by section 880-125; and

(b) the CGT asset is a membership interest, non-share equity interest or debt interest in another entity; and

(c) the requirements in paragraphs 880-105(1)(c), (d) and (e) would be satisfied, on the assumptions that:

(i) the capital gain were an amount of ordinary income or statutory income; and

(ii) the amount mentioned in subparagraph (i) became ordinary income or statutory income of the sovereign entity immediately before the time the CGT event happened; and

(iii) references in those paragraphs to the test entity were references to the other entity mentioned in paragraph (b) of this section.

Section 880-120 provides that a sovereign entity disregards a capital loss from a CGT event if, on the assumption that the loss were a capital gain, the capital gain would be disregarded because of section 880-115.

As established in Question 1, the Bank:

(a) is covered by section 880-125

(b) holds debt interests in the Test Entities, and

(c) satisfied the requirements in paragraphs 880-105(1)(c), (d) and (e) in relation to ordinary or statutory income that it will derive from the Test Entities.

Therefore, the Bank will be required to disregard any capital gain or loss made in respect of its debt interests in the Test Entities.