Edited version of private advice

Authorisation Number: 1051717815770

Date of advice: 16 November 2020

Ruling

Subject: Sovereign immunity

Question 1

Is the ordinary and statutory income derived by the Bank from its 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 interests in the Test Entities disregarded under sections 880-115 and 880-120 of the ITAA 1997 respectively?

Answer

Yes.

Question 4

Does paragraph 128B(3)(n) of the ITAA 1936 apply to exclude the Bank from liability to withholding tax on income from its interests in the Test Entities that is non-assessable non-exempt income due to the operation Division 880 of the ITAA 1997?

Answer

Yes.

Question 5

Does subsection 840-805(9) of the ITAA 1997 apply to exclude the Bank from liability to withholding tax on income from its interests in the Test Entities that is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997?

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

The Bank

The Bank is the central bank of Country A.

The Bank receives all Government revenues and pays out funds in accordance with the Government's instructions.

The Bank does not have share capital, and must repay its entire capital to the Government.

The Bank is not a partnership.

The Bank is controlled by a board of directors.

The Bank's objectives and functions align with it only carrying out activities that are consistent with the Bank being an entity that only carries on central banking activities.

The Bank's activities are conducted primarily using funds belonging to the Government and/or its constituent entities, as well as funding from financial institutions licensed by the Bank. To the extent the Bank obtains funding from financial institutions licensed by the Bank, funds are received in the course of it carrying out functions of the Government Bank. The Bank's activities are not financed by any funds or assets belonging to or held for the benefit of any private individual or entity

Australian Investments

The Bank has appointed custodians to facilitate trading in Australian listed debt and equity securities issued by Australian resident companies or managed investment trusts (MITs).

The Bank expects to derive interest income, dividend income, MIT fund payments, revenue gains and/or capital gains from its investments.

The Bank invests in Australian equity and debt investments (as detailed in Appendix 1). These investments 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 debt and/or equity interest held.

g.    the Bank only holds rights to vote in proportion to its equity interest in each investment.

h.    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.

i.      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.

j.      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 Investments as at 30 June 20XX

Reasons for decision

Question 1

Is the ordinary and statutory income derived by the Bank from its 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?

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.

A 'foreign government agency' is defined in subsection 995-1(1) of the ITAA 1997 as:

(a)   the government of a foreign country or of part of a foreign country; or

(b)   an authority of the government of a foreign country; or

(c)   an authority of the government of part of a foreign country.

Country A is a foreign country.

The Bank is considered an authority of the government of a foreign country therefore it is a foreign government agency.

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 Bank is the central bank of Country A.

The Bank does not have share capital, and must repay its entire capital to the government. Further, the Bank is required to undertake the functions of the Government bank in receiving all Government revenues and in paying out funds in accordance with its instructions.

The Bank is not permitted to receive private deposits, or to engage in commercial activities. The Bank's activities are conducted primarily using funds belonging to the Government and/or its constituent entities, as well as funding from financial institutions licensed by the Bank. To the extent the Bank obtains funding from financial institutions licensed by the Bank, funds are received in the course of it carrying out functions of the Government Bank. the Bank's activities are not financed by any funds or assets belonging to or held for the benefit of any private individual or entity.

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

All returns on the Bank's investments are public monies

The Bank does not have share capital, and must repay its entire capital to the government.

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

The Bank is not a partnership

The Bank 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.

The Bank carries out activities including the following:

(a)  stabilise and strengthen the internal and external value of the currency and take measures capable of strengthening the currency's cover;

(b)  hold and operate monetary reserve funds as separate funds earmarked for monetary purposes only;

(c)   mint, print and issue currency; and

(d)  supervise commercial banks and exchange dealers.

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

As the Bank satisfies each of the requirements in paragraphs 880-125(a) through (d) it is considered 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 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 equity securities in which the Bank (via its Australian custodians) invests will be either 'membership interests' as defined in section 960-135 of the ITAA 1997 or 'non-share equity interests' as defined in subsection 995-1(1) of the ITAA 1997, and the debt securities in which the Bank (via its Australian custodians) invests will be 'debt interests' for the purposes of section 974-15 of the ITAA 1997. In addition, the Bank expects to derive interest income, dividend income, MIT fund payments, and revenue gains from such debt and equity securities.

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 issuers of the relevant equity and debt securities are Australian resident

companies or MITs at the time the Bank derives any dividend income, interest income, MIT fund payments or revenue gains in relation to such securities.

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 entity/ies 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, in combination with any other Government body politics, agencies, or other non-resident entities in which a Government body politic or agency holds a total participation interest (as defined in section 960-180 of the ITAA 1997) of 100%, has a total participation interest (including, for this purpose, treating any equity holders as shareholders, and the total amount contributed in respect of non-share equity interests in the total paid-up share capital) in the issuers of the relevant equity and debt securities, of less than 10% at both (i) the time the relevant payments are derived by the Bank, and (ii) throughout any 12 month period beginning no earlier than 24 months before such time and ended no later than such time.

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 such that amounts of ordinary and statutory income derived by the Bank from its Investments 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?

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 membership interests, non-share equity interests or 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 interests in the Test Entities.

Question 3

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

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

holds membership interests, non-share equity interests or debt interests in the Test Entities, and

(b)  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 interests in the Test Entities.

Question 4

Does paragraph 128B(3)(n) of the ITAA 1936 apply to exclude the Bank from liability to withholding tax on income from its interests in the Tests Entities that is non-assessable non-exempt income due to the operation Division 880 of the ITAA 1997?

Detailed reasoning

Section 128B of the ITAA 1936 imposes liability to withholding tax on income derived by a non-resident that consists of dividend income (subsection 128B(1) of the ITAA 1936), interest income (subsection 128B(2) of the ITAA 1936) as well as other income prescribed in that section.

Subsection 128B(3) of the ITAA 1936 notes that section 128B of the ITAA 1936 will not apply to prescribed categories of income. Relevantly, paragraph 128B(3)(n) of the ITAA 1936 states that this includes income that is non-assessable non-exempt income because of Division 880 of the ITAA 1997 or Division 880 of the IT(TP)A 1997.

As established in Question 1, the ordinary and statutory income derived by the Bank as a return on its investments in the Test Entities is considered non-assessable non-exempt income under Division 880 of the ITAA 1997.

Therefore, the Bank is excluded from liability to withholding tax on its interest and/or dividend income in respect of these investments under paragraph 128B(3)(n) of the ITAA 1936.

Question 5

Does subsection 840-805(9) of the ITAA 1997 apply to exclude the Bank from liability to withholding tax on income from its interests in the Test Entities that is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997?

Detailed reasoning

Exclusion under subsection 840-805(9) of the ITAA 1997

Subsection 840-805(1) of the ITAA 1997 imposes a liability for MIT withholding tax on amounts paid to in accordance with subsections 840-805(2), (3) and (4) of the ITAA 1997.

Subsection 840-805(9) of the ITAA 1997 notes that subsections 840-805(2), (3) and (4) of the ITAA 1997 do not apply to you if the payments made relate to an amount that is non-assessable non-exempt income because of:

(a)  Division 880 of the ITAA 1997, or

(b)  Division 880 of the IT(TP)A 1997.

The income derived by the Bank as a return on its interests in the Test Entities is considered non-assessable non-exempt income under Division 880 of the ITAA 1997.

Therefore, the Bank is excluded from liability to withholding tax on amounts it receives under subsections 840-805(2), (3) and (4) of the ITAA 1997 in accordance with subsection 840-805(9) of the ITAA 1997.