Edited version of private advice

Authorisation Number: 1051744391974

Date of advice: 11 September 2020

Ruling

Subject: International issues - sovereign immunity

Question 1

Is the ordinary and statutory income derived by the Foreign Entity from its Australian investments, not assessable and not exempt income under section 880-105 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will any capital gain arising to Foreign Entity in respect of the equity investment assets, comprised in Fund 1 be disregarded pursuant to section 880-115 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

1 July 2019 to 30 June 2024

The scheme commences on:

1 July 2019

Relevant facts and circumstances

Foreign Entity

1.    Foreign Entity is a resident of Foreign State for Foreign State's tax purposes.

2.    Foreign Entity was established by an act of Foreign State and its activities areexempt from Norwegian tax.

3.    Foreign Entity is a separate legal entity and its issued capital is owned by Foreigns State's government.

4.    Foreign Entity performs public tasks and manages assets on behalf of the Foreign State.

5.    Foreign Entity reports to the relevant government entity of the Foreign State.

6.    Foreign Entity manages Fund 1 and Fund 2. Fund 2 is managed on behalf of the Foreign State.

7.    Monies invested by Foreign Entity are sourced from the Foreign State.

8.    The Governor of the Foreign Entity is responsible for the day to day management of the Foreign Entity.

Fund 1

9.    Fund 1 is the long-term portfolio of the foreign exchange reserves of Foreign Entity.

10.  The beneficial owner of the assets of Fund 1, along with the income and capital gains generated by those assets, is the Foreign Entity.

11.  A dedicated asset management department within the Foreign Entity manages the equity assets of Fund 1.

12.  The asset manager manages Fund 1 in accordance with the asset allocation rules laid down by the government of Foreign State.

13.  Fund 1 is used for transactions in the foreign exchange market.

14.  Fund 1 is divided into a money market portfolio and a long-term portfolio.

Foreign Entity's investments in Australia

15.  The Australian equity investments held by Foreign Entity include shares in Australian companies and units in Australian managed investment trusts (MITs) with the following characteristics:

(a)  All investments are listed on the Australian Securities Exchange (ASX)

(b)  Foreign Entity holds less than 10% of the total equity interests on issue of each Australian company / MIT

(c)   Foreign Entity has no involvement in the day to day management of the business of any of the Australian companies / MITs

(d)  Foreign Entity has no right to appoint a director to the Board of Directors of the Australian company or equivalent role in a MIT

(e)  Foreign Entity has no right to representation on any investor's representative or advisory committee (or similar) of the Australian company or MIT

(f)    Foreign Entity has no ability to direct or influence the operation of the Australian company or MIT outside of the ordinary rights conferred by the equity interest held, and

(g)  Foreign Entity only hold rights to vote in proportion to their equity interest in each Australian company or MIT.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 880

Income Tax Assessment Act 1997 section 880-105

Income Tax Assessment Act 1997 section 880-115

Reasons for decision

Question 1

Is the ordinary and statutory income derived by Foreign Entity from its Australian investments, not assessable and not exempt income under section 880-105 of the ITAA 1997?

Summary

Ordinary and statutory income derived by Foreign Entity as a return on its Australian investments is not assessable and not exempt income due to the operation of section 880-105 of the ITAA 1997.

Detailed reasoning

Section 880-105 of the ITAA 1997 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) of the ITAA 1997:

(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.

Foreign Entity is a covered sovereign entity

Section 880-125 of the ITAA 1997 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.

Foreign Entity is a sovereign entity

For an entity to be covered by section 880-125 of the ITAA 1997, it must be a sovereign entity. Section 880-15 of the ITAA 1997 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.

Foreign Entity conducts central banking activities. It is established by an act Foreign Government and is a resident of Foreign State. Foreign State is a separate legal entity which is wholly owned by the Government.

The primary role of Foreign Entity is to undertake central bank activities.

Foreign Entities's highest decision-making bodies are appointed by the State and the Government.

Based on the above facts, Foreign Entity is a foreign government agency as defined in subsection 995-1(1) of the ITAA 1997 and is therefore a sovereign entity under paragraph 880-15(b) of the ITAA 1997.

Therefore, this requirement is satisfied.

Foreign Entity 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 of the ITAA 1997, 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.

In accordance with the Foreign Legislation, Foreign Entity is tasked with managing Fund 1. Monies invested in Fund 1 by Foreign Entity are sourced from the Foreign State.

Foreign Entity is therefore funded solely by public monies.

All returns on Foreign Entity's investments are public monies

Foreign Entity owns Fund 1and is to retain the profits from its Fund 1 investments for use in its foreign exchange market transactions.

Therefore, all returns on Foreign Entity's investments are public monies.

Foreign Entity is not a partnership

Foreign Entity is a separate legal entity which is owned by the Foreign State. It is not a partnership. As such, it passes this condition.

Foreign Entity is not a public non-financial entity or public financial entity

Subsection 880-130(1) of the ITAA 1997 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) of the ITAA 1997 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) of the ITAA 1997 excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

Foreign Entity was created by Foreign State through legislation, to conduct its central banking activities.

Foreign Entity does not produce or trade non-financial goods and does not provide services that are not financial services. Whilst Foreign Entity does trade in financial assets and liabilities, and undertakes the activities listed in paragraph 880-130(2)(c) of the ITAA 1997, whilst conducting its central banking activities. As such it is excluded from being a public financial entity under subparagraph 880-125(d)(ii) of the ITAA 1997.

As such, Foreign Entity is not a public non-financial entity nor a public financial entity and passes the condition in paragraph 880-125(d) of the ITAA 1997.

As Foreign Entity satisfies each of the requirements in paragraphs 880-125(a) through (d) of the ITAA 1997 it is considered a sovereign entity that is covered by section 880-125 of the ITAA 1997 for the purposes of paragraph 880-105(1)(a) of the ITAA 1997.

Foreign Entity'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) of the ITAA 1997, 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 membershipinterest 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 for the purposes of this ruling are the publicly-traded companies and MITs in which Foreign Entity holds shares and units respectively (which meet the requirements of being membership interests as defined by the interaction of sections 960-135 and 960-130 of the ITAA 1997) and pay to Foreign Entity:

·   MIT fund payments, including interest components of trust distributions, and

·   dividends.

As such, Foreign Entity will receive amounts which satisfy the requirements of paragraph 880-105(1)(b) of the ITAA 1997.

Foreign Entity's income is received from Australian resident companies or MITs

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(c) of the ITAA 1997, 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 and MITs.

As such, Foreign Entity receives income from entities which satisfy the requirements of paragraph 880-105(1)(c) of the ITAA 1997.

Foreign Entity 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) of the ITAA 1997, 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) of the ITAA 1997, 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 of the ITAA 1997 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.

Foreign Entity holds less than 10% of the total shares on issue of each Australian company and less than 10% of the total units on issue of each Australian trust. Additionally, Foreign Entity is prohibited under its current management agreements from purchasing more than 10% of any overseas entity for investment purposes in Fund 1.

As such, Foreign Entity's interest in the test entities satisfy the requirements of paragraph 880-105(1)(d) of the ITAA 1997.

Foreign Entity does not have influence of a kind described in subsection 880-105(6) of the ITAA 1997

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(e) of the ITAA 1997, 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) of the ITAA 1997.

Subsection 880-105(6) of the ITAA 1997 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.

Sub-test 2 of the influence test, as contained in paragraph 880-105(6)(b) of the ITAA 1997, 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.

In relation to Foreign Entity's investments in the Australian companies and trusts:

(a)  Foreign Entity has no involvement in the day to day management of the business of any of the Australian companies or trusts

(b)  Foreign Entity has no right to appoint a director to the Board of Directors of any of the Australian companies and has no right to appoint a director to the Board of Directors of any of the trustee companies or the trusts

(c)   Foreign Entity has no right to representation on any investor representative or advisory committee (or similar) of any of the Australian companies or trusts

(d)  Foreign Entity has no ability to direct or influence the operation of the Australian company or trust outside of the ordinary rights conferred by the share or unit interest held, and

(e)  Foreign Entity only holds rights to vote as a shareholder or unitholder in proportion to its share interest in the Australian companies or trusts.

Based upon the above, the sovereign entity group of Foreign Entity does not have influence of a kind described in subsection 880-105(6) of the ITAA 1997 and will, therefore, satisfy the requirements of paragraph 880-105(1)(e) of the ITAA 1997.

Conclusion

As all of the conditions listed in subsection 880-105(1) of the ITAA 1997 have been satisfied, section 880-105 of the ITAA 1997 will apply to the effect that amounts of ordinary and statutory income derived by Foreign Entity's from its investments in the Australian investments are not assessable and not exempt income for the period from 1 July 2019 to 30 June 2024.

Question 2

Will any capital gain arising to Foreign Entity in respect of the equity investment assets, comprised within Fund 1, be disregarded pursuant to section 880-115 of the ITAA 1997?

Detailed Reasoning

Section 880-115 of the ITAA 1997 provides that a capital gain of a sovereign entity from a Capital Gains Tax (CGT) event that happens in relation to a CGT asset is disregarded if the following conditions are met:

(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.

1. Foreign Entity is a sovereign entity as covered by section 880-125 of the ITAA 1997

As noted in Question 1, Foreign Entity is considered a sovereign entity for the purposes of section 880-125 of the ITAA 1997.

Therefore, this requirement is satisfied.

2. CGT asset is a membership interest, non-share equity interest or debt interest in another entity

As noted in Question 1, the assets are membership interests in Australian resident companies and MITs.

Therefore, this requirement is satisfied.

3. The requirements of paragraphs 880-105(1)(c) to (e) of the ITAA 1997 have been satisfied.

For the reasons outlined in the answer to Question 1, the requirements in paragraphs 880-105(1)(c), (d) and (e) of the ITAA 1997 are satisfied.

Conclusion

As all the requirements in section 880-115 of the ITAA 1997 are satisfied, Foreign Entity will be entitled to disregard the capital gain in respect to the Australian investments.