Edited version of private advice

Authorisation Number: 1051745057346

Date of advice: 18 September 2020

Ruling

Subject: Sovereign immunity

Question

Is the ordinary and statutory income (including net capital gains) derived by the Bank from its interests in the Test Entities not assessable and not exempt income under section 880-105 of the Income Tax Assessment Act 1997 (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 is a central bank of the government of Country A.

The principal objects of the Bank are to promote monetary stability and financial stability conducive to the sustainable growth of Country A's economy. Its functions are stipulated by various laws.

The primary functions of the Bank are that of a central bank including:

a.    To formulate and conduct monetary policy in Country A

b.    To issue currency in Country A

c.     To regulate and supervise financial institutions which are subject to the laws enforced by the Bank

d.    To provide oversight over money and foreign exchange markets

e.    To exercise oversight over payments systems

f.      To promote a sound, progressive and inclusive financial system

g.    To hold and manage foreign reserves of Country A

h.    To promote an exchange rate regime consistent with the fundamentals of the economy; and

i.      To act as financial adviser, banker and financial agent of the Government.

The governance of the Bank is through a Board of Directors (Board) consisting of Governor, Deputy Governors and directors.

The government of Country A subscribes for and holds the paid-up capital of the Bank.

The Bank holds and manages the foreign reserves in accordance with the policies and guidelines established by the Board.

Any income/gain earned by the Bank will be used to increase the foreign reserves amount or are reinvested.

The net profit of the Bank less any unrealised gains and after transfers from the General Reserve Fund to any contingency reserve, fluctuation reserve or such other reserve as the Board deems prudent or necessary are placed to the credit of the General Reserve Fund and the remainder are paid to the government of Country A.

The Bank's investments are medium to long-term and are managed against specified benchmarks.

The income derived by the Bank from its investments in the Test Entities (which may be used for re-investment purposes) is also wholly owned by government of Country A.

The Bank holds directly equity investments in the Test Entities, being Australian resident companies, which have the following characteristics:

a.    The Bank holds less than 10% of the total participation interests in each of the Test Entities.

b.    The Bank holds less than 10% of the total participation interests in each of the Test Entities in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997.

c.     Each of the Test Entities are listed on the Australian Securities Exchange.

d.    Neither the Bank, nor any related party of the Bank, has involvement in the day to day management of the business of any of the Test Entities.

e.    Neither the Bank, nor any related party of the Bank, has the right to appoint a director to the Board of Directors of any of the Test Entities.

f.      Neither the Bank, nor any related party, holds the right to representation on any investor representative or advisory committee (or similar) of the Test Entities.

g.    Neither the Bank, nor any related party, has the ability to direct or influence the operation of the Test Entities outside of the ordinary rights conferred by the equity interest held.

h.    The Bank only holds rights to vote in proportion to its equity interest in each investment.

i.      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.

j.      The Bank's interests 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.

k.     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.

Relevant legislative provision

Income Tax Assessment Act 1997 Section 880-105

Reasons for decision

All legislative references in the 'Reasons for decision' are to the ITAA 1997, unless otherwise indicated.

Summary

The ordinary and statutory income (including net capital gains) derived by the Bank from its interests in the investments in the Test Entities is not assessable and not exempt income under section 880-105.

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.

*Denotes a term defined in subsection 995-1(1).

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).

*Denotes a term defined in subsection 995-1(1).

These conditions are considered below.

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.

*Denotes a term defined in subsection 995-1(1).

Section 960-180 provides that an entity's total participation interest in another entity is the sum of:

(a) the entity's *direct participation interest in the other entity at that time; and

(b) the entity's *indirect participation interest in the other entity at that time.

*Denotes a term defined in subsection 995-1(1).

Country A is a foreign country.

Country A has a total participation interest of 100% in the Bank. The Bank is not an Australian resident, nor is the Bank a resident trust estate for the purposes of Division 6 of Part III of the Income Tax Assessment Act 1936. Therefore, the Bank meets the requirements of being a sovereign entity in accordance with subsection 880-15(c).

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 paid-up capital of the Bank is wholly owned by the government of Country A and may be increased as the Minister approves from time to time. This increase in capital is subscribed and paid by the government of Country A.

The Bank also manages all of Country A's foreign reserves. The income and gains earned by the Bank are either used to increase the foreign reserves of Country A or reinvested.

The income derived by the Bank from its investments in the Test Entities (which may be used for re-investment purposes) is also wholly owned by the government of Country A.

Accordingly, the Bank is funded solely by public monies.

All returns on the Bank investments are public monies

As a wholly owned entity of Country A and manager of Country A's foreign reserves, all distributions made by the Bank, as funded by the returns on its investments, are received by Country A.

The net profit of the Bank less any unrealised gains and after transfers from the General Reserve Fund to any contingency reserve, fluctuation reserve or such other reserve as the Board deems prudent or necessary are placed to the credit of the General Reserve Fund and the remainder are paid to the government of Country A. Therefore, all returns on the Bank's investments in the Test Entities are public monies.

The Bank is not a partnership

The Bank was established in Country A as a central bank and is not a partnership.

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.

The Bank was established for the purpose of carrying on the business of central banking. The Bank therefore 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 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:

1. To formulate and conduct monetary policy in Country A
2. To issue currency in Country A
3. To regulate and supervise financial institutions which are subject to the laws enforced by the Bank
4. To provide oversight over money and foreign exchange markets
5. To exercise oversight over payments systems
6. To promote a sound, progressive and inclusive financial system
7. To hold and manage foreign reserves of Country A
8. To promote an exchange rate regime consistent with the fundamentals of the economy; and
9. To act as financial adviser, banker and financial agent of the Government.

It is considered that the above activities are consistent with the Bank only being an entity that only carries on central banking activities. Therefore, 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 Revised Explanatory Memorandum to the Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2018, 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)    net capital gains and revenue gains made on the disposal of an interest in the test entity - including gains that pass through a MIT.

The Bank holds shares in each of the Test Entities (which meet the requirements of being membership interests as defined by the interaction of sections 960-135 and 960-130). The Test Entities are entities in which the Bank holds a membership interest and earns returns in the form of dividends.Therefore, 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

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.

*Denotes a term defined in subsection 995-1(1).

The Test Entities are Australian resident companies at the relevant times. Therefore, the Bank receives income from entities which satisfy the requirements of paragraph 880-105(1)(c).

The Bank satisfies the portfolio interest test

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.

*Denotes a term defined in subsection 995-1(1).

There is no entity that can be considered part of the Bank's 'sovereign entity group' as defined in section 880-20. At the relevant times (as required by paragraph 880-105(1)(d)), the Bank holds less than 10% of the total participation interests in each of the Test Entities in the circumstances detailed in paragraph 880-105(4)(b).

Therefore, the portfolio test is satisfied.

The Bank does not have influence of a kind described in subsection 880-105(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), at the income time the sovereign entity 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).

*Denotes a term defined in subsection 995-1(1).

The Bank does not have the right to appoint a director to the Board of Directors of the Test Entities it has investments in, any involvement in the day to day management of the Test Entities, or any right to representation on any advisory committee. The Bank only holds rights to vote in proportion to its equity interest in each Test Entity.

There is no entity identified that can be considered part of the Bank's 'sovereign entity group' as defined in section 880-20. The Bank's interests in the Test Entities constitute less than 10% of the participation interests in those entities, and 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. In addition, no person who makes decisions that comprise the control and direction of the Test Entities' operations are accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of the Bank sovereign entity group.

Based upon the above, 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)(e).

Conclusion

As all the conditions listed in subsection 880-105(1) have been satisfied, the amounts of ordinary and statutory income (including net capital gains) derived by the Bank from its investments in the Test Entities, are not assessable and not exempt income.