Edited version of private advice

Authorisation Number: 1051790179659

Date of advice: 16 December 2020

Ruling

Subject: International issues - sovereign immunity

Question 1

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

Answer

Yes.

Question 2

Is any capital gain or capital loss made by ForeignCo 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 3

Does paragraph 128B(3)(n) of the Income Tax Assessment Act 1936 (ITAA 1936) apply to exclude ForeignCo 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.

This ruling applies for the following period:

1 July 20xx to 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

ForeignCo is a public institution owned, established and supervised by the Government of Country X (the Government).

The Government wholly owns TopCo. TopCo wholly owns SubCo, which wholly owns ForeignCo. The SubCo Chief Executive Officer (CEO) reports to the TopCo's Managing Director and Group CEO.

ForeignCo manages a global investment portfolio in a wide range of asset classes.

ForeignCo's primary objective is to invest funds and deliver sustained long-term financial returns so the government can provide for Country X's current and future welfare. ForeignCo receives its funds from the Government's financial surplus to its budgetary and other funding requirements.

SubCo is a sovereign wealth fund of the Government. SubCo was established by the Government to invest its surplus financial resources through globally diversified asset classes and active investment management strategies and to assist the Government in achieving continuous financial success and wealth protection, while sustaining prosperity for the future.

SubCo's laws and regulations require it (and the companies they have the power to establish), to exercise independent power as separate legal entities when conducting their business and governing their corporate affairs.

SubCo and the companies established by it, including ForeignCo, shall be exempt from all local taxes and duties.

SubCo has legal personality with financial and administrative independence.

SubCo is not a tax resident in Australia. In particular, SubCo has neither its central management and control in Australia nor is its voting power controlled by Australian (tax) residents.

SubCo is the beneficial owner of the assets under custody.

SubCo aims to invest funds allocated by the Government both within and outside Country X, and to diversify investments with a view to achieving balance between such investments, maintain thereby the invested funds, with due coordination with the investment enterprises undertaken by government bodies within the Emirate.

SubCo shall have a board of directors comprising a chairman and directors including the Managing Director.

TopCo wholly owns SubCo2. SubCo2 operates a public bonds program. The proceeds raised from the public bonds program can only be used for SubCo2 and its consolidated subsidiaries, joint operations and equity accounted investees. None of this third party debt funding forms part of Mubadala's monies.

No other third party debt funding is used by ForeignCo.

Any monies given to ForeignCo, or income made by ForeignCo, are ultimately owned by the Government. The Government is able to recall any monies of ForeignCo at any time. At the time of SubCo's dissolution or liquidation, the investment fund shall devolve upon the Government in accordance with the conditions stipulated by the law, as would apply to ForeignCo.

ForeignCo is not a partnership.

ForeignCo is not a resident of Australia for Australian income tax purposes.

Neither SubCo or ForeignCo are resident trust estates for the purposes of Division 6 of Part III of the ITAA 1936.

ForeignCo is not in the business of trading in equity and debt securities with the intent of deriving profits from the buying and selling of securities.

Australian investments

ForeignCo's investment decisions are based solely on economic objectives.

The equity interests held by ForeignCo are all in Australian resident companies or Managed Investment Trusts (MITs).

The equity interests held by ForeignCo all have the following characteristics:

a)    All securities are listed on the Australian Securities Exchange (ASX) or another recognised stock exchange

b)    ForeignCo and all members of its sovereign entity group, to the best of its knowledge, hold collectively less than 10% of the total participation interests in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997

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

d)    Neither ForeignCo, nor any members of its sovereign entity group, has any right to representation on the board of directors of any of the Test Entities

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

f)     Neither ForeignCo, 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)    ForeignCo'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 makes decisions that comprise the control and direction of the Test Entities' operations

h)    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 ForeignCo or members of ForeignCo's sovereign entity group.

ForeignCo is currently in receipt of the following types of Australian source income:

a)    Franked dividend income

b)    Unfranked dividend income,

c)    Australian sourced capital gains income, and

d)    MIT income.

Relevant legislative provisions

Division 880 of the ITAA 1997

Reasons for decision

Question 1

Is the ordinary and statutory income derived by ForeignCo from its interests held in the Test Entities not assessable income and not exempt income under section 880-105 of the ITAA 1997?

Summary

The ordinary and statutory income derived by ForeignCo derived from its interests held in each Test Entity is not assessable and not exempt income due to the operation of 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 (thetest 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.

ForeignCo 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.

ForeignCo 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.

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.

Country X is an independent, sovereign state. TopCo is Country X's investment authority. ForeignCo is indirectly wholly owned by TopCo.

TopCo is supervised by the Government and has its primary objective as investing funds and delivering sustained long-term financial returns so the Government can provide for Country X's current and future welfare.

TopCo is an investment authority of the government of a foreign country (or part of a foreign country) and therefore it is a foreign government agency and meets the requirements of being a sovereign entity as defined in paragraph 880-15(b) of the ITAA 1997.

TopCo owns 100% of SubCo. SubCo owns 100% of ForeignCo. Neither entity are Australian residents or resident trust estates for the purposes of Division 6 of Part III of the ITAA 1936.

Therefore, ForeignCo meets the requirements of being a sovereign entity as defined in paragraph 880-15(c) of the ITAA 1997.

ForeignCo 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.

ForeignCo's primary objective is to invest funds and deliver sustained long-term financial returns so the Government can provide for Country X's current and future welfare. ForeignCo receives its funds from the Government's financial surplus to its budgetary and other funding requirements.

As such, ForeignCo is funded solely by public monies.

All returns on ForeignCo's investments are public monies

ForeignCo manages and administers the Government's investments via SubCo.

Any monies given to ForeignCo, or income made by ForeignCo, are ultimately owned by the Government. The Government is able to recall any monies of ForeignCo at any time. In the event ForeignCo is liquidated or dissolved, all assets and monies will flow back to the Government.

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

ForeignCo is not a public non-financial or 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.

Is ForeignCo a public non-financial entity?

Draft Law Companion Ruling LCR 2019/D4 The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2019/D4) provides that a public non-financial entity is determined by:

70. Whether an entity is producing or trading non-financial goods and/or providing services that are not financial services is a question of fact.

ForeignCo does not produce or trade in non-financial goods or provide non-financial services. As such, it is not a public non-financial entity as defined in subsection 880-130(1).

Is ForeignCo a public financial entity?

ForeignCo was established to be a sovereign wealth fund so the Government can provide for the Country X's current and future welfare. All monies and income gained by ForeignCo are ultimately returned to the Government for this purpose. A genuine sovereign wealth fund like ForeignCo does not trade in financial assets and liabilities but rather to benefit the obligations owed to a foreign government.

Based on the circumstances, the Commissioner accepts that ForeignCo is not either a public non-financial entity or a public financial entity under subsection 880-130(2), being a part of the Government and not engaging in the relevant activities outlined in subsections 880-130(1) or 880-130(2).

As ForeignCo 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).

ForeignCo'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 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 investments in the Test Entities and their characteristics are listed in the Appendix 1.

The Test Entities ForeignCo holds interests in are all Australian resident companies or MITs and are listed in Appendix 1. ForeignCo receives dividend and interest income from holding a relevant membership or debt interest in these entities.

As such, ForeignCo's returns are received on a relevant interest in the Test Entities, satisfying the requirements of paragraph 880-105(1)(b).

ForeignCo'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 from which ForeignCo derives its ordinary and statutory income are listed in the Appendix. All the Test Entities are Australian resident companies or MITs.

As such, ForeignCo's income is received from an entity which satisfies the requirements of paragraph 880-105(1)(c).

ForeignCo 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.

ForeignCo's sovereign entity group includes entities owned by Country X.

With respect to the equity interests in the Test Entities outlined in Appendix 1, ForeignCo holds significantly less than 10% of the participation interests in the Test Entity. To the best of ForeignCo's knowledge, its sovereign entity group as a whole holds less than 10% of the participation interests in the Test Entity.

As such, ForeignCo's sovereign entity group satisfies the requirements of paragraph 880-105(d) with respect to each Test Entity.

ForeignCo's sovereign entity group does not have influence of a kind described in subsection (6)

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.

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

Based upon the above, the sovereign entity group of ForeignCo does not have influence of a kind described in subsection 880-105(6) and, therefore, satisfies 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 ForeignCo from its investments in the Test Entities are not assessable and not exempt income.

Question 2

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

Summary

ForeignCo may disregard any capital gain or loss made in respect of its interests in the Test Entities.

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, ForeignCo:

(a)  is covered by section 880-125

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

(c)   satisfies 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, ForeignCo will be required to disregard any capital gain or loss made in respect of its interests in the Test Entities.

Question 3

Does paragraph 128B(3)(n) of the ITAA 1936 apply to exclude ForeignCo 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 ForeignCo 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, ForeignCo 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.