Edited version of private advice

Authorisation Number: 1051797417710

Date of advice: 28 January 2021

Ruling

Subject: Sovereign immunity

Question 1

Is the Bank immune from income and withholding tax under the common law doctrine of sovereign immunity on any income or capital gains derived on its Australian investments listed in Appendix 1 for the period 1 March 2017 to 30 June 2019?

Answer

Yes

Question 2

Is the ordinary and statutory income derived by the Bank from its interests in the investments listed in Appendix 2 (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 3

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

Answer

Yes

Question 4

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

This ruling applies for the following periods:

For Question 1: 1 July 20xx to 30 June 20xx

For Questions 2, 3 and 4: 1 July 20yy to 30 June 20yy

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

The Bank

1. The Bank is the central bank of the Country X. It is a corporation that acts autonomously in achieving its objectives, carrying out its functions and implementing its powers.
2. The Bank is the sole banker of the Country X Government (Government) in its banking activity of Country X currency.
3. The Bank's objectives include:

(a)  Maintaining price stability.

(b)  To assist in other Government objectives such as economic policy, where in the committee's opinion, this support shall not prejudice achieving of price stability.

(c)   To boost the financial system's stability and efficiency.

4. The Bank's functions include:

(a)  managing monetary policy

(b)  holding and managing Country X's foreign currency reserves

(c)   supporting the orderly activity of Country X's foreign currency market

(d)  acting as the Government's banker

(e)  regulating the economy's payment and clearing systems so as to ensure their efficiency and stability

(f)    issuing currency and regulating and guiding the cash system of the economy, and

(g)  supervising and regulating the banking system in accordance with its legal powers.

5. The Bank consists of a Governor, Committee, and Administrative Body.
6. The Governor is appointed by the Country X Head of State on the recommendation of the government and serves as a Committee chairperson and an Administrative Body member.
7. The Governor also serves as an advisor to the Government on economic matters.
8. All Members from the Public of the Committee and the Administrative Body are appointed by the Government on another committee's recommendation.
9. The Committee is required to publish and report to the Government a summary of its deliberations and resolutions.
10. The Bank has reporting requirements to the Government and Country X parliament. This includes the providing of periodic reports on the state of the economy, effectiveness of economic policy, inflation, the state of foreign currency reserves, and any other matter relating to activities of the Bank in discharging its functions.
11. The Bank is exempt from taxes in Country X.
12. The Bank represents the Country X in any matter relating to international financial institutions according to the decision of the Government.
13. The Bank is required to annually distribute profits to the Government.
14. The Bank cannot generally provide loans to Government to cover expenditure.

Foreign reserves

15. The Bank manages and administers Country X's foreign reserves. The Bank invests the reserves globally, including in Australia.
16. The Bank's investment policy of the reserves, is derived from three objectives:

(a)  Maintaining the reserves' purchasing power.

(b)  Managing the reserves with a high level of liquidity, and

(c)   Achieving an appropriate return on the reserves portfolio.

17. The reserves are invested mainly in short-medium term low risk tradable assets. This includes overseas financial markets, deposits with foreign banks, foreign government bonds, and other financial instruments.
18. The Bank holds the foreign exchange reserves to provide liquidity in foreign currency. The reserves are used to finance the repayments of the country's debt, pay for exceptional Government expenditure on imports at times of emergency, or provide liquidity in the event of a financial crisis. The proper management of the foreign exchange reserves is also important as it helps reduce the Country X's economic risk and improve its international credit rating.
19. The reserves are also used or sold when necessary in the course of conducting the Country X's monetary policy.

Australian investments

20. The Bank currently holds investments in a number of different Australian investment types including debt securities and equity investments in various Australian entities.
21. The Bank has previously derived and expects to derive income including interest income, dividend income, trust distributions, MIT fund payments and capital gains (including from trust distributions) from these investments.
22. The Bank also invests in derivatives to hedge (partially or fully) currency risk when purchasing these fixed income instruments. The derivative primarily invested in is foreign exchange swaps (FX swaps).
23. These derivatives are purchased to maintain liquidity in foreign currency, to hedge (partially or fully) currency risk when purchasing fixed income instruments, and as a short-term investment for the Bank's Australian dollar holdings.

Australian Investments: 1 July 20xx to 30 June 20xx

24.  The Australian equity investments held by the Bank all exhibit the following characteristics:

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

(b)  The Bank, along with any related parties, has a combined holding of less than 10% of the equity securities of the issuer,

(c)   Neither the Bank, nor any related party, has any involvement in the day to day management of the issuing entity's business.

(d)  Neither the Bank, nor a related party, has any right to representation on the board of an equity issuer, which includes the board of the corporate trustee of any unit trust in which the Bank may have acquired units,

(e)  Neither the Bank, nor a related party, has any right to representation on any investor representative or advisory committee (or similar) of any equity issuer, and

(f)    The Bank, along with any related party, only has rights to vote as a shareholder or unitholder in proportion to their equity interest in the relevant entity.

Investments in the Test Entities

25. The Bank has made investments in debt interests and/or equity interests in the Test Entities.
26. The Bank has invested in Australian equity and debt investments (as detailed in Appendix 2. 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.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 880

Reasons for decision

Question 1

Is the Bank immune from income and withholding tax under the common law doctrine of sovereign immunity on any income or capital gains derived on its Australian investments listed in Appendix 1 for the period 1 July 20xx to 30 June 20xx?

Summary

As the conditions for the doctrine of sovereign immunity are satisfied (for the period 1 July 20xx to 30 June 20xx), the ATO will not impose liability to income tax or withholding tax on any income or capital gains derived on its Australian investments listed in Appendix 1 for the period 1 July 20xx to 30 June 20xx.

Detailed reasoning

Prior to the commencement of Division 880 from 1 July 2019, for Australian income tax and withholding tax purposes, it is accepted that the doctrine of sovereign immunity applies to a foreign government or an agency of a foreign government that engages in governmental functions. This approach is consistent with the decision of the British House of Lords in the case I Congreso del Partido [1981] 2 All ER 1064 which held that activities of a trading, commercial or other private law character were not governmental functions.

When determining whether the doctrine of sovereign immunity applies to provide immunity from Australian income tax and/or withholding tax on Australian sourced income and gains, it is necessary to establish the following:

1. that the person making the investment (and therefore deriving the income) is a foreign government or an agency of a foreign government,
2. that the moneys invested are and will remain government moneys, and
3. that the income or gain is being derived from a non-commercial activity.

If these three conditions are satisfied, then the income or gains will not be subject to Australian income tax and/or withholding tax.

Condition 1: A foreign government or agency of a foreign government

A claim for sovereign immunity may only be made by a 'foreign state' (section 9 of the Foreign States Immunities Act 1985 (Immunities Act)).

A foreign state is defined in section 3 of the Immunities Act to be a country outside of Australia that is either:

•                     an independent sovereign state, or

•                     a separate territory (whether or not it is self-governing) that is not part of an independent sovereign state.

Sovereign immunity also extends to a 'separate entity' of a foreign state pursuant to section 22 of the Immunities Act.

A separate entity of a foreign state is defined in section 3 of the Immunities Act to be a natural person, body corporate or corporation sole that:

•                     is an agency or instrumentality of the foreign state, and

•                     is not a department or organ of the executive government of the foreign state.

The lower court decision of the PT Garuda Case (PT Garuda Indonesia Ltd v. Australian Competition and Consumer Commission [2011] FCAFC 52)considered when an entity may be an agency or instrumentality of the foreign state.

The court decided (at paragraph 128), that the correct approach is to consider, on the whole of the evidence, whether the person is acting for, or being used by, the foreign state as its means to achieve some purpose or end of that state in the relevant circumstances. This was not overturned on appeal to the High Court inPT Garuda Indonesia Ltd v. Australian Competition & Consumer Commission [2012] HCA 33 (PT Garuda).

Is the Bank a foreign state or separate entity of a foreign state?

The Bank is the independent central bank of Country X, and performs a number of government functions including issuing currency, managing monetary policy, and managing the foreign reserves. It is a statutory corporation, and holds tax-exempt status in Country X. It may be considered a separate entity of a foreign state for the following reasons:

•   The Bank performs a number of government functions including managing the foreign reserves of Country X.

•   The Bank promotes three objectives, which are far broader than that of a commercial bank and are more consistent with a sovereign entity. These objectives are to:

•   maintain price stability as its central goal

•   support other objectives of the Government's economic policy, especially growth, employment and reducing social gaps, provided that, in the committee's opinion, this support shall not prejudice the attainment of price stability over the course of time, and

•   support the stability and orderly activity of the financial system.

Each of these objectives is directly linked to supporting and maintaining the stability of the economy, and supporting and implementing Government economic and social policy.

•   Though the Bank is an independent entity, the Government retains significant influence over the Bank. The Country X Head of State, on advice of the Government, appoints the Governor. All members of the Committee and the Administrative Body are appointed by the Government.

•   The Bank's Governor and Committee are required to regularly report to the Country X parliament on not only the Bank's performance, but Country X's general economic performance and on issues such as inflation, unemployment, and the regulation of the financial sector.

•   A share of the Bank's profits is distributed to the Government.

•   The Bank represents Country X in any international financial organisation of which it is a member.

The above factors all lead to the conclusion that the Bank is a separate entity of a foreign state, satisfying this requirement.

Condition 2: monies are and will remain government monies

In line with the principle that sovereign immunity applies to foreign states performing only governmental functions, an entity claiming sovereign immunity must establish that the monies being invested in the scheme are and will remain government monies.

The Bank is Country X's central bank. It is considered a sovereign entity as it performs sovereign functions including managing monetary policy, issuing currency, and managing Country X's foreign reserves.

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

The investments may also be sold as necessary in the course of implementing monetary policy, and improving the Country X's international economic standing and credit rating.

Furthermore, any profits made by the Bank are distributed to the Government.

For these reasons, this condition is satisfied as the monies invested and income derived from the investments is and will remain Government monies.

Condition 3: The income or gain is being derived from a non-commercial activity

When determining whether the doctrine of sovereign immunity applies to provide immunity for Australian sourced income and gains from Australian income tax and/or withholding tax, it is necessary to establish that the income or gain is being derived from a non-commercial activity.

As noted in ATO Interpretive Decision ATO ID 2002/45 Withholding Tax: Sovereign Immunity (ATO ID 2002/45), whether an operation or activity is a commercial transaction will depend on the facts of each case. As a guide, a commercial transaction is generally considered to be an activity concerned with the trading of goods and services, such as buying, selling, bartering, transportation, and includes the carrying on of a business. A passive investment is more likely to be considered a non-commercial transaction.

Are the Bank's investments commercial transactions?

The Bank currently holds investments in a number of different Australian investment types including debt securities and equity investments in various Australian entities. The Bank has previously derived and expects to derive interest income, dividend income, trust distributions and capital gains (including from trust distributions) from these investments. The Bank also invests in derivatives to minimise currency risk when purchasing these fixed income instruments. The derivative primarily invested in is foreign exchange swaps (FX swaps). These derivatives are purchased to maintain liquidity in foreign currency, to minimise currency risk when purchasing fixed income instruments, and as a short-term investment for the Bank's Australian dollar holdings.

The proper administration of the foreign reserves assists in improving Country X's international economic standing and credit rating. The type of investments and purpose of the investments in managing the foreign reserves lead to the conclusion that trading in these investments by the Bank is a non-commercial activity.

The Bank also invests in derivatives, primarily FX swaps. The Bank's purposes for trading in derivatives is to minimise foreign exchange risk when purchasing the above-listed investments, as a short-term investment of its Australian dollars, and for liquidity purposes. The investment into derivatives may also be deemed non-commercial as they are purchased and sold in the course of managing the foreign reserves, and funding the purchase of the debt instruments.

The relevant investments for this Ruling on the doctrine of sovereign immunity held by the Bank are in equity interests in listed entities including Australian companies and managed investment trusts. These investments, contained in Appendix 1, exhibit the following characteristics:

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

b)    The Bank, along with any related parties, has a combined holding of less than 10% of the equity securities of the issuer,

c)    Neither the Bank, nor any related party, has any involvement in the day to day management of the issuing entity's business.

d)    Neither the Bank, nor a related party, has any right to representation on the board of an equity issuer, which includes the board of the corporate trustee of any unit trust in which the Bank may have acquired units,

e)    Neither the Bank, nor a related party, has any right to representation on any investor representative or advisory committee (or similar) of any equity issuer, and

f)     The Bank, along with any related party, only has rights to vote as a shareholder or unitholder in proportion to their equity interest in the relevant entity.

Accordingly, the Bank's investments are non-commercial transactions and are performed as part of Bank's governmental functions.

Conclusion

As the conditions for the doctrine of sovereign immunity are satisfied (for the period 1 July 20xx to 30 June 20xx), the ATO will not impose liability to income tax or withholding tax on any income or capital gains derived on its Australian investments listed in Appendix 1 for the period 1 July 20xx to 30 June 20xx.

Question 2

Is the ordinary and statutory income derived by the Bank from its interests in the investments listed in Appendix 2 (the Test Entities) not assessable and not exempt income under section 880-105 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

Section 880-105 will apply so 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.

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) 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 a foreign country.

The Bank is the central bank of Country X. It is an independent corporation that acts autonomously in attaining its objectives, discharging its functions and exercising its powers.

As an agency or instrumentality of Country X, the Bank undertakes its activities in accord with its embodying law. Accordingly, the Bank would constitute a body corporate (not being a natural person or corporation sole) that is an entity, i.e. an agency or instrumentality of the Country X.

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

The investments may also be sold as necessary in the course of implementing monetary policy, and improving the state's international economic standing and credit rating.

Therefore, the Bank is funded solely by public monies.

All returns on the Bank's investments are public monies

The Bank manages and administers Country X's foreign reserves. The Bank invests the reserves globally, including in Australia.

The Bank follows a cautious approach with respect to its management of the reserves, considering three objectives:

(a)  maintaining a high level of liquidity

(b)  minimising the various financial and credit risks, and

(c)   maintaining the purchase power of the reserves and obtaining an adequate return on the investments.

The reserves are invested mainly in short-term low risk tradable assets. This includes overseas financial markets, deposits with foreign banks, foreign government bonds, and other financial instruments.

The Bank holds the foreign exchange reserves to provide liquidity in foreign currency. The reserves are used to finance the repayments of the country's debt, pay for exceptional government expenditure on imports at times of emergency, or provide liquidity in the event of a financial crisis. The proper management of the foreign exchange reserves is also important as it helps reduce the Country X's economic risk and improve its international credit rating.

The reserves are also used or sold when necessary in the course of conducting the Country X's monetary policy.

The Bank is required to annually distribute profits to the Government.

Therefore, all returns on the Bank's investments are public monies. The Bank cannot issue loans or shares to be transferred to a non-Government entity.

The Bank is not a partnership

The Bank is an independent corporation that acts autonomously in achieving its objectives, carrying out its functions and implementing its powers. Therefore, 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 81 of the Law Companion Ruling LCR 2020/3 The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2020/3) 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)  managing monetary policy

(b)  holding and managing Country X's foreign currency reserves

(c)   supporting the orderly activity of Country X's foreign currency market

(d)  acting as a banker of the government

(e)  regulating the economy's payment and clearing systems so as to ensure their efficiency and stability

(f)    issuing currency and regulating and guiding the cash system of the economy, and

(g)  supervising and regulating the banking system in accordance with its legal powers.

It is considered that the above activities are consistent with the Bank 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 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 Bank currently holds investments in a number of different Australian investment types including debt securities and equity investments in various Australian entities of which the Bank holds membership interests and debt interests. The Bank has previously derived and expects to derive income including interest income, dividend income, trust distributions, MIT fund payments and capital gains (including from trust distributions) from these investments.

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 or managed investment trusts

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

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

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

The Test Entities are Australian resident companies or managed investment trusts at the relevant times.

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

Therefore, the portfolio test is satisfied.

The Banks'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 so 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 3

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

Summary

The Bank cannot deduct an amount if it is a loss in respect of its 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 2, the Bank:

(a)  is covered by section 880-125

(b)       holds membership 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, the Bank cannot deduct an amount if it is a loss in respect of its interests in the Test Entities.

Question 4

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?

Summary

The Bank will be required to 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 2, the Bank:

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