Edited version of private advice

Authorisation Number: 1051825783003

Date of advice: 12 April 2021

Ruling

Subject: International issues - sovereign immunity

Question

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

Answer

Yes

This ruling applies for the following period:

x July 20XX to x June 20XX

The scheme commenced on:

X July 20xx

Relevant facts and circumstances

ForeignCo

ForeignCo is a wholly owned corporate subsidiary of TopCo, a foreign government agency established and supervised by the Government of Country X ('the Government').

The establishment of ForeignCo is enabled by Law. This Law provides that TopCo is permitted to establish companies and other entities in order to achieve its statutory objectives.

TopCo's statutory powers also extend to the winding up, liquidation, merging, amalgamation and/or consolidation of any subsidiary (including ForeignCo).

In line with TopCo, ForeignCo's primary objective is to invest funds and deliver sustained long-term financial returns so the Government can provide for Country X.

ForeignCo manages and administers a range of infrastructure and real estate assets on behalf of TopCo and the Government.

ForeignCo receives its funds from TopCo, who in turn receive its funds from the Government's financial surplus to its budget and other funding sources.

Any monies provided to ForeignCo, or income made on ForeignCo's investments, are ultimately owned by the Government.

Any returns on investment by ForeignCo are not reinvested but remitted to TopCo who are only able to remit those funds to the Government.

The Government is able to recall any monies of TopCo or its subsidiaries (including ForeignCo) at any time. In the event TopCo (or ForeignCo) is liquidated or dissolved, under Law, all assets and monies will flow back to the Government.

ForeignCo has a Board of Directors.

ForeignCo is not a partnership.

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

ForeignCo is exempt from taxes in Country X.

ForeignCo is not a public non-financial entity or a public financial entity as defined in section 880-130 of the ITAA 1997.

Australian investments

The majority of ForeignCo's investments are into publicly traded funds.

All ForeignCo's directly held investments within Australia are equity interests.

The investments 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 the 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 member of its sovereign entity group, has any involvement in the day to day management of the Test Entities.

d.    Neither ForeignCo, nor any member 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 member of its sovereign entity group, has any right to representation on any investor representative or advisory committee (or similar) of any Test Entity.

f.      Neither ForeignCo, nor any member 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 compromise 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 and expects to receive Australian source income including franked dividend income, unfranked dividend income, MIT fund payments, interest income, and Australian sourced capital gains 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 and not exempt income under section 880-105 of the ITAA 1997?

Answer

Yes.

Summary

The ordinary and statutory income derived by ForeignCo 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 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):

(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 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 that that time; and

(e)  the sovereign entity group of which the sovereign entity is a member does not 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 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 the returns on the entity's investment 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 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.

Section 960-180 of the ITAA 1997 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. Country X constitutes a body politic of a foreign country.

TopCo is a foreign government agency of the Country X. TopCo holds a total participation interest of 100% in ForeignCo, being its sole shareholder.

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

•         is an entity that has a total participation interest of 100% held by a foreign government agency (i.e. TopCo);

•         is not an Australian resident; and

•         is not a resident trust estate.

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 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 will often 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 issues of government bonds, the proceeds of privatisations etc.

ForeignCo receives its funds from TopCo, who in turn receive its funds from the Government. The Government sources these funds from financial surpluses to its budget and other funding requirements. TopCo is legally responsible for receiving the funds of the Government earmarked for investment. In line with TopCo, ForeignCo's primary objective is to invest funds and deliver sustained long-term financial returns so the government can provide for Country X.

As such, it can be concluded that ForeignCo is funded solely by public monies.

All returns on ForeignCo's investments are public monies

ForeignCo manages and administers a range of investments on behalf of TopCo and the Government.

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

Therefore, it is concluded that all returns on ForeignCo's investment are public monies.

ForeignCo is not a partnership

ForeignCo is not a partnership. Therefore, it satisfies paragraph 880-125(c) of the ITAA 1997.

ForeignCo is not a public non-financial or 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 investments 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?

Law Companion Ruling 2020/3 The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2020/3) provides, in relation to subsection 880-130(1) of the ITAA 1997, that:

76. Whether an activity 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) of the ITAA 1997.

Is ForeignCo a public financial entity?

ForeignCo is not a public financial entity as defined in subsection 880-130(2) of the ITAA 1997 and therefore satisfies paragraph 880-125(d) of the ITAA 1997.

As ForeignCo satisfies each of the requirements in paragraph 880-125(a) through (d) it is 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.

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) 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.

ForeignCo invests in the Test Entities, which are all Australian resident companies or managed investment trusts. ForeignCo holds either shares or units 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 of the ITAA 1997). The Test Entities are entities in which ForeignCo holds a membership interest and earns returns including dividends, interest or managed investment trust fund payments.

As such, ForeignCo satisfies the requirements of paragraph 880-105(1)(b) of the ITAA 1997.

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) 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 from which ForeignCo derives its ordinary and statutory income and are all Australian resident companies or managed investment trusts.

As such, ForeignCo satisfies the requirements of paragraph 880-105(1)(c) of the ITAA 1997.

ForeignCo's sovereign entity group satisfies the portfolio interest test

For an amount of ordinary 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 Entities 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 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.

ForeignCo's sovereign entity group consists of all entities that are ultimately wholly owned by Country X.

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

As such, the Commissioner accepts that ForeignCo satisfies the requirements of paragraph 880-105(1)(d) of the ITAA 1997 with respect to each Test Entity.

ForeignCo's sovereign entity group does not have influence of a kind described in subsection 880-105(6) in relation to the Test Entities

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) 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) of the ITAA 1997, 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, make (or might reasonably be expected to make) the decisions that comprise 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, assess 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 a member of the group.

ForeignCo's interests in the Test Entities have the characteristics outlined in fact 17 of the Ruling. ForeignCo's interests 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 ForeignCo or its sovereign entity group 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.

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) of the ITAA 1997 and, therefore, satisfies the requirements of paragraph 880-105(1)(f) 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 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.