Edited version of private advice

Authorisation Number: 1051931896311

Date of advice: 16 December 2021

Ruling

Subject: Sovereign immunity

Question

Is the ordinary and statutory income derived by Entity A as a return on its debt interest in Aus Co 1 not assessable income and not exempt income under section 880-105 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

October 20XX to June 20XX

The scheme commences on:

October 20XX

Relevant facts and circumstances

Entity A

Entity A is an exempt limited liability company located in Foreign Country A that is ultimately wholly owned by Entity B.

Entity A was incorporated in 20XX.

Entity A acts as a holding company for certain investments of Entity B and conducts activities relevant to holding these investments and does not otherwise conduct any independent/active business activity.

Entity A currently holds several investments in Australia, and apart from the debt interest in Aus Co 1 does not currently hold any other debt investments.

Entity A is not a resident for Australian tax purposes, nor is it a trust under Division 6 of the Income Tax Assessment Act 1936 (ITAA 1936).

Entity A is solely funded by Entity B.

Entity B

Entity B is a public institution directly wholly owned, established and supervised by the Foreign Country B Government.

Entity B's primary objective is to invest the Foreign Country B Government's surplus financial resources and deliver sustained long-term financial returns.

Entity B receives its funds from the Foreign Country B Government's financial surplus to its budgetary and other funding requirements.

Entity B was created in 20XX.

Entity B's Articles of Association provide it has the power to borrow money however it has made no such borrowings.

Any monies given to Entity B, or income made by Entity B, are ultimately owned by the Foreign Country B Government. The Foreign Country B Government is able to recall any monies of Entity B at any time.

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

Aus Group

Aus Group is a private Australian firm identified as a best-in-class real estate operator and investment manager.

Aus Group is operated and owned by Person A.

Loan to Aus Co 1

In 20XX, Entity A and Aus Co 1 entered into a Loan Facility Agreement (the Loan) under which Aus Co 1 obtains an interest-bearing loan from Entity A under arms-length conditions.

The purpose of the Loan is for Aus Co 1 to on-lend the amount to a different member of Aus Group, TT 1. TT 1 will use the proceeds to purchase Aus Investment.

The Loan is a debt interest for the purposes of Division 974 of the ITAA 1997.

Aus Co 1 is a company and an Australian resident for tax purposes.

Aus Co 1 is a wholly owned subsidiary of the Aus Group and is ultimately wholly owned and controlled by Person A.

The following entities are parties to the Loan:

(a)  Aus Co 1 as the Borrower;

(b)  Aus Co 3 in its capacity as trustee of the TT 1 as a Guarantor;

(c)   Aus Co 2 as a Guarantor;

(d)  Aus Co 4 in its capacity as trustee of TT 2 as a Guarantor; and

(e)  Entity A as the Lender.

The Guarantors under the Loan are all members of Aus Group.

Aus Co 1 can renew the Loan for an additional period if it gives notice to Entity A prior to the Termination Date.

In 20XX a Deed of Amendment was entered into whereby the parties to the Loan agreed to increase the Commitment of the Loan. No other terms of the Loan were amended.

Entity A expects to receive interest income from Aus Co 1 in accordance with the terms of the Loan.

The return on the Loan is not determined by, contingent on or otherwise linked to the performance of the Aus Investment.

Irrespective of the nature of the cashflows from the Aus Investment, Aus Co 1 will continue to have interest accruing throughout the year on the Loan.

Terms of the Loan

Aus Co 1 must apply any amounts borrowed from Entity A under the Loan to fund loans to TT 1 (Related Facility Agreement).

The loan from Aus Co 1 to TT 1 under the Related Facility Agreement must be used to fund TT 1's acquisition of units and an ownership interest in the Aus Investment.

The Loan from Entity A to Aus Co 1 is secured against Aus Group's interest in the Aus Investment.

Aus Co 1 must cause TT 1 to apply all distributions and proceeds as soon as they are due or payable to make repayments to Aus Co 1 under the Related Facility Agreement. Aus Co 1's liability to pay any amount under or in connection with the Loan is limited to any repayment made to it, or directed to it, as the Lender under the Related Facility Agreement.

Subject to the limited recourse, Aus Co 1 must repay the total of the outstanding loans under the Loan on the Termination Date.

Each of the Guarantors to the Loan guarantee that on demand by Entity A, it will pay any amount as though it is the Borrower.

Each Guarantors' liability to pay any amount under or in connection with the Loan is limited to any proceeds or distributions from the Aus Investment and its Secured Property under the Security Document's to which it is a party.

Entity A cannot seek to recover any shortfall between the amounts owing to it under the Loan and the amounts recoverable by it under the Loan.

Aus Co 1 is able to prepay the whole or any part of any loan it receives under the Loan provided it gives Entity A prior notice.

If a Review Event occurs under the Loan, Entity A can cancel its commitments under the Loan where it will no longer be obliged to provide further funding to Aus Co 1 and it can declare all outstanding loans due and payable.

A Review Event occurs where there is a change in 'control' and include that a member of the Aus Group ceases to be 'ultimately controlled' by Person A.

Interest on the Loan accrues daily and is payable on the termination date of the Loan.

The Loan outlines that unless otherwise agreed by Entity A and Aus Co 1, interest will capitalise as a loan on a quarterly basis and will then be treated as a loan.

Where an amount payable under the Loan is not paid on its due date, default interest may accrue on the overdue amount.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1997 section 880-105

Income Tax Assessment Act 1997 section 880-110

Income Tax Assessment Act 1997 section 880-115

Income Tax Assessment Act 1997 section 880-120

Reasons for decision

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 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.

Entity A is a covered sovereign entity

Section 880-125 of the ITAA 1997 states:

A *sovereign entity is covered by this section if it satisfies all of the following requirements:

(a) the entity is funded solely by public monies;

(b) all returns on the entity's investments are public monies;

(c) the entity is not a partnership;

(d) the entity is not any of the following:

(i) a *public non-financial entity;

(ii) a *public financial entity (other than a public financial entity that only carries on central banking activities).

These conditions are considered below.

Entity A 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.

Entity B is an investment authority of the Foreign Country B Government.

Entity B is supervised by the Foreign Country B Government and has its primary objective as investing funds of the Foreign Country B Government.

As Entity B is an investment authority of the government of a foreign country (or part of a foreign country), it is a foreign government agency and meets the requirements of being a sovereign entity as defined in section 880-15 of the ITAA 1997.

Entity A is ultimately wholly owned by Entity B. Entity A is not an Australian resident, nor is it a resident trust estate for the purposes of Division 6 of Part III of the ITAA 1936.

As Entity A is an entity in which a 'foreign government agency' being Entity B holds a total participation interest of 100%, is not an Australian resident, and is not a resident trust estate for the purposes of Division 6 of Part III of the Income Tax Assessment Act 1936, it is a sovereign entity as defined in section 880-15 if the ITAA 1997.

Entity A is funded solely by public monies

The phrase 'public monies' is not defined and as such takes its ordinary meaning. In the context of Division 880 of the ITAA 1997, this phrase essentially means monies raised by a foreign government (or part of a foreign government) for a public purpose which form part of the foreign government's (or part of the foreign government's) equivalent to Australia's Consolidated Revenue Fund (Roy Morgan Research Pty Ltd v FC of T & Anor [2011] HCA 35). This would ordinarily include general tax revenue, proceeds from the issue of government bonds, the proceeds of privatisations etc.

Entity B's primary objective is to invest funds and deliver sustained long-term financial returns so the Foreign Country B Government can provide for the current and future welfare of Foreign Country B. Entity B receives its funds from the Foreign Country B Government's financial surplus to its budgetary and other funding requirements. Although Entity B wholly owns Entity C, which operates a public bonds program, none of the third party debt funding raised by Entity C through these activities form part of Entity B's monies. Despite having the power to borrow funds, Entity B has no such borrowings. As such, Entity B is funded solely by public monies.

Entity A is solely funded by Entity B and is therefore ultimately funded by the Foreign Country B Government. Accordingly, Entity A is funded solely by public monies.

Therefore, Entity A satisfies this requirement.

All returns on Entity A's investments are public monies

Entity A acts as a holding company for Entity B, carrying out investment requests of Entity B. Entity B was established to invest the financial surplus resources of the Foreign Country B Government and does not undertake any other activities.

Entity A is ultimately wholly owned by Entity B, which is owned by the Foreign Country B Government.

Entity B is the beneficial owner of the assets of Entity A, and therefore it is beneficially entitled to the income.

Any monies given to Entity B, or income made by Entity B, are ultimately owned by the Foreign Country B Government. The Foreign Country B Government is able to recall any monies of Entity B at any time.

Accordingly, the monies that are invested by Entity A are and will remain government monies.

Therefore, Entity A satisfies this requirement.

Entity A is not a partnership

Entity A is a company incorporated under the laws of Foreign Country A and is not a partnership.

Therefore, Entity A satisfies this requirement.

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

Subsection 880-130(1) of the ITAA 1997 defines the term public non-financial entity:

An entity is a public non-financial entity if its principal activity is either or both of the following:

(a) producing or trading non-financial goods;

(b) providing services that are not financial services.

Subsection 880-130(2) of the ITAA 1997 defines the term public financial entity:

An entity is a public financial entity if any of the following requirements are satisfied:

(a) it trades in financial assets and liabilities;

(b) it operates commercially in the financial markets;

(c) its principal activities include providing any of the following financial services:

(i) financial intermediary services, including deposit-taking and insurance services;

(ii) financial auxiliary services, including brokerage, foreign exchange and investment management services;

(iii) capital financial institution services, including financial services in relation to assets or liabilities that are not available on open financial markets.

Entity A acts as a holding company for certain investments of Entity B and does not otherwise conduct any independent/active business activity.

Entity A does not engage in producing or trading non-financial goods or providing services that are not financial services. Entity A does not trade in financial assets and liabilities and does not operate commercially in financial markets or provide services listed in paragraph 880-130(2)(c) of the ITAA 1997.

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

Entity A's return is received on a relevant interest in the Test Entity (Aus Co 1)

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.

Section 995-1 of the ITAA 1997 defines 'debt interest' in an entity as having the meaning given by Subdivision 974-B of the ITAA 1997. The loan from Entity A to Aus Co 1 is a debt interest for the purposes of Subdivision 974-B of the ITAA 1997.

Under the terms of the Loan, Entity A is entitled to receive interest income from Aus Co 1. Interest received by Entity A in respect of the Loan are returns on a debt interest held in Aus Co 1.

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

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

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(c) of the ITAA 1997, it must be received from an entity that is either:

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

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

Aus Co 1 is an Australia resident company for Australian income tax purposes.

As such, Entity A's income is received from an entity which satisfies the requirements of paragraph 880-105(1)(c) of the ITAA 1997.

Entity A'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) of the ITAA 1997, the sovereign entity and the sovereign entity group to which it belongs must satisfy the portfolio interest test in relation to the test entity at both the income time and throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time.

The portfolio interest test is outlined in subsection 880-105(4) of the ITAA 1997, which states:

A *sovereign entity group satisfies the portfolio interest test in this subsection in relation to the test entity at a time if, at that time, the sum of the *total participation interests that each *member of the group holds in the test entity:

(a)       is less than 10%; and

(b)       would be less than 10% if, in working out the *direct participation interest that any entity holds in a company:

(i) an *equity holder were treated as a shareholder; and

(ii) the total amount contributed to the company in respect of *non-share equity interests were included in the total paid-up share capital of the company.

Section 880-20 of the ITAA 1997 provides the definition of sovereign entity group. Broadly, sovereign entities of the same foreign government will be members of the same sovereign entity group and sovereign entities of the same part of a foreign government will be members of the same sovereign entity group.

Aus Co 1 is wholly owned by Person A who is not a member of Entity A's sovereign entity group. Accordingly, no members of the sovereign entity group of which Entity A is a member has or has ever had any participation interest in Aus Co 1.

As such, the requirements of paragraph 880-105(d) of the ITAA 1997 are satisfied.

Entity A's sovereign entity group does not have influence of a kind described in subsection (6) in relation to the Test Entity at the income time

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(e) of the ITAA 1997, at the income time the sovereign entity group to which the sovereign entity belongs must not have influence over the test entity of a kind described in subsection 880-105(6) of the ITAA 1997.

Subsection 880-105(6) of the ITAA 1997 states:

A *sovereign entity group has influence of a kind described in this subsection in relation to the test entity at a time if any of the following requirements are satisfied at that time:

(a) a *member of the group:

(i) is directly or indirectly able to determine; or

(ii) in acting in concert with others, is directly or indirectly able to determine;

the identity of at least one of the persons who, individually or together with others, make (or might reasonably be expected to make) the decisions that comprise the control and direction of the test entity's operations;

(b) at least one of those persons is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of a member of the group (whether those directions, instructions or wishes are expressed directly or indirectly, or through the member acting in concert with others).

In determining whether a sovereign entity group has the requisite level of influence, subsection 880-105(7) requires that any breaches of the terms of a debt interest by any entity be ignored.

As such, there are two distinct sub-tests within the influence test.

Sub-test 1 is contained in paragraph 880-105(6)(a) of the ITAA 1997 and assesses whether the sovereign entity group is able to directly or indirectly 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.

Entity A's debt interest in Aus Co 1 does not provide it, 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 Entity, being Aus Co 1's operations. Nor does Entity A or any member of its sovereign entity group hold the ability to approve or veto decisions which go to the control or direction of Aus Co 1.

Sub-test 2 of the influence test, as contained in paragraph 880-105(6)(b) of the ITAA 1997, assesses whether at least one of the relevant decision-making persons of the test entity is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of the sovereign entity group.

No person involved in the control and direction of Aus Co 1's operations is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of Entity A's sovereign entity group.

Based on the above, neither Entity A nor any member of its sovereign entity group has 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) 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 Entity A from its debt interest in Aus Co 1 are not assessable and not exempt income.