Edited version of private advice

Authorisation Number: 1051958805934

Date of advice: 11 March 2022

Ruling

Subject: Sovereign immunity

Question

Is the ordinary and statutory income derived by ForCo as trustee of the ForCo Trust (ForCo Trust) from the loan notes it holds that were issued by the Issuer (Loan Notes) not assessable and not exempt income under section 880-105 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

X July XXXX to Y June YYYY

The scheme commences on:

XX July XXXX

Relevant facts and circumstances

ForGov

ForGov is a statutory body corporate established to own and administer assets of the Country X Government. It is a body corporate and a legal person capable of suing and being sued and has the ability to hold the title to movable and immovable property.

ForGov owns 100% of the shares in a number of Country X government corporations including ForCo.

ForCo

ForCo is a company incorporated in Country X and is a resident of Country X for tax purposes.

ForCo's business activity is the holding of loan notes. ForCo holds these assets on trust for the Government. A trust declaration provides that all of the rights, titles and interests in any and all assets of ForCo shall be held by ForCo on trust for the Government and that ForCo has no beneficial interest in the assets.

ForCo Trust (i.e. the trust created by ForCo holding loan notes on trust for the Government and not ForCo in its capacity as a company) is an entity under paragraph 960-100 of the ITAA 1997 (i.e. a trust) and is not a resident of Australia for income tax purposes, is not a resident trust estate as defined in Part III of the Income Tax Assessment Act 1936 (ITAA 1936) and is not a partnership under section 6 of the ITAA 1936.

ForCo Trust does not actively trade in financial assets and liabilities, nor does it operate commercially in financial markets or provide any services listed in paragraph 880-130(2)(c) of ITAA 1997.

ForCo Trust receives its funds from the Government.

The sources of Government funds include Government revenue.

The funds used for the proposed investments are from the foreign reserves of Country X and will remain so for the period that ForCo Trust holds the investment.

The moneys invested, and the returns on those moneys are, and will remain funds beneficially owned by the Government.

There are no third-party borrowings entered into by the above entities.

The Government is beneficially entitled to all of the income from the assets which ForCo Trust holds on trust for the Government.

Any returns on investment made by ForCo Trust are either reinvested or remitted to the Government for it to distribute to various public institutions in the exercise and execution of government purposes and functions. All ForCo Trust funds are exempt from Country X Government taxes.

ForCo Trust is part of a sovereign entity group consisting of all entities ultimately wholly owned by the Government as well as the Government itself.

Loan Notes

ForCo Trust has acquired Loan Notes issued by the Issuer in respect of the Series. The Issuer is an Australian company wholly owned by Issuer Group that engages in the provision of financial services.

Series Scheme ('the scheme')

The Issuer will issue a series of Loan Notes of different alphanumeric classes to investors. These will be backed in turn by their corresponding classes of Trust Notes issued by Trust Issuer to the Issuer, which in turn are backed by Trust Issuer's purchase, as trustee, of a pool of Loans and related securities underwritten and arranged by Issuer Group.

The scheme is a two-tiered scheme. The first tier is the Trust that has the sole purpose of entering into transactions as required by the Transaction Documents. The trustee of the Trust is the Trust Issuer. The Trust Notes issued by the Trustee will be entirely subscribed to by the Issuer (the second tier), which are subordinated by alphanumerical order.

The Issuer will then issue classes of Loan Notes corresponding to the Trust Notes to investors (including ForCo Trust). The Issuer uses the proceeds of the Loan Notes to acquire the Trust Notes. The Trustee uses the proceeds of the Trust Notes to invest in a portfolio of Loans. These Loans are underwritten by the Issuer in the ordinary course of their financial services business.

Investors in Loan Notes receive an interest return based on the Australian Bank Bill swap rate, and a repayment of principal at maturity. The return paid to the Investors is not based on the underlying performance of the portfolio of Loans.

The Trust

The manager of the Trust is the Manager. The Manager holds all ordinary shares in the Trust Issuer.

The Issuer holds all of the Trust Notes issued by the Trust.

The Trust Issuer's obligation with the Trust Notes is secured by a granting a Trust Charge over the assets of the Trust in favour of the Trust Security Trustee. The Trust Security Trustee holds the benefit of the Trust Charge on trust for (among others) the Holders of the Trust Notes (i.e. the Issuer) and any other person who is specified as a "Trust Secured Creditor".

Neither ForCo Trust, or to the best of ForCo Trust's knowledge, any member of its sovereign entity group, has a direct membership or debt interest in the Trust or Trust Issuer.

Neither the Master Trust Deed nor the Trust General Security Deed confers any right, power or authority on the Issuer, as the Holder of the Trust Notes, to:

a.    take any action, or to direct the Manager or Trust Issuer to take or refrain from taking any action, with respect to any asset of the Trust;

b.    remove the Manager, Trust Issuer, the Trust Security Trustee, the Trust Servicer, the Trust Custodian, the Trust Registrar, the Trust Standby Servicer, the Trust Standby Manager, the Trust Standby Trustee or the Trust Originator;

c.     call or to attend certain meetings (other than under the Trust General Security Deed);

d.    wind up the Trust; or

e.    take any other action which would breach the intent of the Master Trust Deed.

Loan Note Terms

The key terms of the Loan Notes can be found in the Information Memorandum and Pricing Term Sheet issued by the Issuer with respect to the Series in priority in terms of loan amount, class, interest rate and rating.

The Issuer's obligations in respect of the Loan Notes are secured by a Trust Charge granted by the Issuer over the Series Assets in favour of the Series Security Trustee. The Series Security Trustee holds the benefit of the Series Charge on trust for (among others) the Holders of Loan Notes and any other person who is specified as a "Series Secured Creditor".

Repayments of principal on the Loan Notes will be made on each payment date to the Holders of Loan Notes entitled to receive such payments.

Holders of Loan Notes have the ability to vote on certain matters through ordinary or extraordinary resolutions. These matters relate to the altering of terms of the Loan Notes, or matters arising in the event of Default.

Neither the Series Master Security Deed nor the Series General Security Deed confers any right, power or authority on the Holders of Loan Notes to:

f.      take any action, or to direct the Series Manager or the Issuer to take or refrain from taking any action, with respect to any Trust asset;

g.    remove the Series Manager, the Issuer, the Series Security Trustee, the Series Security Trustee, Series Registrar or the Series Standby Manager;

h.    call or to attend certain meetings (other than under the Series General Security Deed);

i.      wind up the Issuer or the Trust; or

j.      take any other action which would breach the Series Master Security Trust Deed's intent.

Default in respect of the Series occurs if:

k.     the Issuer does not pay on time any amount, or does not comply with any other obligation where such non-compliance will affect payments or their timing;

l.      an Insolvency occurs in respect of the Issuer in regards to the Loan Notes;

m.   a Transaction Document, or a transaction in connection with it, becomes voidable where such event will affect payments or their timing; or

n.    the Series General Security Deed is not (or ceases to be) valid and enforceable, or the Issuer takes any step that would affect payments or their timing.

If Default occurs while any Loan Notes are outstanding, the Holders of Loan Notes may vote to direct the Trustee to enforce the sale of the Series Assets.

If Default occurs and is continuing, the Holders of Loan Notes will meet and vote to direct or give instructions or approvals to the Trustee in accordance with the Transaction Documents.

ForCo Trust's investment

ForCo Trust holds 100% of X-Y classes of Loan Notes. ForCo Trust does not hold notes in any other Notes Series issued by the Issuer Group or its related parties.

ForCo Trust is not aware, to the best of its knowledge, of any equity or debt investments held by any of the above entities, including the Government, in the Issuer or the Trust, other than the Loan Notes to be held by ForCo.

ForCo Trust will hold 100% of the votes in the event X-Y classes are not yet paid off when the Default or extraordinary resolution occurs. This will include voting on the matters outlined in facts [28] to [29] and [31] to [32].

ForCo Trust's rights with respect to the Loan Notes all relate to enforcing the terms, including payment of returns, of the Loan Notes themselves (i.e. the return which ForCo Trust is receiving through the holding of the debt interest) and do not relate to the control and management of the Issuer or its operations.

Specifically, with regards to ForCo Trust's interest in the Issuer, to the best of ForCo Trust's knowledge:

o.    Neither ForCo Trust nor any member of its sovereign entity group hold, either directly or indirectly, any right to appoint a person to a board, committee or similar of the Issuer,

p.    Neither ForCo Trust nor any member of its sovereign entity group has entered into any side letters, arrangements or agreements with the Issuer or its related parties; and

q.    Neither ForCo Trust nor any member of its sovereign entity group have any other influence over the Issuer potentially of a kind described in subsection 880-105(6) of the ITAA 1997.

Relevant legislative provisions

Division 880 of the Income Tax Assessment Act 1997

Reasons for decision

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 Australia 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.

ForCo Trust 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.

ForCo Trust 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 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.

Section 960-180 provides than 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.

Section 960-190 provides that as ForCo Trust is a trust (within the meaning of Part X of the ITAA 1936), the direct control interest (within the meaning of section 351 of the ITAA 1936) is relevant to determine the direct participation interest that the Government holds in ForCo Trust.

Section 351 of the ITAA 1936 provides that an entity that is a beneficiary in a trust holds a direct control interest in the trust at a particular time equal to the percentage of the income or corpus of the trust represented by the share of the income or corpus to which the beneficiary is entitled, of that the beneficiary is entitled to acquire.

The Government is a body politic of a foreign country.

As the sole beneficiary of the trust with rights to all its income and corpus, the Government has a 100% direct control interest in ForCo Trust and therefore holds a total participation interest of 100% in ForCo Trust.

ForCo Trust is not an Australian resident and is not a resident trust estate for the purposes of Division 6 of Part III of the ITAA 1936.

As such, ForCo Trust meets the requirements of being a sovereign entity in accordance with paragraph 880-15(c).

ForCo Trust 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 privatisation etc.

ForCo Trust receives its funds from the Government. The sources of the Government's funds include Government revenue.

As such, ForCo Trust is funded solely by public monies.

All returns on ForCo Trust's investments are public monies

The Government is beneficially entitled to all of the income from the assets which ForCo Trust holds on trust for the Government, including the Loan Notes. As such, all returns on ForCo Trust's investments will be paid to the Government, making them public monies.

ForCo Trust is not a partnership

ForCo Trust is a trust. It is not a partnership under subsection 6(1) of the ITAA 1936. ForCo Trust therefore satisfies this requirement.

ForCo Trust 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 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.

While ForCo holds the Loan Notes on trust for the Government, it is considered that neither ForCo, nor ForCo Trust produces or trades non-financial goods or provides services that are not financial services. ForCo Trust does not actively trade in financial assets and liabilities, operate commercially in financial markets or provide services listed is paragraph 880-130(2)(c).

As such, ForCo Trust does not meet either definition of being a public non-financial or financial entity, satisfying the condition in paragraph 880-125(d).

As ForCo Trust satisfies each of the requirements in paragraphs 880-125(a) through (d) it is a sovereign entity that is covered by section 880-125 for the purposes of paragraph 880-105(1)(a).

ForCo Trust'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.

The Issuer, being the test entity, is a company which has issued the Loan Notes (a debt interest) to investors including ForCo Trust. ForCo Trust receives interest income as a return on this debt interest.

As such, ForCo Trust will receive amounts which satisfy the requirements of paragraph 880-105(1)(b).

ForCo Trust'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 Issuer, as the issuer of the Loan Notes, pays interest to ForCo Trust. The Issuer is an Australian resident company.

As such, ForCo Trust receives income from an entity which satisfied the requirements of paragraph 880-105(1)(c).

ForCo Trust'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 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 the 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 an 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 shares in the Issuer are wholly owned by the Issuer Group, an entity in which, to the best of ForCo Trust's knowledge, no Government entities holds an interest. As such, ForCo Trust's sovereign entity group, consisting of all Government entities and their wholly owned subsidiaries, do not hold directly or indirectly 10% or more of the participation interests in the Issuer. As such, paragraph 880-105(1)(d) is satisfied.

ForCo Trust'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 the 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.

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.

The holding of Loan Notes does not give ForCo Trust, directly or indirectly, or acting in concert with others, any ability to appoint, control or influence any person that has the ability to participate in or influence decisions that comprise the control or direction of the Issuer. Neither ForCo Trust or its sovereign entity group have any rights to appoint a person to a board, committee or similar, either directly or indirectly to the Issuer. Additionally, ForCo Trust has not entered into or received any side letters, arrangements or agreements involving their investment into Loan Notes. All of the above points regarding influence are true, to the best of ForCo Trust's knowledge, with respect to all members of its sovereign entity group.

As a holder of Loan Notes, ForCo Trust has the ability to vote on decisions to accept or reject proposed changes to the terms of the Loan Notes, and the ability to vote on decisions as to enforcing the terms of the Loan Notes where a Default occurs. As an entity that holds 100% of the classes of Loan Notes (X-Y), its vote will be decisive in making such decisions.

The decisions to accept or reject proposed changes to the terms of the Loan Notes by the Issuer are decisions that solely relate to the terms of the debt interest; such decisions do not relate to the control and direction of the Issuer or its related parties. Such decisions also do not relate to the management or operations of any Issuer entity.

Additionally, under the terms of the Series Master Security Trust Deed and the Series General Security Deed, it explicitly states that ForCo Trust does not have any right, power, or authority to:

a.    take any action, or to direct the Series Manager or the Issuer to take or refrain from taking any action, with respect to any Series Assets; or

b.    remove the Series Manager, the Issuer (in its capacity as trustee of the Trust), the Series Security Trustee, the Series Registrar or the Series Standby Manager; or

c.     call or to attend certain meetings (other than under the Series General Security Deed); or

d.    wind up the Issuer or the Trust; or

e.    take any other action which would breach the Series Master Security Trust Deed's intent.

With respect to the ability to vote on extraordinary resolutions in the event of a Default, it is important to consider subsection 880-105(7), which states:

However, a *sovereign entity group does not have influence of a kind described in subsection (6) if, disregarding any breach of terms of a *debt interest by any entity, the sovereign entity group would not have influence of that kind.

The Loan Notes are debt interests for the purposes of the ITAA 1997 as defined in section 974-20.

ForCo Trust will hold 100% of the votes in the event a Default arises with respect to X to Y classes of Loan Notes which requires the consideration of an extraordinary resolution. This is because ForCo Trust holds 100% of the X to Y classes of the notes. ForCo Trust is entitled to vote on its course of action in the event a Default occurs. Its vote will be decisive in these circumstances. A Default occurs in the following situations:

a.    The Issuer does not pay on time any amount, or does not comply with any other obligation where such non-compliance will affect payments or their timing;

b.    an Insolvency occurs in respect of the Issuer in regards to the Loan Notes;

c.     a Transaction Document, or a transaction in connection with it, becomes voidable where such event will affect payments or their timing; or

d.    the Series General Security Deed is not (or ceases to be) valid and enforceable, or the Issuer takes any step that would affect payments or their timing.

Ordinarily, the giving of such directions may fall within the type of influence described in sub test 2. However, given that such directions may only be provided in the event of a Default, which constitute a material breach of the terms of a debt interest, such directions are excluded from the analysis. The influence is only of a kind that arises from a breach of the terms of the debt interest, so is not of a kind described in subsection 880-105(6) by virtue of the operation of subsection 880-105(7).

Based upon the above, the sovereign entity group of ForCo Trust does not have influence of a kind described in subsection 880-105(6) and will, therefore, satisfy the requirements of paragraph 880-105(1)(e).

Conclusion

As all conditions listed in subsection 880-105(1) have been satisfied, section 880-105 of the ITAA 1997 will apply to the effect that amounts of interest income derived by ForCo Trust from its investments in the Loan Notes are not assessable and not exempt income.