Edited version of private advice

Authorisation Number: 1051961595649

Date of advice: 15 March 2022

Ruling

Subject: International issues - sovereign immunity

Question

Is the ordinary and statutory income derived by Foreign Bank from its Australian investments 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 periods:

30 June 20XX

30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Foreign Bank

Foreign Bank was established under the ABC Act (Act) to serve as the central bank of XX country.

Foreign Bank is a quasi-governmental organisation which operates in consultation with the Government of XX country. It is a non-capital special juridical person created by statute.

Foreign Bank is resident of XX country for the purposes of taxation and pays corporate tax. Foreign Bank's main office is located in the capital city of XX country.

Foreign Bank was established to contribute to the development of the national economy, to pursue price stability and formulate and implement monetary and credit policies.

Foreign Bank's operations

In accordance with the Act, Foreign Bank's operations include, but are not limited to:

•                has the sole right to issue currency in XX country

•                may accept and hold deposits on behalf of banking institutions

•                may conduct emergency credit operations with banking institutions

•                as the depository of the Government of XX country, handles national revenue deposits and holds and manages foreign reserves

•                may accept custody of securities, documents or other valuable objects belonging to the Government of XX country, and

•                shall exercise an advisory function concerning the Government of XX country's policies on exchange rates.

Foreign Bank is prohibited by the Act from:

•                accepting deposits from, making loans to, or purchasing the obligations of companies or individuals other than the government of XX, except where severe impediments arise to obtaining funds from financial institutions, including when there is a severe contraction of credit or a strong likelihood of a severe contraction of credit arising, and

•                from participating, directly or indirectly, in profit-making activities, or the ownership or management of any profit making-enterprise, and may not purchase or permanently own real property unless it is necessary for the conduct of its business.

Foreign Bank's Assets

Foreign Bank holds and manages XX country's foreign reserves, which are the official reserve assets of XX country. Foreign Bank has made investments in Australia using the foreign reserves.

Foreign Bank's own funds are separated from the income from the foreign reserves.

All profits and losses coming from the management of the foreign reserves revert to the Foreign Bank and the Government of XX country.

If Foreign Bank makes a net profit at the end of a fiscal year, Foreign Bank's retained earnings are

Any loss incurred by Foreign Bank during any fiscal year shall be offset from the reserves. Should the reserves be insufficient, the deficiency shall be made up by the Government of XX country.

Foreign Bank's Australian Investments

Foreign Bank's Australian investments include:

•                Equity investments in Australian resident companies and managed investment trusts (MITs), and

•                Debt securities issued by Australian resident companies, including Australian state governments.

To the best of Foreign Bank's knowledge, the equity investments held by Foreign Bank have the following characteristics:

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

•                Foreign Bank and the members of its sovereign entity group, hold less than 10% of the total participation interests in each of the entities in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997

•                neither Foreign Bank, nor any member of its sovereign entity group, has any involvement in the day to day management of any of the entities

•                neither Foreign Bank, nor any member of its sovereign entity group, has any right to representation on the board of directors, or any investor representative or advisory committee (or similar) of any of the entities

•                neither Foreign Bank, nor any member of its sovereign entity group, has the ability to direct or influence the operation of the entities outside the ordinary rights conferred by the interest held

•                Foreign Bank'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 entities' operations, and

•                no person involved in the control and direction of the entities' operations is accustomed or obliged to act in accordance with the directions, instructions or wishes of Foreign Bank or members of Foreign Bank's sovereign entity group.

To the best of Foreign Bank's knowledge, the debt investments held by Foreign Bank have the following characteristics

•                Foreign Bank and the members of its sovereign entity group, hold less than 10% of the total participation interests in each of the entities in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997

•                neither Foreign Bank, nor any member of its sovereign entity group, has any involvement in the day to day management of any of the entities

•                neither Foreign Bank, nor any member of its sovereign entity group, has any right to representation on the board of directors, or any investor representative or advisory committee (or similar) of any of the entities

•                neither Foreign Bank, nor any member of its sovereign entity group, has the ability to direct or influence the operation of the entities outside the ordinary rights conferred by the interest held

•                Foreign Bank'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 entities' operations

•                no person involved in the control and direction of the entities' operations is accustomed or obliged to act in accordance with the directions, instructions or wishes of Foreign Bank or members of Foreign Bank's sovereign entity group

•                neither Foreign Bank, nor any member of its sovereign entity group, has any voting rights in respect of the debt investments held, and

•                there are no special relationships or arrangements between Foreign Bank, nor any member of its sovereign entity group, and the issuers of the Australian debt investments held which affect the amount of interest income that is paid from those investments.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 880

Reasons for decision

Section 880-105 of the ITAA 1997 provides that a sovereign entity's income from an interest in a trust or company will be non-assessable non-exempt income if certain conditions are met.

The conditions are listed in subsection 880-105(1) of the ITAA 1997 as follows:

(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.

Foreign Bank is a 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).

Therefore, Foreign Bank is a sovereign entity for the purposes of section 880-125 of the ITAA 1997 if the following requirements are met:

i. Foreign Bank is a 'sovereign entity'

ii. Foreign Bank is funded solely by public monies

iii. all returns on Foreign Bank's investments are public monies

iv. Foreign Bank is not a partnership, and

v. Foreign Bank is not a public non-financial entity or public financial entity.

These requirements are considered below.

i.    Foreign Bank is a 'sovereign entity'

For an entity to be covered by section 880-125 of the ITA 1997, it must be a sovereign entity. Section 880-15 of the ITAA 1997 defines 'sovereign entity' as:

A sovereign entity is 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.

'Foreign government agency' is defined in section 995-1 of the ITAA 1997 as meaning:

(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.

Foreign Bank was established under the Act by the Government of XX country to serve as the central bank of XX country.

Foreign Bank is a quasi-governmental organisation and operates in consultation with the Government of XX country.

Foreign Bank is a resident of XX country for taxation purposes.

As such, Foreign Bank meets the requirements of being a sovereign entity in accordance with section 880-15 of the ITAA 1997 as it is a foreign government agency as defined in subsection 995-1(1) of the ITAA 1997.

Therefore, this requirement is satisfied.

ii.    Foreign Bank is funded solely by public monies

The phrase 'public monies' is not defined and as such takes its ordinary meaning.

Law Companion Ruling LCR 2020/3 - The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2020/3) provides guidance on the term 'public monies'.

In the context of Division 880 of the ITAA 1997, LCR 2020/3 provides at paragraph 54, that this phrase essentially means monies of a foreign government (or part of a foreign government) held 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.

Foreign Bank holds and manages XX country's foreign reserves. In addition, Foreign Bank is prohibited from participating in profit-making activities, and except for exceptional circumstances, is prohibited from accepting deposits from, or making loans to, individuals or for-profit enterprises.

Further, in the event that Foreign Bank incurs a loss during a financial year and its reserves are insufficient, then the deficiency is made up by the Government of XX country.

It is therefore reasonable to conclude that Foreign Bank is solely funded by public monies attributable to the Government of XX country.

Therefore, this requirement is satisfied.

iii.   All returns on Foreign Bank's investments are public monies

If Foreign Bank makes a net profit at the end of a fiscal year, Foreign Bank's retained earnings are appropriated to reserves, of which the Government of XX country is beneficial owner.

In accordance with the above, it is reasonable to conclude that the return's on Foreign Bank's investments are public monies.

Therefore, this requirement is satisfied.

iv.   Foreign Bank is not a partnership

Foreign Bank is a non-capital special juridical person created by statute

As such, Foreign Bank is not a partnership.

Therefore, this requirement is satisfied.

v.   Foreign Bank 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' as:

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.

The term 'principal' is not defined and LCR 2020/3 states at paragraph 74 that the term takes its ordinary meaning having regard to the purpose and context in which it appears. The Macquarie Dictionary defines 'principal' as 'first or highest in rank, importance, value, etc.; chief, foremost...'.

The terms 'non-financial goods' and 'services that a not financial services' are also not defined, so should be given their ordinary meaning according to context and purpose.

The Explanatory Memorandum to the Treasury Laws Amendment (Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2018 (EM) provides the following guidance with regard to public non-financial entities:

4.27 Public non-financial entities include entities such as airline corporations, postal authorities, state water corporations and port authorities. They also include public non-profit institutions engaging in market production (such as hospitals, schools, or colleges) if they are separate institutional units and charge economically significant prices.

In addition to the example entities listed in the EM, LCR 2020/3 states at paragraph 76 that state electricity corporations and state mining corporations are also examples of public non-financial entities.

Foreign Bank was established as the central bank of XX country, for the principal purpose of contributing to the sound development of the national economy through the formulation and implementation of efficient monetary and credit policies.

Foreign Bank does not produce or trade non-financial goods, nor does it provide services that are not financial services as its principal activity. Therefore Foreign Bank is not a public non-financial entity.

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

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) of the ITAA 1997 excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

Accordingly, in order for Foreign Bank to be excluded from subparagraph 880-125(d)(ii) of the ITAA 1997, it must be established that Foreign Bank as a public financial entity only carries on central banking activities.

LCR 2020/3 states the following with regard to central banking activities at paragraphs 80 to 83:

80. A public financial entity under subsection 880-130(2) is excluded from subparagraph 880-125(d)(ii) where it only carries on central banking activities.

81. Based on principles drawn from Government Finance Statistics Manual 2014 and Australian System of Government Finance Statistics: Concepts, Sources and Methods, 2015, the following are considered 'central banking activities':

•      monetary policy development

•      issuing national currency

•      acting as custodian for international reserves, and

•      providing banking services to government.

82. The Reserve Bank of Australia is Australia's central bank. The activities of the Reserve Bank of Australia are consistent with those outlined in paragraph 81 of this Ruling and provide a useful reference point in considering whether a public financial entity is undertaking central banking activities.

83. Whether a public financial entity is 'only' carrying on central banking activities is a question of fact. It is important to note that a public financial entity may carry on both central banking activities and non-central banking activities (for example, commercial banking). Where this is the case, the public financial entity is not excluded from subparagraph 880-125(d)(ii).

LCR 2020/3 refers to the Reserve Bank of Australia (RBA), Australia's central bank, as a useful reference point in considering whether a public financial entity is undertaking central banking activities.

The RBA is a statutory authority established by an Act of Parliament, the Reserve Bank Act 1959, which gives it specific powers and obligations. The roles and functions of the RBA are underpinned by various pieces of legislation.

The RBA conducts monetary policy, works to maintain a strong financial system and issues Australia's currency. As well as being a policy-making body, the RBA provides selected banking and registry services to a range of Australian government agencies and to a number of overseas central banks and official institutions. The RBA also manages Australia's gold and foreign exchange reserves.

The RBA is not a commercial bank and does not provide banking facilities to the general public. However, the RBA does provide some banking services to commercial banks and other clients. The RBA is also authorised to provide emergency support to the Australian economy in response to severe economic conditions.

Foreign Bank's operations are prescribed by the Act and include:

•         having the sole right to issue currency in XX country

•         exercising an advisory function concerning the Government of XX country's policies on exchange rates, foreign currency loans etc

•         assisting in the collection of national revenues and handling national revenue deposits

•         holding and managing XX country's foreign reserves

•         accepting custody of securities, documents and other valuable documents belonging to the Government of XX country, and

•         conducting emergency credit operations with banking institutions where the stabilisation of currency and banking business are directly threatened.

The Act specifically prohibits Foreign Bank from participating in profit-making activities, except for in exceptional circumstances, and is prohibited from accepting deposits from, or making loans to, individuals or for-profit enterprises.

It is evident that Foreign Bank undertakes a range of central banking activities consistent with those undertaken by the RBA. It is therefore reasonable to conclude that Foreign Bank is a public financial entity that only carries on central banking activities and is not a public financial entity for the purposes of paragraph 880-125(d) of the ITAA 1997.

Therefore, this requirement is satisfied.

As Foreign Bank satisfies each of the requirements in paragraphs 880-125(a) - (d) of the ITAA 1997, inclusive, it is reasonable to conclude that Foreign Bank 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.

Foreign 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) 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.

As detailed in paragraph 4.37 of the EM, a 'return on' for the purposes of paragraph 880-105(1)(b) of the ITAA 1997 includes, but is not limited to:

•         dividends - including non-share dividends and dividends that pass through a Managed Investment Trust (MIT)

•         interest - including interest that passes through a MIT

•         fund payments made by a MIT (other than fund payments to the extent that they are attributable to non-concessional MIT income, or would be non-concessional MIT income if certain provisions were disregarded, in accordance with subsection 880-105(3) of the ITAA 1997), and

•         revenue gains made on the disposal of an interest in the test entity, including revenue gains that pass through a MIT.

Foreign Bank holds shares and units in ASX listed Australian resident companies and MITs from which it derives various forms of income, including dividend, interest and MIT fund payments.

Foreign Bank also holds debt interests in Australian resident companies, including state government entities from which it derives interest income.

Therefore, the returns that Foreign Bank will receive from the Australian investments meet the requirements of paragraph 880-105(1)(b) of the ITAA 1997.

Test entities meet the requirements of paragraph 880-105(1)(c) of the ITAA 1997

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

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

•         a managed investment trust in the income year in which the income time occurs.

The test entities are Australian resident companies or MITs for Australian income tax purposes and it is expected that the test entities will continue to be Australian residents at the respective income times.

Therefore, the income received by Foreign Bank will be from entities that satisfy the requirements of paragraph 880-105(1)(c) of the ITAA 1997.

Foreign Bank'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 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.

Subsection 880-105(4) of the ITAA 1997 contains the portfolio interest test and states:

Portfolio interest test

(4)       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 that 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.

'Sovereign entity group' is defined in section 880-20 of the ITAA 1997, which provides that each of the following is part of a sovereign entity group (member):

•         a body politic of a foreign country or part of a foreign country

•         a foreign government agency in relation to that foreign country or that part of that foreign country, and

•         an entity in which an entity covered by either of the above 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 (ITAA 1936).

Accordingly, Foreign Bank's sovereign entity group consists of all entities that are ultimately wholly owned by the Government of XX country.

Foreign Bank hold significantly less than 10% of the participation interests in each of the entities and to the best of Foreign Bank's knowledge, its sovereign entity group together holds less than 10% of the participation interest in each test entity.

As such, the Commissioner accepts that Foreign Bank satisfies the requirements of paragraph 880-105(1)(d) of the ITAA 1997.

Foreign Bank's sovereign entity group satisfies the influence test

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(e) of the ITAA 1997, 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 at the income time.

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

Influence test

(6)       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 the 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, makes or is reasonably expected to make, 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 entities.

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, 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. Foreign Bank's interests in the test entities have the characteristics outlined at Fact 13 of this ruling.

Foreign Bank'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, Foreign Bank's interests, when combined with the other interests held by members of its sovereign entity group, do not provide Foreign Bank 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.

In addition, 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 Foreign Bank or members of Foreign Bank's sovereign entity group.

Based on the above, it is reasonable for the Commissioner to conclude that neither Foreign Bank, nor its sovereign group, have influence over the test entities of the kind described in subsection 880-105(6) of the ITAA 1997.

Therefore, Foreign Bank and its sovereign entity group satisfy the requirements of paragraph 880-105(e) 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 Foreign Bank from its investments in the test entities is not assessable and not exempt income.