Edited version of private advice

Authorisation Number: 1052136220441

Date of advice: 5 July 2023

Ruling

Subject: Sovereign immunity

Question

Is the ordinary and statutory income derived by ForCo as trustee of the ForCo Trust (ForCo Trust) from the notes it holds that were issued by the Issuer (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:

XX July 20YY to XX June 20YY

The scheme commenced on:

XX July 20YY

Relevant facts and circumstances

ForGov

1.    ForGov is a statutory body corporate established to own and administer assets of the Country X Government (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.

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

ForCo

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

4.    ForCo was incorporated for the purpose of investing in term loans in the debt-syndication market.

5.    A trust declaration provides that all of the rights, tiles 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.

6.    ForCo Trust (i.e. the trust created by ForCo holding loan notes on trust for the Country X 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.

7.    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.

8.    ForCo Trust receives its funds from the Government.

9.    The sources of Government funds include Government revenue.

10.  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.

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

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

13.  ForCo Trust is part of a sovereign group (as that term is defined in section 880-20 of the ITAA 1997) consisting of all entities ultimately wholly owned by the Government as well as the Government itself.

Loan Notes

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

Notes: Key terms

15.  The key terms of the Notes can be found in the Note Poll Deed, the Security Trust Deed and the Commitment Letter issued by the Issuer.

16.  The Issuer irrevocably undertakes to pay principal, any interest and any other amounts payable in respect of each Note held in accordance with the Conditions of the Note.

17.  The Interest Rate for a Note for each Interest Period is the sum of the relevant Margin for that Notes and the Bank Bill Rate for that Interest Period.

18.  The Issuer agrees to redeem each Note on its Maturity Date by paying to ForCo Trust the Invested Amount for the Note plus all accrued and unpaid interest on such Note up to its Maturity Date and any other amount payable but unpaid with respect to the Note.

19.  Secured Creditors have the ability to vote on certain matters through extraordinary or special quorum resolutions. These matters relate to the altering of terms of the Notes, or matters arising in the event of Default as that term is defined in the terms of the Notes.

20.  An Event of Default occurs if:

(a)  the Issuer fails to pay any amount payable on time, or does not comply with any other obligation where such non-compliance will affect payments or their timing;

(b)  a Transaction Document, or a transaction in connection with it, becomes voidable or does not have the priority intended or a party becomes entitled to rescind and such an event would affect payments or their timing;

(c)   the Issuer becomes insolvent;

(d)  the General Security Agreement or any security interest created ceases to be valid and enforceable or any Encumbrance is created in respect of the Collateral for more than 10 business days after the Issuer became aware; and

(e)  distress is levied or a judgement, order or Encumbrance is enforced against the Collateral.

21.  If an Event of Default is continuing, the Secured Creditors will meet and vote in an Extraordinary Resolution to direct or give instructions or approvals to the Trustee in accordance with the Transaction Documents.

ForCo Trust's investment

22.  ForCo Trust holds 100% of X-Y classes of Notes. As such, ForCo Trust holds 100% of the Secured Creditor voting rights in respect of each class of those Notes.

23.  ForCo Trust is not aware, to the best of its knowledge, of any equity or debt investments held by any member of its sovereign entity group, including the Government, in the Issuer other than the Notes to be held by ForCo.

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

(a)  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;

(b)  Neither ForCo Trust nor any member of its sovereign entity group hold any veto rights on security holder notes; and

(c)   Neither ForCo Trust nor any member of its sovereign entity group hold any other influence over the Issuer potentially of a kind described in subsection 880-150(6) of the ITAA 1997.

25.  ForCo Trust's rights with respect to the Notes pertain to typical debt securityholder rights, rather than rights with respect to the control and operation of the Issuer.

Relevant legislative provisions

Division 880 of the ITAA 1997

Reasons for decision

Question

Is the ordinary and statutory income derived by ForCo Trust from the Notes not assessable and not exempt income under section 880-105 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Detailed reasoning

Section 880-105 provides that amounts of ordinary and statutory income derived by a sovereign entity are not assessable and not exempt income if certain conditions are met. Those conditions are listed in subsection 880-105(1):

(a)  the sovereign entity is covered by section 880-125; and

(b)  the amount is a return on any of the following kinds of interest that the sovereign entity holds in another entity (the test entity):

i.      a membership interest;

ii.     a debt interest;

iii.    a non-share equity interest; and

(c)   the test entity is:

i.      a company that is an 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

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, being Country X.

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 Notes. As such, all returns on ForCo Trust's investments will be paid to the Government, making them public monies.

ForCo 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.

Law Companion Ruling 2020/3: The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2020/3) provides the following examples of public non-financial entities:

•         airline corporations;

•         postal authorities;

•         state water corporations;

•         port authorities;

•         hospitals;

•         schools;

•         colleges;

•         state electricity corporations; and

•         state mining corporations.

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.

LCR 2020/3 provides the following examples of public financial entities:

•         banks;

•         deposit taking corporations;

•         captive financial institutions;

•         pension/superannuation funds;

•         insurance corporations;

•         entities in the business of investment management;

•         entities in the business of share trading; and

•         entities in the business of money lending.

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 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 intends to hold the Notes across a medium to long-term holding period and has not made the investment for the purpose of trading in the Notes. ForCo Trust makes passive investments in debt instruments for the purpose of preserving and enhancing the Government's reserves. Therefore, ForCo Trust does not actively trade in financial assets and liabilities, operate commercially in financial markets or engage in the activities contemplated in subparagraph 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 Notes (a debt interest) to ForCo Trust and in return ForCo Trust receives interest income 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 or 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 pays interest to ForCo Trust. The Issuer is an Australian resident company.

As such, ForCo Trust receives income from an entity which satisfies 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.

ForCo Trust does not hold an equity interest in the Issuer. To the best of ForCo Trust's knowledge, no Government entities holds any debt or equity interest in the Issuer, or the broader Issuer's corporate group. 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-makers 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 Notes does not give ForCo Trust the ability to determine the identity of any persons who make decisions that comprise the control and direction of the Issuer's operations. Further, none of the persons who make such decisions are accustomed or obliged to act, or might reasonably be expected to act, in accordance with ForCo Trust's wishes or directions. Neither ForCo Trust or its sovereign entity group hold, either directly or indirectly, any right to appoint a person to a board, committee or similar of the Issuer. All of the above points regarding influence over the Issuer group are true, to the best of ForCo Trust's knowledge, with respect to all members of its sovereign entity group.

ForCo Trust's holding of the Notes means that it has customary voting rights as a voting secured creditor. The decisions on which ForCo Trust is entitled to vote pertain to typical debt security holder rights, as opposed to rights comprising the control and direction of the operations of the Issuer or the Issuer's Trust. ForCo Trust does not hold any veto rights over any decisions pertaining to the Issuer or the Issuer's Trust. Further, these decisions do not relate to the management or operations of the Issuer. As a Note Holder, ForCo Trust has the ability to vote on decisions altering the terms of the Notes, and the ability to vote to determine how to enforce the terms of the Notes if an Event of Default occurs.

With respect to the ability to vote on an Extraordinary Resolution in the event of an Event of 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 Notes are debt interests for the purposes of the ITAA 1997 as defined in section 974-20.

As the sole Note Holder, ForCo Trust will hold 100% of the votes in an Extraordinary Resolution in response to the occurrence of an Event of Default. An Event of Default occurs in the following circumstances:

(a)  the Issuer fails to pay any amount payable on time, or does not comply with any other obligation where such non-compliance will affect payments or their timing;

(b)  a Transaction Document, or a transaction in connection with it, becomes voidable or does not have the priority intended or a party becomes entitled to rescind and such an event would affect payments or their timing;

(c)   the Issuer becomes insolvent;

(d)  the General Security Agreement or any security interest created ceases to be valid and enforceable or any Encumbrance is created in respect of the Collateral for more than 10 business days after the Issuer became aware; and

(e)  distress is levied or a judgement, order or Encumbrance is enforced against the Collateral.

If an Event of Default occurs, ForCo Trust may vote to direct the Security Trustee to enforce the terms of the Notes, including recovering payments due and payable to it per the terms of the Notes and Transaction Security Documents.

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 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 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 will apply to the effect that amounts of interest income derived by ForCo Trust from its investments in the Notes are not assessable and not exempt income.