Edited version of private advice

Authorisation Number: 1052150839544

Date of advice: 2 August 2023

Ruling

Subject: Sovereign immunity

Question

Is the ordinary and statutory income derived by the Bank from its interest in the investment (the Test Entity) not assessable income 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:

1 July 20xx to 30 June 20yy.

The scheme commenced on:

1 July 20xx

Relevant facts and circumstances

Establishment

1. The Bank is the central bank of Country X.
2. The Bank is registered as a public limited company whose sole shareholder is the State of Country X (the Government). The Bank is funded by authorised capital, which is fully issued and paid up.
3. The Bank's Governing Body may only make distributions to shareholders, being the Government, to the extent that the Bank's shareholders' equity exceeds the amount of paid-up capital plus the reserves that must be maintained by law.
4. The registered office for the Bank is located in Country X.

Governance of the Bank

5. The Bank's central management and control is carried on in Country X, by persons none of whom are Australian residents.
6. The Governing Body is responsible for the Bank's management.

Functional Tasks

7. The Bank is responsible for:

•         Supervising financial institutions pursuant to relevant statutory provisions;

•         Promoting the smooth operation of payment systems;

•         Promoting the stability of the financial system;

•         Collecting statistical data and compiling statistics in accordance with relevant statutory provisions; and

•         Performing resolutions tasks relating to financial undertakings in accordance with relevant statutory regulations.

8. The Bank is also in charge of safeguarding the smooth operation of the payment system in Country X and managing the circulation of banknotes.

Funds of the Bank

9. The profit of the Bank is at the disposal of the general meeting of shareholders.

Investment in the Test Entity

10. The Bank holds a membership interest in the Test Entity which is an Australian resident company. This investment has the following characteristics:

a.    The Test Entity in which the Bank has invested is listed on the Australian Securities Exchange (ASX).

b.    The Bank, and, to the best of the Bank's knowledge, its sovereign entity group, hold collectively less than 10% of the total participation interests in the Test Entity.

c.    The Bank, and, to the best of the Bank's knowledge, its sovereign entity group, would hold collectively less than 10% of the total participation interest in the Test Entity in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997.

d.    Neither the Bank nor, to the best of the Bank's knowledge, any members of its sovereign entity group has involvement in the day to day management of the business of the Test Entity.

e.    Neither the Bank nor, to the best of the Bank's knowledge, any members of its sovereign entity group, has the right to appoint a director to the Board of Directors of the Test Entity.

f.     Neither the Bank nor, to the best of the Bank's knowledge, any members of its sovereign entity group, holds the right to representation on any investor representative or advisory committee (or similar) of the Test Entity.

g.    Neither the Bank nor, to the best of the Bank's knowledge, any members of its sovereign entity group, has the ability to direct or influence the operation of the Test Entity outside of the ordinary rights conferred by the membership interest held.

h.    The Bank only holds rights to vote in proportion to its membership interest in the investment.

i.      The Bank's interests, when combined with the other interests held within its sovereign entity group, do not provide it or the sovereign entity group an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entity's operations.

j.      No person involved in the control and direction of the Test Entity's operations is accustomed or obliged to act in accordance with the directions, instructions or wishes of the Bank, or, to the best of the Bank's knowledge, the Bank's sovereign entity group.

Relevant legislative provisions

Division 880 of the Income Tax Assessment Act 1997

Income Tax (Transitional Provisions) Act 1997 section 880-5

Reasons for decision

Section 880-105 provides that amounts of ordinary and statutory income derived by a sovereign entity are not assessable income 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.

The Bank 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.

The Bank 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 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.

Section 960-180 provides that an entity's total participation interest in another entity is the sum of:

(a) the entity's direct participation interest in the other entity at that time; and

(b) the entity's indirect participation interest in the other entity at that time.

Country X is a foreign country.

The Bank is the central bank of Country X.

The Bank is registered as a company whose sole shareholder is the Government.

Through its 100% ownership of the Bank, the Government has a total participation interest of 100% in the Bank.

The Bank is not an Australian resident, nor is it a resident trust estate for the purposes of Division 6 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936).

Therefore, the Bank meets the requirements of being a sovereign entity in accordance with paragraph 880-15(c) as it is an entity in which the Government, being the body politic of a foreign country, holds a total participation interest of 100%.

The Bank is funded solely by public monies

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.

The Bank is funded solely by public monies.

The capital of the Bank is wholly owned by the Government.

The income derived by the Bank from its investment in the Test Entity is also wholly owned by the Government.

Therefore, the Bank is funded solely by public monies and satisfies this requirement.

All returns on the Bank's investments are public monies

As a wholly owned entity of the Government, all distributions made by the Bank, as funded by the returns on its investments, are received by the Government.

The Bank may only make distributions to the shareholders to the extent that the Bank's shareholders' equity exceeds the amount of paid-up capital plus the reserves that must be maintained by law. The profit is at the disposal of the general meeting of shareholders where the sole shareholder is the Government.

Therefore, all returns on the Bank's investments are public monies and will remain public monies.

The Bank is not a partnership

The Bank is not a partnership.

Therefore, the Bank satisfies this requirement.

The Bank 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 financial services in relation to assets or liabilities that are not available on open financial markets.

Subparagraph 880-125(d)(ii) excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

The Bank was created by the Government to conduct central banking activities.

The Bank does not produce or trade non-financial goods and does not provide services that are not financial services. As such, the Bank is not a public non-financial entity as defined in subsection 880-130(1).

As a central bank, the Bank likely undertakes the activities listed in paragraph 880-130(2)(c). However, subparagraph 880-125(d)(ii) excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

Paragraph 81 of LCR 2020/3 lists the following as 'central banking activities':

• monetary policy development
• issuing national currency
• acting as custodian of international reserves, and
• providing banking services to government.

Paragraph 83 of the LCR 2020/3 also states:

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).

When determining whether an activity constitutes the exercise of governmental functions, it is necessary to examine the nature of the activity conducted by the foreign government or its instrumentality. Whether an operation or activity is commercial in nature will depend on the facts of each particular case.

The Bank is responsible for many activities, including supervising financial institutions, promoting the smooth operation of payment systems, promoting the stability of the financial system and managing the circulation of banknotes.

The Bank therefore does not just carry out the 'central banking activities' identified in paragraph 81 of LCR 2020/3, but also other regulatory activities that are consistent with central banking activities.

It is considered that all of the Bank's activities are consistent with the Bank being an entity that only carries on central banking activities. Therefore, the Bank satisfies the requirement in paragraph 880-125(d).

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

The Bank's return is received on a relevant interest in the Test Entity

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 entity.

As detailed in paragraph 4.37 of the Explanatory Memorandum to the Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Act 2019 ('the EM'), a 'return on' a membership interest, debt interest or non-share equity interest for the purposes of paragraph 880-105(1)(b) will include:

1.            dividends - including non-share dividends and dividends that pass through a managed investment trust (MIT)

2.            interest - including interest that passes through a MIT

3.            fund payments made by a MIT (other than fund payments that are attributable to non-concessional MIT income), and

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

The Bank holds a membership interest in the Test Entity (which meets the requirements of being membership interests as defined by the interaction of sections 960-135 and 960-130). The Test Entity is an entity of which the Bank holds a membership interest and earns returns in the form of dividends.

Therefore, the Bank will receive amounts which satisfy the requirements of paragraph 880-105(1)(b).

The Bank'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 Test Entity is an Australian resident company at the relevant time.

Therefore, the Bank receives income from an entity which satisfies the requirements of paragraph 880-105(1)(c).

The Bank'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 entities at both the income time and throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time.

The portfolio interest test is outlined in subsection 880-105(4), 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 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 Bank is part of the sovereign entity group of the Government. At the relevant times (as required by paragraph 880-105(1)(d)), the Bank, and its sovereign entity group collectively, with respect to its membership interest in the Test Entity, holds less than 10% of the total participation interests in the Test Entity. Further, the Bank, and its sovereign entity group collectively, would hold less than 10% of the total participation interests in the Test Entity in the circumstances detailed in paragraph 880-105(4)(b).

Therefore, the portfolio test is satisfied.

The Bank'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), 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 a time if any of the following requirements are satisfied at that time:

(a) a *member of the group:

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

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

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

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

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

Sub-test 1 of the influence test, as contained in paragraph 880-105(6)(a), 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.

The Bank's interest in the Test Entity does not provide the Bank with an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entity's operations. Furthermore, the Bank's interests, when combined with the other interests held within its sovereign entity group, do not provide its sovereign entity group with an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entity's operations.

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.

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

Based upon the above, the sovereign entity group of the Bank 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 of the conditions listed in subsection 880-105(1) have been satisfied, section 880-105 will apply to the effect that amounts of ordinary and statutory income derived by the Bank from its investment in the Test Entity are not assessable income and not exempt income.