Edited version of private advice

Authorisation Number: 1052247610164

Date of advice: 8 May 2024

Ruling

Subject:Sovereign Immunity

Question

Is the ordinary and statutory income derived by the non-resident entity 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:

1 July 20YY to 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

The non-resident entity

The non-resident entity is a sovereign wealth fund and was established by a Decree of the government of the foreign country.

The non-resident entity has a separate legal identity with financial and administrative independence reporting directly to a Cabinet of Ministers.

The non-resident entity carries out its investment program independently and without reference to the Government or other entities that also invest funds on the Government's behalf.

The objective of the non-resident entity is to invest the foreign country's funds and assets to generate maximum returns.

The non-resident entity does not produce or trade non-financial goods and does not provide non-financial services.

Contributions into the non-resident entity

The funding for the non-resident entity are mainly comprised of funds allocated from the foreign country's budget, any surpluses at the end of the year and the return on its investments.

The withdrawals from the non-resident entity are outlined in the foreign country's budget which is announced annually.

Management and Control of the non-resident entity

The governance framework of the non-resident entity is subject to a number of executive, administrative, and regulatory levels.

The relevant Decrees clearly sets out an independent Board of Directors which has the ultimate authority to approve all of the non-resident entity's operational matters.

The non-resident entity has a department in place to manage its corporate governance.

The non-resident entity's annual financial statements are compiled in accordance with International Financial Reporting Standards (IFRS) and audited by the Big 4 Audit Firms on semi-annual basis.

The non-resident entity is not a partnership.

The non-resident entity is not a resident of Australia for Australian income tax purposes.

Use of the non-resident entity's Assets

The relevant Decree specifies how the non-resident entity will operate and defines its purpose.

The non-resident entity's Australian Investments

The non-resident entity does not actively trade in financial assets and liabilities, operate commercially in financial markets or provide any of the services listed in paragraph 880-130(2)(c) of the ITAA 1997.

The non-resident entity's sovereign entity group consists of all entities that are wholly owned by the foreign government.

The non-resident entity holds investments (debt interests) issued by ASX listed entities.

These investments have the following characteristics:

•         To the best of non-resident entity's knowledge, the non-resident entity and all members of its sovereign entity group hold collectively less than 10% of the total participation interests in each of the Australian companies.

•         To the best of the non-resident entity's knowledge, the non-resident entity and all members of its sovereign entity group hold collectively less than 10% of the total participation interests in any of the Australian companies in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997.

•         Neither the non-resident entity, nor any members of its sovereign entity group, has involvement in the day to day management of the business of any of the Australian companies.

•         Neither the non-resident entity, nor any members of its sovereign entity group, has the right to appoint a director to the Board of Directors of any of the Australian companies.

•         Neither the non-resident entity, nor any members of its sovereign entity group, holds the right to representation on any investor representative or advisory committee (or similar) of the Australian companies.

•         Neither the non-resident entity, nor any members if its sovereign entity group, has the ability to direct or influence the operation of any of the Australian companies outside of the ordinary rights conferred by the debt and/or interest held.

•         The investments provide no voting rights to the non-resident entity or any members of its sovereign group.

•         The non-resident entity's interests in the Australian companies 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 any of the Australian companies' operations.

•         The non-resident entity's interests, when combined with the other interests held within its sovereign entity group, do not provide an entitlement to either directly or indirectly determine the identity of any person who makes decisions that comprise the control and direction of any of the Australian companies' operations.

•         No person involved in control and direction of any of the Australian companies' operations is accustomed or obliged to act in accordance with the directions, instructions or wishes of the non-resident entity or members of the non-resident entity's sovereign entity group.

Reasons for decision

Summary

The ordinary and statutory income derived by the non-resident entity from its Australian investments is not assessable and not exempt income due to the operation of section 880-105 of the ITAA 1997.

Detailed reasoning

Subdivision 880-C of the ITAA 1997 contains the provisions that provides a tax exemption for certain sovereign entities in respect of certain returns on membership interests in entities that are Australian resident companies or managed investments trusts. To obtain this exemption, the relevant sovereign entity group can hold only a portfolio interest in the entity and cannot have relevant influence over the entity.

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.

The non-resident entity 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, the non-resident entity is a sovereign entity for the purposes of section 880-125 of the ITAA 1997 if the following requirements are met:

            i.         The non-resident entity is a 'sovereign entity'

            ii.         The non-resident entity is funded solely by public monies

            iii.         all returns on the non-resident entity's investments are public monies

            iv.         The non-resident entity is not a partnership, and

            v.        & The non-resident entity is not a public non-financial entity or public financial entity.

These requirements are considered below.

          & i.         The non-resident entity is a 'sovereign entity'

For an entity to be covered by section 880-125 of the ITAA 1997, it must be a sovereign entity. Section 880-15 of the ITAA 1997 defines '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 subsection 995-1(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.

The foreign country is an independent sovereign state. The non-resident entity was established as an independent legal entity by Decree for the purpose of investing the foreign government's funds and assets to generate maximum returns. The non-resident entity contributes towards the state's general budget and achieves financial sustainability while playing an instrumental role in executing the government's policies and strategies toward the advancement of targeted economic sectors.

The non-resident entity has a separate legal identity with financial and administrative independence.

The governance framework of the non-resident entity is subject to a number of executive, administrative, and regulatory levels.

The Decree clearly sets out an independent Board of Directors which has the ultimate authority to approve all of the non-resident entity's operational matters.

The non-resident entity's assets are wholly owned by the foreign government.

The withdrawals from the non-resident entity are outlined in the National Budget which is announced annually.

The non-resident entity's annual financial statements are compiled in accordance with International Financial Reporting Standards (IFRS) and audited by the Big 4 Audit Firms on semi-annual basis.

As such, the non-resident entity 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.       The non-resident entity 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

The non-resident entity was established to benefit the foreign government and its people and provides liquidity to the government whenever required.

The sources of funding to the non-resident entity are funds allocated in the general budget, surpluses and returns on investments.

The non-resident entity and its assets are wholly owned by the foreign government and as such, the foreign government is the beneficial owner of all the capital invested and all income that the non-resident entity derives from that capital is for the benefit of the foreign government.

Therefore, this requirement is satisfied.

            iii.       All returns on the non-resident entity's investments are public monies:

The non-resident entity and its assets are wholly owned by the foreign government. As such, the foreign government is the beneficial owner of all the capital invested and all income that the non-resident entity derives from that capital. Surplus income derived by the non-resident entity is available for use by the foreign government. Therefore, the monies will remain government monies.

The withdrawals are outlined in the foreign government's budget which is announced annually.

Therefore, all returns on the non-resident entity's investments are public monies and will remain assets of the foreign government.

Therefore, this requirement is satisfied.

            iv.        The non-resident entity is not a partnership:

The non-resident entity is an independent legal entity created by Decree and is wholly owned by the foreign government.

As such, the non-resident entity is not a partnership.

Therefore, this requirement is satisfied.

             v.       The non-resident entity 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.

The non-resident entity was established to manage, grow and invest the foreign government's funds and assets to generate financial reserves for the purpose of contributing towards the state's general budget. Therefore, the principal activity of the non-resident entity for the purposes of subsection 880-130(1) of the ITAA 1997 is to invest and manage the funds of the foreign government.

The non-resident entity does not produce or trade non-financial goods and does not provide non-financial services.

Therefore, the non-resident entity is not in the business of producing or trading non-financial goods and / or providing non-financial services.

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.

The EM provides the following guidance with regards to public financial entities:

4.28 Public financial entities include deposit-taking corporations, financial intermediaries (such as banks), financial auxiliaries and captive financial institutions.

The non-resident entity was established to be a sovereign wealth fund so the foreign government can provide for the state's current and future welfare. All monies and income gained by the non-resident entity are ultimately returned to the foreign government for this purpose. The foreign government does not actively trade in financial assets and liabilities, operate commercially in financial markets or provide any of the services listed in paragraph 880-130(2)(c) of the ITAA 1997. Therefore, the non-resident entity is not a public financial entity under subsection 880-130(2) of the ITAA 1997.

Based on the relevant facts, the non-resident entity satisfies the condition outlined in paragraph 880-125(d) of the ITAA 1997.

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

The non-resident entity'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.

The non-resident entity currently holds debt interests in an Australian entity and derives interest income.

The non-resident entity's investments in the test entities meet the requirement of being a membership interest as defined by the interaction of sections 960-130 and 960-135 of the ITAA 1997, and the non-resident entity receives returns.

Therefore, the returns that the non-resident entity will receive from the Australian investments satisfy 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 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 the non-resident entity will be from entities that satisfy the requirements of paragraph 880-105(1)(c) of the ITAA 1997.

The non-resident entity 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, sovereign entities of the same foreign government are members of the same sovereign entity group.

The non-resident entity is part of the sovereign entity group of the foreign government. At the relevant times (as required by paragraph 880-105(1)(d)), the non-resident entity, and its sovereign entity group, collectively holds less than 10% of the total participation interests in each of the Test Entities and the non-resident entity and its sovereign entity group collectively hold less than 10% of the total participation interests in each of the test entities.

The non-resident entity's interest, and the sovereign entity group to which it belongs, therefore satisfies the requirements of paragraph 880-105(1)(d) of the ITAA 1997.

The non-resident entity'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.

LCR 2020/3 provides examples and guidance on the 'influence test' and states the following at paragraphs 11 to 13 with respect to sub-test 1:

11. Whether the relevant entity is able to determine the identity of (to settle or decide upon, to choose or appoint) one of those persons is a question of fact. The phrase 'able to' focuses on the relent entity's capacity or power. The sub-test is therefore not limited to situations where the entity has already determined, or intends to determine, the identity of one of the relevant decision makers. A right to determine will be sufficient for the requisite level of influence to exist.

12. The relevant entity will not be 'able to' determine, as a matter of fact, where it has irrevocably and unconditionally waived its rights by way of a legally enforceable agreement.

13. The sub-test also extends to situations where the relevant entity has the indirect capacity to determine the identity of one of the relevant decision makers. This may occur, for example, where the relevant entity controls another entity and that other entity holds the right to determine the decision-maker's identity.

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.

LCR 2020/3 provides the following guidance at paragraph 29 in respect of sub-test 2:

29. The three matters ('accustomed', 'obliged' or 'might reasonably be expected to') are not a composite phrase denoting a single test; they comprise different considerations each of which is sufficient to establish influence:

•                    Whether a person is 'accustomed' to act in accordance with the directions, instructions or wishes of the relevant entity requires an analysis of past facts. This necessitates an examination of any discernible pattern of the person following the directions, instructions or wishes given by the relevant entity.

•                    Whether a person is 'obliged' to act in accordance with the directions, instructions or wishes of the relevant entity depends upon a formal or informal obligation existing at the relevant time.

•                    Whether a person 'might reasonably be expected' to act in accordance with the directions, instructions or wishes of the relevant entity requires a prediction as to future events and a consideration as to the objective likelihood of those future events occurring. This requires a consideration of all of the facts and circumstances impacting upon the relationship between the two parties.

The following are relevant in determining whether the non-resident entity's sovereign entity group satisfies the 'influence test' in respect of the test entities:

•         neither the non-resident entity, nor any member of its sovereign entity group, has the right to appoint a director to the Board of Directors of any of the test entities.

•         neither the non-resident entity, nor any member of its sovereign entity group, hold the right to representation on any investor representative or advisory committees (or similar) of any of the test entities.

•         neither the non-resident entity, nor any member of its sovereign entity group, has the ability to direct or influence the operation of any of the test entities.

•         The non-resident entity's sovereign entity group's interest of less than 10% in each of the test entities does 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 any of the test entities' operations.

•         The non-resident entity's sovereign entity group's interest of less than 10% does not provide the non-resident entity or its sovereign entity group with the right to approve or veto decisions which contribute to the control or direction of any of the test entities.

•         neither the non-resident entity, nor any member of its sovereign entity group, has any involvement in the day-to-day management of the business of any of the test entities.

•         neither the non-resident entity, nor any member of its sovereign entity group, have the ability to exert actual or potential influence over the operations or investments of the test entities outside the ordinary rights conferred by the equity interest held, and

•         The non-resident entity's sovereign entity group consists of all entities that are wholly owned by the foreign government. With respect to the interests in the Test Entities, the non-resident entity holds significantly less than 10% of the participation interests in the Test Entity. To the best of the non-resident entity's knowledge, its sovereign entity group as a whole holds less than 10% of the participation interests in the Test Entity.

The non-resident entity's interests in the Test Entities 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, the non-resident entity's interests do not provide 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. 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 the non-resident entity or members of the non-resident entity's sovereign entity group.

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

In addition, it is reasonable for the Commissioner to conclude that the non-resident entity and its sovereign entity group do not have influence over the test entities of the type set out in the examples of LCR 2020/3.

Therefore, the non-resident entity 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 the non-resident entity from its investments in the test entities is not assessable and not exempt income.