Edited version of private advice

Authorisation Number: 1052250944351

Date of advice: 14 May 2024

Ruling

Subject: Sovereign immunity

Question 1

Is the ordinary and statutory income derived by the Foreign Entity from its Australian debt interests in the Australian resident companies listed in Appendix 1 (the 'Test Entities'), not assessable income and not exempt income under section 880-105 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Does section 880-110 of the ITAA 1997 operate to deny the Foreign Entity a deduction for any loss in respect of its debt interests in the Test Entities?

Answer

Yes.

Question 3

Is any capital gain or capital loss made by the Foreign Entity with respect to its debt interests in the Test Entities disregarded under sections 880-115 and 880-120 of the ITAA 1997 respectively?

Answer

Yes.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Overview:

1. The Foreign Entity is a legal entity under public law and is wholly owned by the Foreign Country.
2. The Foreign Entity is the Central Bank of the Foreign Country and is governed by the Foreign Country's Law on the Foreign Entity (The Law).
3. The primary goal of the Foreign Entity is to ensure price stability within the authorities as defined within The Law and shall not be profit-making. The Foreign Entity also safeguards financial stability within the powers established by the laws regulating financial markets.
4. The Foreign Entity assists in pursuing the economic policy of the Foreign Country according to its goals.
5. The Foreign Entity acts as the financial agent to the Foreign Country.
6. The Foreign Entity is independent in the discharge of its responsibilities and exercise of its authorities. No body, individual, or legal entity may directly or indirectly constrain, influence, or interfere with its activities.
7. The Foreign Entity is eligible for tax exemptions pursuant to the laws of the Foreign Country and is exempt from all kinds of state duties and levies.

Funding:

8. On establishment, the Foreign Entity was handed the assets and liabilities of former state-owned entities.
9. The Foreign Entity has an amount of capital as determined by The Law, an independent balance sheet, charter fund and other property in its own name. The capital reserves of the Foreign Entity are formed through deductions from the profit of the reporting year provided they do not fall below the charter fund.
10. In accordance with the laws of the Foreign Country, the Foreign Entity shall own, use and dispose of the property on its books.
11. The Foreign Entity may not be declared bankrupt and any capital shortfall of the Foreign Entity is covered at the expense of securities issued by the Foreign Country.
12. The profit of the Foreign Country is calculated by deducting expenditures from revenues in compliance with the International Financial Reporting Standards. Revenue is formed from the income generated from the Foreign Entity's activity and receipts from other sources that do not conflict with The Law.
13. The reporting year profit of the Foreign Entity is firstly directed toward the formation of its capital reserves, following this any free balance of realised gains is transferred to the state budget of the Foreign Country.

Functions:

14. In order to achieve its goal, under The Law, the Foreign Entity shall undertake activities that are consistent with central banking activities including implementing monetary and foreign exchange policy, currency control, setting exchange rates, maintaining gold and foreign exchange reserves.
15. In implementing the monetary policy, the Foreign Entity can set reserve requirements for credit institutions and refinance credit institutions.
16. To accomplish its goals, the Foreign Entity is also able to accept deposits from and place deposits with credit institutions.
17. All domestic banks in the Foreign Country have accounts at the Foreign Entity and these accounts are used only for monetary policy (maintaining minimum reserve requirements) and financial stability (such as refinancing and deposit operations) purposes. Banking services offered by the Foreign Entity to domestic commercial banks are limited to conducting interbank operations only. The Foreign Entity does not facilitate any commercial payments.
18. Under The Law, the Foreign Entity cannot:

a.    Engage in banking transactions with legal entities and individuals other than persons specified in The Law

b.    Engage in manufacturing, trade, insurance and other commercial activities, except for the cases specified in the The Law, or

c.     Purchase, sell or otherwise acquire full or partial ownership over real estate for purposes other than to sustain its activities, implement commitments before it as well as meet social needs of its staff.

Structure and Accountability:

19. The Foreign Entity is governed by the Management Board, members of which are appointed in accordance with the Constitution of the Foreign Country.
20. The Foreign Entity is solely accountable to the Leader of the Foreign Country.
21. A report is delivered to the Leader on the implementation of major objectives and functions of the Foreign Entity, as well as audited financial statements and reporting operational budget. The Foreign Entity must also report on key directions of the country's monetary policy for the upcoming year.

Sovereign entity group:

22. For the purpose of applying Division 880 of the ITAA 1997 (except in the circumstances outlined in the Fact below), the Foreign Entity is considered to form part of a sovereign entity group as set out in section 880-20 of the ITAA 1997. The Foreign Entity, as the central bank of the Foreign Country, will form part of a sovereign entity group including Entity A (a wholly-owned subsidiary of the Foreign Entity), the Foreign Country and any entities in which the Government of the Foreign Country either directly or indirectly holds 100% of the participation interests.
23. For the purpose of applying subsection 880-105(6) of the ITAA 1997, the Foreign Entity will form part of a sovereign entity group including the Entity A, the Foreign Entity and any entities in which the Government of the Foreign Entity either directly or indirectly holds 50% of the participation interests.

Investment in the Test Entities:

24. The Foreign Entity's investments covered by this ruling consist only of debt interests in Australian commercial banks, which are companies resident in Australia (the Test Entities).
25. The Foreign Entity does not hold an equity interest in the Test Entities.
26. Neither the Foreign Entity, nor any members of its sovereign entity group, has involvement in the day to day management of the business of the Test Entities.
27. Neither the Foreign Entity, nor any members of its sovereign entity group, has the right to appoint a director to the Board of Directors of the Test Entities.
28. Neither the Foreign 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 Test Entities.
29. Neither the Foreign Entity, nor any members of its sovereign entity group, has the ability to direct or influence the operation of the Test Entities outside of the ordinary rights conferred by any debt interest held.
30. Voting rights, if any, of debt interests in the Test Entities held by the Foreign Entity, and any members of its sovereign entity group, do not exceed the proportion of debt interests held by the Foreign Entity and any members of its sovereign entity group.
31. The Foreign Entity's interests in the Test Entities, and the interests of any members of its sovereign entity group, do not provide it or them 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 Entities' operations.
32. The Foreign 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 make decisions that comprise the control and direction of the Test Entities' operations.
33. 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 Foreign Entity or members of the Foreign Entity's sovereign entity group.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 880-105

Reasons for decision

Question 1

Summary

The ordinary and statutory income derived by the Foreign Entity from its Australian debt interests in the Test Entities is not assessable and not exempt income due to the operation of section 880-105 of the ITAA 1997.

Detailed reasoning

Section 880-105 of the ITAA 1997 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 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 Foreign Entity is a covered 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).

These conditions are considered below.

The Foreign 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 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.

A 'foreign government agency' is defined in subsection 995-1(1) of the ITAA 1997 as:

(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 Entity is the Central Bank of the Foreign Country and is a legal entity under public law; it is wholly and exclusively owned by the Foreign Country. The Foreign Country is a body politic of a foreign country.

The Foreign Entity is not an Australian resident, nor is it a resident trust estate for the purposes of Division 6 of Part III of the ITAA 1936.

As such, the Foreign Entity meets the requirements of being a sovereign entity in accordance with section 880-15 of the ITAA 1997 as it is an entity wholly owned by a body politic.

The Foreign Entity 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.

On its creation, the Foreign Entity was handed the assets and liabilities of former state owned entities.

The Foreign Entity has an amount of capital that is determined by The Law, an independent balance sheet, charter fund and other property in its own name. In accordance with the laws of the Foreign Country, the Foreign Entity shall own, use and dispose of the property on its books. In addition, the Foreign Entity is unable to be declared bankrupt and any capital shortfall is covered at the expense of securities issued by the Foreign Country.

The capital of the Foreign Entity consists of its charter fund and capital reserves. The Foreign Entity's capital reserves are formed up from its profits, which are calculated by deducting expenditure from revenue. The revenue of the Foreign Entity is made up of income generated from its activities as the Central Bank and receipts from other sources permitted under The Law. The Foreign Entity's primary source of funds is from the management of reserves and market operations. The Law of the Foreign Entity sets out that it's primary goal shall not be profit making.

Furthermore, The Law prohibits the Foreign Entity from engaging in banking transactions with legal entities and individuals; and manufacturing, trade, insurance and other commercial activities other than those activities permitted by The Law. The Law also prohibits the Foreign Entity from purchasing, selling or otherwise acquiring real estate for purposes other than to sustain its activities.

It is therefore reasonable to conclude that the Foreign Entity is solely funded by public monies and satisfies this requirement.

All returns on the Foreign Entity's investments are public monies

In addition to the Foreign Entity being funded solely by public monies, the monies invested by the Foreign Entity are public monies and all returns on its investments remain public monies. The profit of the Foreign Entity is directed to the formation of capital reserves in the first instance. Following this, a free balance of realised gains is transferred to the state budget of the Foreign Country.

Accordingly, the monies that are invested by the Foreign Entity are and will remain public monies.

Therefore, the Foreign Entity satisfies this requirement.

The Foreign Entity is not a partnership

The Foreign Entity is an autonomous public entity and is not a partnership.

Therefore, the Foreign Entity satisfies this requirement.

The Foreign 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:

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 Foreign Entity does not produce or trade non-financial goods and does not provide non-financial services.

Therefore, the Foreign Entity is not a public non-financial entity.

Subsection 880-130(2) of the ITAA 1997 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) of the ITAA 1997 excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

Paragraph 79 of the LCR 2020/3 lists common examples of public financial entities which includes banks and deposit taking corporations.

As the Foreign Entity is the Central Bank of the Foreign Country and has been created as an autonomous public entity, it is a public financial entity. For the Foreign Entity to be excluded from subparagraph 880-125(d)(ii) of the ITAA 1997 it must be established that, as a public financial entity, it only carries on central banking activities.

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

•         monetary policy development

•         issuing national currency

•         acting as custodian of international reserves, and

•         providing banking services to government.

The primary goal of the Foreign Entity is to ensure price stability within the authorities as defined within

The Law. It is also a goal of the Foreign Entity to organise and ensure the operation of centralised interbank and other unlicensed payments systems, as well as supporting the stability of the banking system.

It is considered that based on the facts and circumstances of this Ruling, the activities of the Foreign Entity are consistent with the Foreign Entity being an entity that only carries on central banking activities. As such, the Foreign Entity passes the condition in paragraph 880-125(d) of the ITAA 1997.

As the Foreign Entity satisfies each of the requirements in paragraphs 880-125(a) through (d) of the ITAA 1997 it 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 Foreign 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 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 Foreign Entity's investment in the Test Entities are debt interests from which the Foreign Entity earns returns in the form of interest, or gains on their disposal.

As such, the Foreign Entity receives amounts which satisfy the requirements of paragraph 880-105(1)(b) of the ITAA 1997.

The Foreign Entity's income is received from Australian resident companies or MITs

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(c) of the ITAA 1997, 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 Entities that the Foreign Entity holds debt interests in are, and will continue to be, Australian resident companies at the time when interest income was/is derived by the Foreign Entity.

As such, the Foreign Entity has received, and will continue to receive, income from entities which satisfy the requirements of paragraph 880-105(1)(c) of the ITAA 1997.

The Foreign Entity'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) 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 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) of the ITAA 1997, 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 of the ITAA 1997 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 Foreign Entity does not hold a membership interest in the Test Entities and therefore satisfies the portfolio interest test.

The Foreign Entity is part of the sovereign entity group of the Foreign Country.

The Commissioner accepts, based on the information provided, that the portfolio interest test is satisfied in this instance.

As such, the requirements of paragraph 880-105(1)(d) of the ITAA 1997 are satisfied.

The Foreign Entity's sovereign entity group did not have influence of a kind described in subsection (6) in relation to the Test Entities at the income time

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(e) of the ITAA 1997, at the income time the sovereign entity group to which the sovereign entity belongs must not have influence over the test entities of a kind described in subsection 880-105(6) of the ITAA 1997.

Subsection 880-105(6) of the ITAA 1997 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).

In determining whether a sovereign entity group has the requisite level of influence, subsection 880-105(7) requires that any breaches of the terms of a debt interest by any entity be ignored.

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

Sub-test 1 is contained in paragraph 880-105(6)(a) of the ITAA 1997 and assesses whether the sovereign entity group is able to directly or indirectly 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 entities' 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 entities.

The Foreign Entity's interests in 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 the Test Entities' operations. Furthermore, its interest, when combined with those of 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 makes decisions that comprise the control and direction of the Test Entities' operations.

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 entities 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 Entities' operations is or was 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.

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 Foreign Entity from its debt interests in the Test Entities are not assessable and not exempt income.

Question 2

Summary

Section 880-110 of the ITAA 1997 operates to deny the Foreign Entity a deduction for any loss it incurs in respect of its debt interests in the Test Entities.

Detailed reasoning

Section 880-110 provides that a sovereign entity cannot deduct an amount if:

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

(b) the amount is a loss in respect of any of the following kinds of interest that the sovereign entity holds in another entity:

...

(ii) a debt interest;

(c) the requirements in paragraphs 880-105(1)(c), (d) and (e) would be satisfied, on the assumptions that:

(i) the amount were ordinary income or statutory income; and

(ii) the amount became ordinary income or statutory income of the sovereign entity at the time it arose; and

(iii) references in those paragraphs to the test entity were references to the other entity mentioned in paragraph (b) of this section.

As established in Question 1, the Foreign Entity:

(a) is covered by section 880-125

(b) holds debt interests in the Test Entities, and

(c) satisfied the requirements in paragraphs 880-105(1)(c), (d) and (e) in relation to ordinary or statutory income that it will derive from the Test Entities.

Therefore, the Foreign Entity cannot deduct an amount if it is a loss in respect of its debt interests in the Test Entities.

Question 3

Summary

Any capital gain or loss made by the Foreign Entity with respect to its investments in the Test Entities will be disregarded under sections 880-115 and 880-120 of the ITAA 1997.

Detailed reasoning

Section 880-115 of the ITAA 1997 provides that a sovereign entity disregards a capital gain from a CGT event that happens in relation to a CGT asset if:

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

(b) the CGT asset is a membership interest, non-share equity interest or debt interest in another entity; and

(c) the requirements in paragraphs 880-105(1)(c), (d) and (e) would be satisfied, on the assumptions that:

(i) the capital gain were an amount of ordinary income or statutory income; and

(ii) the amount mentioned in subparagraph (i) became ordinary income or statutory income of the sovereign entity immediately before the time the CGT event happened; and

(iii) references in those paragraphs to the test entity were references to the other entity mentioned in paragraph (b) of this section.

Section 880-120 of the ITAA 1997 provides that a sovereign entity disregards a capital loss from a CGT event if, on the assumption that the loss were a capital gain, the capital gain would be disregarded because of section 880-115 of the ITAA 1997.

As established in Question 1, the Foreign Entity:

(a) is covered by section 880-125

(b) holds debt interests in the Test Entities, and

(c) satisfied the requirements in paragraphs 880-105(1)(c), (d) and (e) in relation to ordinary or statutory income that it will derive from the Test Entities.

Therefore, the Foreign Entity will be required to disregard any capital gain or loss made in respect of its debt interests in the Test Entities.