Edited version of private advice

Authorisation Number: 1052264259103

Date of advice: 24 June 2024

Ruling

Subject: Sovereign immunity

Question 1

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

Answer

Yes.

Question 2

Will any capital gain from a CGT event that happens in relation to Entity A's investment in Entity B be disregarded under section 880-115 of the of the ITAA 1997?

Answer

Yes.

Question 3

Does paragraph 128B(3)(n) of the Income Tax Assessment Act 1936 (ITAA 1936) (for interest and dividends) and subsection 840-805(9) of the ITAA 1997 (for fund payments from MITs) apply to exclude Entity A from liability to withholding tax on income from Entity B that is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX to Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Entity C

1.     Entity C is a resident in Country A for income tax purposes and is not subject to income tax in Country A.

2.     Entity C is recognised as a government authority in Country A, and Entity C has its own legal personality and an independent budget.

3.     Entity C is attached to the highest decision-making body in Country A.

4.     Entity C is based in Country A and may establish offices abroad.

5.     Entity C has the power to and has established a number of entities that hold Entity C's investments.

6.     Entity C was established with the objective to invest for the future of Country A, in accordance with policies approved by Country A.

7.     Entity C was established using assets assigned to it by Country A. No personal monies of any individual have been contributed to Entity C.

8.     The income generated by Entity C on the investment of Country A's fund, is either reinvested by Entity C or, in cases of emergency expenditures, distributed to Country A's government.

9.     No distributions of income or gains from Entity C have been made or can be made to any person other than the Government of Country A.

10.  Entity C is not established for the principal purpose of funding pensions (including disability or similar benefits) for the citizens of Country A or other contributors of Country A.

Entity A

11.  Entity A is a wholly-owned subsidiary of Entity C that was incorporated in Country B.

12.  Entity A is not subject to income tax in Country A or Country B.

13.  Entity A is a special purpose vehicle established by Entity C and holds Entity C's investment in Entity B, as well as several other investments.

14.  Entity A has not received any funding other than funding from Entity C.

15.  No further equity has been issued to Entity A since this time and Entity A has never held an indirect interest in Entity B.

Entity B

16.  Entity B's Constitution, in its entirety, forms part of the scheme to which this ruling relates.

17.  Entity B was established as a trust allowing investors to benefit from exposure to a portfolio of investments across Australia.

18.  Entity B is an open-ended Australian unit trust that is a registered managed investment scheme and is also a managed investment trust (MIT) for Australian tax purposes.

19.  The beneficial interest in Entity B is divided into units.

20.  The Trustee holds all investments in Entity B as legal owner and all investments must be registered in the name of the Trustee.

21.  Per the Constitution of Entity B, the Trustee has established an Investor Review Committee (IRC) for the purpose of protecting investor rights.

22.  Entity C does not have a right to appoint a member on the Entity B IRC, nor does Entity C have a current member on the Entity B IRC.

23.  The investment in Entity B has been made in accordance with guidelines, principles and is overseen by Entity C's governance members.

24.  Entity C does not hold any other representative memberships in Entity B.

1.     By way of the investment in Entity B, Entity A expects to receive:

•         MIT fund payments

•         capital gains, and

•         returns of capital.

25.  Entity A may also receive interest or dividends in respect of its investment in Entity B.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 840-805(9)

Income Tax Assessment Act 1997 section 880-105

Income Tax Assessment Act 1997 section 880-115

Income Tax Assessment Act 1936 paragraph 128B(3)(n)

Reasons for decision

Question 1

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

Summary

Any ordinary income or statutory income derived by Entity A from its investment in Entity B is not assessable income and is not exempt income of Entity A under subsection 880-105(1) of the ITAA 1997.

Detailed reasoning

Section 880-105 of the ITAA 1997 provides that an amount of ordinary or statutory income that a sovereign entity receives as a return on an interest in another entity is not assessable income and is not exempt income if certain conditions are met. Those conditions are listed in subsection 880-105(1) of the ITAA 1997:

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.

Entity A 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).

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.

Entity C was established with the purpose to develop, invest and manage the reserve funds of Country A. Entity C is officially recognised as a government body of Country A. Further, the policies, strategies and plans implemented by Entity C must be approved by a government body of Country A. Entity C therefore meets the requirements of an agency of a foreign government.

Entity A is a wholly-owned subsidiary of Entity C that was incorporated in Country B. Entity A is not subject to income tax in Country A or Country B. Entity A is a special purpose vehicle established by Entity C and holds Entity C's investment in Entity B, as well as several other investments.

Based on these facts and circumstances, it is accepted that Entity A is an entity in which a foreign government agency holds a total participation interest (as defined by section 960-180 of the ITAA 1997) of 100%.

Entity A 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, Entity A will meet the definition of a 'sovereign entity' by virtue of the operation of paragraph 880-15(c) of the ITAA 1997.

Therefore, this requirement is satisfied.

Entity A is funded solely by public monies

Entity C was established using assets assigned to it by Country A. Additionally, no personal monies of any individual have been contributed to Entity C.

The income generated by Entity C on the investment of Country A's reserve funds is re-invested by Entity C or distributed to the Government of Country A. The funds of Entity C will be withdrawn in limited circumstances as determined by Country A's government. No distributions of income or gains from Entity C have been made or can be made to any person other than the Government of Country A.

In addition, Entity A is a wholly owned subsidiary of Entity C, Entity A is entirely funded by Entity C and the public monies invested by Entity A in Entity B are and will remain the monies of the Government of Country A.

Therefore, this requirement is satisfied.

Entity A is not a partnership

Entity C is recognised as a government authority of Country A, Entity C has its own legal personality and an independent budget and therefore is not a partnership.

Entity A is a wholly owned subsidiary of Entity C and is a special purpose vehicle established by Entity C and holds Entity C's investment in Entity B, as well as several other investments. Entity A is not a partnership.

Therefore, this requirement is satisfied.

Entity A 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.

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.

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.

Entity A is a wholly-owned subsidiary of Entity C that was incorporated in Country B. Entity A is a special purpose vehicle established by Entity C and holds Entity C's investment in Entity B, as well as several other investments.

The investment in Entity B has been made in accordance with Entity C's overarching guidelines, principles.

Therefore, the principal activity of Entity A for the purposes of subsection 880-130(1) of the ITAA 1997 is to invest and manage the funds of Country A. Entity A does not produce or trade non-financial goods and does not provide non-financial services. Therefore, Entity A is not in the business of producing or trading non-financial goods and/or providing non-financial services.

Entity A 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, Entity A is not a public financial entity, nor a public non-financial entity and passes the condition in paragraph 880-125(d) of the ITAA 1997.

As Entity A 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.

Entity A'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) 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 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 for the purposes of paragraph 880-105(1)(b) of the ITAA 1997 will include:

1.    dividends - including non-share dividends and dividends that pass through a 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.

Entity B is an open-ended Australian unit trust that is a registered managed investment scheme and is also a MIT for Australian tax purposes. The beneficial interest in Entity B is divided into units.

By way of the investment in Entity B, Entity A expects to receive:

•         MIT fund payments

•         capital gains, and

•         returns of capital.

Entity A may also receive interest or dividends in respect of its investment in Entity B.

Therefore, Entity A will receive amounts which satisfy the requirements of paragraph 880-105(1)(b) of the ITAA 1997.

Entity A'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;

(ii)   a *managed investment trust in relation to the income year in which the income time occurs...

Entity A directly holds unit interests in Entity B. Entity B is an open-ended Australian unit trust that is a registered managed investment scheme and is also a managed investment trust for Australian tax purposes. It is expected that Entity B will continue to be a managed investment trust in relation to the income years covered by this Ruling when ordinary and statutory income is derived by Entity A.

Therefore, Entity A's income is received from an entity that satisfies the requirements of paragraph 880-105(1)(c) of the ITAA 1997.

Entity A'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 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) 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.

Entity A subscribed for a percentage of units in Entity B. No further equity has been issued to Entity A since this time and Entity A has never held an indirect interest in Entity B.

Entity C does not hold any other representative memberships in Entity B. Further, no other sovereign entities of Country A hold an interest in Entity B. Entity A's interest and, therefore, the collective interest held in the test entity of its sovereign entity group, is less than 10%.

Entity A and its sovereign entity group collectively held less than 10% interest in 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.

Therefore, Entity A's interest in Entity B satisfies the requirements of paragraph 880-105(1)(d) of the ITAA 1997.

Entity A's sovereign entity group does not have influence of a kind described in subsection 880-105(6) of the ITAA 1997

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 entity 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).

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 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.

Entity A's sovereign entity group (including any entity directly or indirectly owned by Country A) collectively hold less than 10% interest in Entity B. Entity A, nor any member of its sovereign entity group, does not hold rights to appoint a director to the Board of Directors nor the right to representation on any investor representative or advisory committee (or similar) of Entity B.

Entity A's interest of less than 10% 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 Entity B's operations.

In addition, Entity A's interest holding does not provide Entity A or the sovereign entity group with the right to approve or veto decisions which contribute to the control or direction of Entity B.

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.

Entity A has no involvement in the day to day management of the business of Entity B. Entity A has no right to appoint a director to the Board of Directors nor the right to representation on any investor representative or advisory committee (or similar) of Entity B.

Entity A has no ability to exert actual or potential influence over the operations or investments of Entity B outside of the ordinary rights conferred by the interest held.

Therefore, no person involved in the control and direction of Entity B's operations are accustomed or obliged to act in accordance with the directions, instructions or wishes of Entity A.

Based on the above, the sovereign entity group of Entity A does not have influence of a kind described in subsection 880-105(6) of the ITAA 1997. Therefore, Entity A satisfies the requirements of paragraph 880-105(1)(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 Entity A from its investment in Entity B is not assessable income and is not exempt income.

Question 2

Will any capital gain from a CGT event that happens in relation to Entity A's investment in Entity B be disregarded under section 880-115 of the of the ITAA 1997?

Summary

Any capital gain arising to Entity A in respect of its investment in Entity B will be disregarded under subsection 880-115 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.

As established in Question 1, Entity A:

a)    is covered by section 880-125 of the ITAA 1997

b)    holds membership interests in the test entity, and

c)    satisfies the requirements in paragraphs 880-105(1)(c), (d) and (e) of the ITAA 1997 in relation to ordinary or statutory income that it will derive from the test entity.

Therefore, Entity A will disregard any capital gain made in respect of its ownership interests in the test entity, by virtue of the operation of section 880-115 of the ITAA 1997.

Question 3

Does paragraph 128B(3)(n) of the ITAA 1936 (for interest and dividends) and subsection 840-805(9) of the ITAA 1997 (for fund payments from MITs) apply to exclude Entity A from liability to withholding tax on income from Entity B that is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997?

Summary

Entity A is excluded from liability to withholding tax on income from Entity B that is non-assessable non-exempt income under Division 880 of the ITAA 1997 due to paragraph 128B(3)(n) of the ITAA 1936 and subsection 840-805(9) of the ITAA 1997in relation to the respective types of income.

Detailed reasoning

Section 128B of the ITAA 1936 imposes liability to withholding tax on income derived by a non-resident that consists of dividend income (subsection 128B(1) of the ITAA 1936), interest income (subsection 128B(2) of the ITAA 1936) as well as other income prescribed in that section.

Subsection 128B(3) of the ITAA 1936 notes that section 128B of the ITAA 1936 will not apply to prescribed categories of income. Relevantly, paragraph 128B(3)(n) of the ITAA 1936 states that this includes income that is non-assessable non-exempt income because of Division 880 of the ITAA 1997 or Division 880 of the Income Tax (Transitional Provisions) Act 1997 (IT(PA)A 1997).

As established in Question 1, the ordinary and statutory income derived by Entity A as a return on the units it owns in Entity B is non-assessable non-exempt income under Division 880 of the ITAA 1997.

Therefore, Entity A is excluded from liability to withholding tax on its interest and/or dividend income in respect of this investment under paragraph 128B(3)(n) of the ITAA 1936.

Exclusion under subsection 840-805(9) of the ITAA 1997

Subsection 840-805(1) of the ITAA 1997 imposes a liability for MIT withholding tax on amounts paid to in accordance with subsections 840-805(2), (3) and (4) of the ITAA 1997.

Subsection 840-805(9) of the ITAA 1997 provides that subsections 840-805(2), (3) and (4) of the ITAA 1997 do not apply to you if the payments made relate to an amount that is non-assessable non-exempt income because of:

a)    Division 880 of the ITAA 1997, or

b)    Division 880 of the IT(TP)A 1997.

The income derived by Entity A as a return on the units it holds in Entity B is non-assessable non-exempt income under Division 880 of the ITAA 1997.

Therefore, Entity A is excluded from liability to withholding tax on amounts it receives under subsections 840-805(2), (3) and (4) of the ITAA 1997 in accordance with subsection 840-805(9) of the ITAA 1997.