Edited version of private advice

Authorisation Number: 1052265763304

Date of advice: 1 July 2024

Ruling

Subject: Sovereign immunity

Question 1

Is the ordinary and statutory income derived by ForeignCo from its interests in the Test not assessable and not exempt income under section 880-105 of the ITAA 1997?

Answer

Yes.

Question 2

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

Answer

Yes.

Question 3

Does paragraph 128B(3)(n) of the ITAA 1936 apply to exclude ForeignCo from liability to withholding tax on income that is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997?

Answer

Yes.

Question 4

Does subsection 840-805(9) of the ITAA 1997 apply to exclude ForeignCo from liability to withholding tax on income 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 period:

1 July 20xx to #0 June 20yy

The scheme commenced on:

1 July 20xx

Relevant facts and circumstances

ForeignCo

1. ForeignCo is a public institution owned, established and supervised by the Government of Country X (the Government)
2. ForeignCo is established as an investment authority for the Government.
3. ForeignCo is located in Country X.
4. ForeignCo's objective to undertake, in the name and for the account of the Government, the management of Country X's Fund A as well as such other monies that the Government may entrust ForeignCo with its management.
5. ForeignCo also manages Fund B, which cannot change from Country X's ownership.
6. Funds A and B are separate allocations of Country X's funds. None of the funds are legal entities in their own right but are special purpose accounts of Country X.
7. ForeignCo's assets do not change from Country X's ownership.
8. ForeignCo is funded solely by monies of the Government.
9. ForeignCo carries out its investment program independently and without reference to the Government or other entities that also invest funds on the Government's behalf.
10. ForeignCo is administered by the Board of Directors.
11. ForeignCo is managing assets on Country X's behalf. The costs of running ForeignCo are paid by an annual budget. There is no equity in ForeignCo (it does not have a balance sheet) therefore it cannot be dissolved or liquidated.
12. Any government monies allocated to ForeignCo to manage, or income received by ForeignCo as result of managing the monies, are ultimately owned by Country X.
13. ForeignCo is not a partnership.
14. ForeignCo is not a resident of Australia for Australian income tax purposes. ForeignCo does not have an Australian tax file number, maintain an office or engage in any trade or business in Australia.
15. ForeignCo is excluded from all tax laws in Country X.
16. ForeignCo is not a resident trust estate for the purposes of Division 6 of Part III of the ITAA 1936.
17. ForeignCo is not in the business of trading in equity and debt securities with the intent of deriving profits from the buying and selling of securities.

Australian investments

17. ForeignCo's investment decisions are based solely on economic objectives, including delivering long-term returns in excess of its composite benchmarks.
18. ForeignCo currently holds a number of direct equity investments in Australia including interests in Australian listed companies or Managed Investment Trusts (MITs). ForeignCo also directly holds debt investments.
19. The equity interests held by ForeignCo are all in Australian resident companies or MITs.
20. The equity interests held by ForeignCo all have the following characteristics:

a)    All securities are listed on the Australian Securities Exchange ('ASX') or another recognised stock exchange

b)    ForeignCo and all members of its sovereign entity group, to the best of its knowledge, hold collectively less than 10% of the total participation interests in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997.

c)    Neither ForeignCo, nor any members of its sovereign entity group, to the best of its knowledge, has any involvement in the day to day management of the Test Entity

d)    Neither ForeignCo, nor any members of its sovereign entity group, to the best of its knowledge, has any right to representation on the board of directors of any of the Test Entities

e)    Neither ForeignCo, nor any members of its sovereign entity group, to the best of its knowledge, has any right to representation on any investor representative or advisory committee (or similar) of any Test Entity, and

f)     Neither ForeignCo, nor any members of its sovereign entity group, to the best of its knowledge, has the ability to direct or influence the operation of the Test Entities outside of the ordinary rights conferred by the interest held;

g)    ForeignCo'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;

h)    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 ForeignCo or members of ForeignCo's sovereign entity group.

21. The debt investments ForeignCo hold, which are listed in Appendix 2, are bonds issued by ASX listed entities.
22. These debt interests that ForeignCo hold in Australian Test Entities have the following characteristics:

a)    The debt securities provide no rights to representation, no voting rights, and no ability to influence the Test Entity

b)    The debt securities have broad financial covenants, and do not allow ForeignCo or its sovereign entity group, to the best of its knowledge, to have any influence or control over the debt issuer's management. The covenants are in accordance with industry standard

c)    The debt securities do not provide any right or option for conversion to equity at any time, and

d)    The debt interests do not otherwise give ForeignCo or its sovereign entity group, to the best of its knowledge, any other influence in the Test Entities potentially of a kind described in subsection 880-105(6) of the ITAA 1997.

23. ForeignCo is currently in receipt of the following types of Australian source income:

a)    Interest income

b)    Franked dividend income

c)    Unfranked dividend income

d)    MIT income, and

e)    Australian sourced capital gains income.

Relevant legislative provisions

Income Tax Assessment Act 1997, Division 880

Reasons for decision

All provisions refer to the Income Tax Assessment Act 1997 unless stated otherwise.

Question1

Is the ordinary and statutory income derived by ForeignCo from its interests in the Test Entities not assessable and not exempt income under section 880-105 of the ITAA 1997?

Summary

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

Detailed reasoning

Section 880-105 provides that amounts of ordinary and statutory income derived by a sovereign entity are not assessable and not exempt income if certain conditions are met. The 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.

ForeignCo 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.

ForeignCo 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.

A 'foreign government agency' is defined in subsection 995-1(1) 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.

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 an independent sovereign state. The Government constitutes a body politic of a foreign country.

ForeignCo is the Government's investment authority. ForeignCo is an independent legal entity that acts autonomously in attaining its objectives, discharging its functions and exercising its powers. It is wholly-owned and supervised by the Government.

It is considered that ForeignCo:

•         is the investment authority of part of a foreign country

•         is supervised by the Government

•         was established by, capitalised, and funded by the Government

•         has its primary objective as managing the investment of Country X's Funds A and B in the name and account of the Government and also other funds entrusted for ForeignCo's management by the Government, and

•         is not an Australian resident or a resident trust estate.

Therefore, ForeignCo meets the requirements of being a sovereign entity as defined in subsection 880-15.

ForeignCo is funded solely by public monies

The phrase 'public monies' is not defined and as such takes its ordinary meaning. In the context of Division 880, this phrase essentially means monies raised by a foreign government (or part of a foreign government) for a public purpose which form part of the foreign government's (or part of the foreign government's) equivalent to Australia's Consolidated Revenue Fund (Roy Morgan Research Pty Ltd v FC of T & Anor [2011] HCA 35). This would ordinarily include general tax revenue, proceeds from the issue of government bonds, the proceeds of privatisations etc.

ForeignCo's primary objective is to undertake, in the name and for the account of the Government, the management of Funds A and B as well as such other monies that the Government may entrust ForeignCo with its management.

As such, ForeignCo is funded solely by public monies.

All returns on ForeignCo's investments are public monies

ForeignCo manages and administers the Government's investments.

Any monies given to ForeignCo, or income made by ForeignCo, are ultimately owned by the Government.

ForeignCo is managing assets on behalf of Country X. There is no equity in ForeignCo (it does not have a balance sheet) therefore it cannot be dissolved or liquidated.

Therefore, all returns on ForeignCo's investments are public monies.

ForeignCo is not a public non-financial or 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.

Is ForeignCo a public non-financial entity?

The Law Companion Ruling 2020/3 The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2020/3) provides that a public non-financial entity is determined by:

76. Whether an entity is producing or trading non-financial goods and/or providing services that are not financial services is a question of fact...

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

Is ForeignCo a public financial entity?

ForeignCo was established to be a sovereign wealth fund so the Government can provide for Country X's current and future welfare. All monies and income received by ForeignCo are ultimately returned to the Government for this purpose.

A genuine sovereign wealth fund like ForeignCo does not trade in financial assets and liabilities but rather to benefit the obligations owed to a foreign government.

Whether ForeignCo operates commercially in the financial market above requires an examination of its principal purpose. ForeignCo manages the Government's investments - it does not act as a business or in a commercial manner when acting on behalf of the Government.

As a sovereign wealth fund, it is not a public financial entity that charges an economically significant price for its principal activities.

Based on the circumstances, the Commissioner accepts that ForeignCo is neither a public non-financial entity or public financial entity under subsection 880-130(2), being a part of Country X and not engaging in the relevant activities outlined in subsection 880-130(1) or paragraph 880-130(2).

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

ForeignCo's return is received on a relevant interest in the Test Entities

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(b), it must be a 'return on' a membership interest, debt interest or non-share equity interest held by the sovereign entity in the test entities.

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) 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.

ForeignCo invests in the Test Entities, which are Australian resident companies or MITs. ForeignCo holds both shares and debt interests in the Test Entities. ForeignCo receives income from these interests.

As such, ForeignCo will receive amounts which satisfy the requirements of paragraph 880-105(1)(b).

ForeignCo'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.

As previously outlined, the Test Entities from which ForeignCo derives its ordinary and statutory income are all Australian resident companies or MITs.

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

ForeignCo sovereign entity group satisfies the portfolio interest test

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(d), the sovereign entity and the sovereign entity group to which it belongs must satisfy the portfolio interest test in relation to the test entity/ies 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.

ForeignCo's sovereign entity group consists of all entities that are wholly owned by Country X.

With respect to the equity interests in the Test Entities, ForeignCo holds significantly less than 10% of the participation interests in the Test Entity. To the best of ForeignCo's knowledge, its sovereign entity group as a whole holds less than 10% of the participation interests in the Test Entity.

As such, ForeignCo's sovereign entity group satisfies the requirements of paragraph 880-105(d) with respect to each Test Entity.

ForeignCo's sovereign entity group does not have influence of a kind described in subsection (6)

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

Subsection 880-105(6) states:

A *sovereign entity group has influence of a kind described in this subsection in relation to the test entity at 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.

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.

ForeignCo's interests in the Test Entities, to the best of its knowledge, 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, ForeignCo's interests, when combined with the other interests held by members of 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 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 ForeignCo or members of ForeignCo's sovereign entity group.

Based upon the above, the sovereign entity group of ForeignCo does not have influence of a kind described in subsection 880-105(6) and, therefore, satisfies the requirements of paragraph 880-105(1)(f).

Conclusion

As all of the conditions listed in subsection 880-105(1) have been satisfied, section 880-105 will apply such that amounts of ordinary and statutory income derived by ForeignCo from its investments in the Test Entities is not assessable and not exempt income.

Question 2

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

Summary

ForeignCo may disregard any capital gain or loss made in respect of its interests in the Test Entities.

Detailed Reasoning

Section 880-115 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 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.

As established in Question 1, ForeignCo:

(a)  is covered by section 880-125

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

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

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

Question 3

Does paragraph 128B(3)(n) of the ITAA 1936 apply to exclude ForeignCo from liability to withholding tax on income that is non-assessable non-exempt income due to the operation of Division 880?

Summary

Paragraph 128B(3)(n) of the ITAA 1936 applies to exclude ForeignCo from liability to withholding tax on income that is non-assessable non-exempt income due to the operation of Division 880.

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

As established in Question 1, the ordinary and statutory income derived by ForeignCo as a return on its investments in the Test Entities is considered non-assessable non-exempt income under Division 880.

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

Question 4

Does subsection 840-805(9) apply to exclude ForeignCo from liability to withholding tax on income that is non-assessable non-exempt income due to the operation of Division 880?

Summary

Subsection 840-805(9) applies to exclude ForeignCo from liability to withholding tax on income that is non-assessable non-exempt income due to the operation of Division 880.

Detailed Reasoning

Exclusion under subsection 840-805(9)

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

Subsection 840-805(9) applies to exclude liability to withholding tax if the payments made relate to an amount that is non-assessable non-exempt income because of:

(a) Division 880, or

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

The income derived by ForeignCo as a return on its interests in the Test Entities is considered non-assessable non-exempt income under Division 880.

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