Edited version of private advice

Authorisation Number: 1052276577445

Date of advice: 17 July 2024

Ruling

Subject: Sovereign immunity

Question

Is the ordinary and statutory income derived by The Bank from its interests in the Test Entities 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 period:

1 July 20XX to 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Overview:

1.     The Bank is the Central Bank of the Foreign Country, established by statute as a body corporate with perpetual succession and continues to exist under the Act. The Bank is wholly owned by the Government of the Foreign Country (Foreign Government).

2.     The principal objectives of The Bank are to promote monetary stability and financial stability conducive to the sustainable growth of the economy.

3.     In promoting monetary stability, The Bank pursues a monetary policy which serves the interests of the Foreign Country with the primary objective of maintaining price stability.

4.     The Bank acts as banker and financial agent to the Foreign Government, and in doing so keeps account of Government moneys that it receives and disburses. The Bank may also undertake the issue and management of securities, Treasury Bills and other financial instruments issued by the Foreign Government.

5.     The Board is responsible for the general administration and business of The Bank, including approval of the budget and operation plan. The Board also have oversight of the management of The Bank and review its performance.

6.     In accordance with the policies and guidelines established by The Board, The Bank shall hold and manage the foreign reserves for the purpose of giving effect to its objects and carrying out its functions under the Act.

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

Funding:

8.     The Bank has paid up capital which is wholly owned by the Foreign Government.

9.     The Bank has a General Reserve Fund.

10.  At the end of each financial year, the net profit of The Bank is determined after allowing for the expenses of operations in giving effect to its objects, carrying out its functions and conducting its business or affairs. The Bank may transfer any amount from the net profit to any reserve as The Board deems prudent or necessary.

11.  Any income or gain earned by The Bank as part of the mandates in managing the Foreign Country's foreign reserves will also increase the foreign reserves amount and will be reinvested.

12.  The net profit of The Bank less any unrealised gains and after approved transfers shall be dealt with as follows:

a.    such amount as determined by relevant authorities will be placed to the credit of the General Reserve Fund, and

b.    the remainder is to be paid to the Government of the Foreign Country.

Functions of The Bank:

13.  The primary functions of The Bank include to:

a.    formulate and conduct monetary policy

b.    issue currency

c.     regulate and supervise financial institutions

14.  The Bank may undertake a range of activities so long as it is consistent with its objects, functions and provisions of the Act.

15.  Except where permitted, The Bank may not:

a.    engage in trade or otherwise have a direct interest in any commercial, agricultural, industrial or any other undertaking except in the course of satisfaction of debts due to The Bank provided that any such interest shall be disposed of at the earliest suitable opportunity

b.    provide financing upon security of any shares

c.     purchase the shares of any corporation

d.    extend unsecured financing or financing secured otherwise than as set out in the Act

e.    draw or accept bills payable otherwise than on demand; or

f.      accept for discount, or as security for any financing extended by The Bank, bills or notes signed by members of The Board or by officers or employees of The Bank.

Sovereign entity group:

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

17.  For the purpose of applying subsection 880-105(6) of the ITAA 1997, The Bank will form part of a sovereign entity group including the Foreign Country and any entities in which the Foreign Government either directly or indirectly holds 50% of the participation interests.

Investment in the Test Entities:

18.  The Bank holds its Australian investments in the Test Entities directly and is the beneficial owner of these investments.

19.  The Bank holds a membership interest in the Test Entities and earns returns in the form of dividends and/or fund payments and/or interest.

20.  The Australian investments held by The Bank have the following characteristics:

a.     The Bank, and its sovereign entity group, hold less than 10% of the total participation interests in each of the Test Entities.

b.     Each of the Test Entities are listed on the ASX.

c.     The Bank, and its sovereign entity group, holds less than 10% of the total participation interests in the Test Entities in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997.

d.     Neither The Bank, nor any members of its sovereign entity group, has involvement in the day-to-day management of the business of any of the Test Entities.

e.     Neither The Bank, nor any members of its sovereign entity group, has the right to appoint a director to the Board of Directors of any of the Test Entities.

f.      Neither The Bank, 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.

g.     Neither The Bank, 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 the equity interest held.

h.     Voting rights of the membership interests in the Test Entities held by The Bank, and any members of its sovereign entity group, do not exceed the proportion of equity interests held by The Bank and any members of its sovereign entity group.

i.      The Bank's interests in the Test Entities, and any interests of any member of 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.

j.      The Bank's interests, when combined with 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.

k.     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 Bank or members of The Bank's sovereign entity group.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 880-105

Reasons for decision

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. 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.

*Denotes a term defined in subsection 995-1(1).

These conditions are considered below.

The Bank is a covered sovereign entity

Section 880-125 states:

A *sovereign entity is covered by this section if it satisfies all of the following requirements:

(a) the entity is funded solely by public monies;

(b) all returns on the entity's investments are public monies;

(c) the entity is not a partnership;

(d) the entity is not any of the following:

(i) a *public non-financial entity;

(ii) a *public financial entity (other than a public financial entity that only carries on central banking activities).

These conditions are considered below.

The Bank is a sovereign entity

For an entity to be covered by section 880-125, it must be a sovereign entity.

Section 880-15 defines a sovereign entity to be any of the following:

(a) a body politic of a foreign country, or a part of a foreign country;

(b) a *foreign government agency;

(c) an entity:

(i) in which an entity covered by paragraph (a) or (b) holds a *total participation interest of 100%; and

(ii) that is not an Australian resident; and

(iii) that is not a resident trust estate for the purposes of Division 6 of Part III of the Income Tax Assessment Act 1936.

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.

*Denotes a term defined in subsection 995-1(1).

The Bank is a body corporate that is the Central Bank of the Foreign Country. The Bank is wholly and exclusively owned by the Foreign Government. The Foreign Government is a body politic of a foreign country.

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

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

The Bank is funded solely by public monies

Law Companion Ruling LCR 2020/3 - The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2020/3) provides guidance on the term 'public monies'.

In the context of Division 880, 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 paid-up capital of The Bank is wholly owned by the Foreign Government.

The Bank also manages all of the Foreign Country's foreign reserves. The income and gains earned by The Bank are either used to increase the foreign reserves of the Foreign Country or reinvested.

The income derived by The Bank from its investments in the Test Entities (which may be used for re-investment purposes) is also wholly owned by the Foreign Government. Therefore, The Bank is funded solely by public monies.

All returns on The Bank's investments are public monies

As a wholly owned entity of the Foreign Government, and manager of the Foreign Country foreign reserves, all distributions made by The Bank, as funded by the returns on its investments, are received by the Foreign Country.

The net profit of The Bank less any unrealised gains and after transfers from the General Reserve Fund to any contingency reserve, fluctuation reserve or such other reserve as the Board deems prudent or necessary are placed to the credit of the General Reserve Fund and the remainder are paid to the Foreign Government.

Accordingly, all returns on The Bank's investments are public monies.

The Bank is not a partnership

The Bank was established as a body corporate and continues to exist under the Act and is not a partnership.

Therefore, The Bank satisfies this requirement.

The Bank is not a public non-financial entity or public financial entity

Subsection 880-130(1) defines the term public non-financial entity:

An entity is a public non-financial entity if its principal activity is either or both of the following:

(a) producing or trading non-financial goods;

(b) providing services that are not financial services.

The Bank does not produce or trade non-financial goods and does not provide non-financial services as its principal activity.

Therefore, The Bank is not a public non-financial entity.

Subsection 880-130(2) defines the term public financial entity:

An entity is a public financial entity if any of the following requirements are satisfied:

(a) it trades in financial assets and liabilities;

(b) it operates commercially in the financial markets;

(c) its principal activities include providing any of the following financial services:

(i) financial intermediary services, including deposit-taking and insurance services;

(ii) financial auxiliary services, including brokerage, foreign exchange and investment management services;

(iii) capital financial institution services, including financial services in relation to assets or liabilities that are not available on open financial markets.

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

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

As The Bank is the Central Bank of the Foreign Country it is a public financial entity. For The Bank to be excluded from subparagraph 880-125(d)(ii) it must be established that The Bank, as a public financial entity, 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 principal objectives of The Bank are to promote monetary stability and financial stability conducive to the sustainable growth of the Foreign Country's economy.

It is considered that the activities undertaken by The Bank in accordance with the Act are consistent with The Bank being an entity that only carries on central banking activities. Accordingly, The Bank passes the condition in paragraph 880-125(d).

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

The Bank's return is received on a relevant interest in the Test 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, 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 Test Entities are entities of which The Bank holds a membership interest in and earns returns in the form of dividends and/or fund payments and/or interest.

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

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

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(c), it must be received from an entity that is either:

(i) a company that is an Australian resident at the time (the income time) when the amount becomes ordinary or statutory income of the sovereign entity; or

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

The income received by The Bank from its membership interests in the Test Entities is received from Australian resident companies or managed investment trusts at the relevant times.

As such, The Bank receives income from entities which satisfy the requirements of paragraph 880-105(1)(c).

The Bank's sovereign entity group satisfies the portfolio interest test

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(d), the sovereign entity and the sovereign entity group to which it belongs must satisfy the portfolio interest test in relation to the test entities at both the income time and throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time.

The portfolio interest test is outlined in subsection 880-105(4), which states:

A *sovereign entity group satisfies the portfolio interest test in this subsection in relation to the test entity at a time if, at that time, the sum of the *total participation interests that each *member of the group holds in the test entity:

(a)  is less than 10%; and

(b)  would be less than 10% if, in working out the *direct participation interest that any entity holds in a company:

(i) an *equity holder were treated as a shareholder; and

(ii) the total amount contributed to the company in respect of *non-share equity interests were included in the total paid-up share capital of the company.

Section 880-20 provides the definition of sovereign entity group. Broadly, sovereign entities of the same foreign government will be members of the same sovereign entity group and sovereign entities of the same part of a foreign government will be members of the same sovereign entity group.

The Bank holds a less than a 1% membership interest in each of the Test Entities and therefore satisfies the portfolio interest test.

The Bank is part of the sovereign entity group of the Foreign Government. As membership interests held in the Test Entities are in Australian resident companies or managed investment trusts publicly traded on the ASX the risk of any other members of The Bank's sovereign entity group collectively holding a membership interest of 10% or more in the Test Entities is extremely low and it is highly unlikely that the portfolio interest test would be failed in the circumstances. Therefore, the Commissioner accepts that the portfolio interest test is satisfied in this instance.

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

The Bank's sovereign entity group does not have influence of a kind described in subsection 880-105(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), 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).

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).

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) 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 Bank'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, The Bank's 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), 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.

Neither The Bank nor its sovereign entity group have the right to appoint a director to the Board of Directors of the Test Entities. They also do not have any involvement in the day-to-day management of the Test Entities, or any right to representation on any advisory committee. The Bank only holds rights to vote in proportion to its equity interest in each Test Entity.

Based on the above, The Bank, or its sovereign entity group, does not have influence of a kind described in subsection 880-105(6) and will therefore satisfy the requirements of paragraph 880-105(1)(e).

Conclusion

As all 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 The Bank from its membership interests in the Test Entities are not assessable and not exempt income.