Edited version of private advice

Authorisation Number: 1052279800649

Date of advice: 23 July 2024

Ruling

Subject: Sovereign immunity

Question 1

Is the ordinary and statutory income derived by the Bank from its interests in the investments not assessable 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 Bank a deduction for any loss it incurs in respect of its interests in the Test Entities?

Answer

Yes.

Question 3

Is any capital gain or capital loss made by the Bank with respect to its 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 20yy

The scheme commenced on:

1 July 20xx

Relevant facts and circumstances

The Bank

1. The Bank is responsible for the management of the Country X's reserves, it supervises monetary and financial operations according to terms established in regulatory statutes and advises on monetary policies.

2. The Bank acts as the central bank of Country X.

3. The Bank is governed by the Rules.

4. The Bank is subject to the Head of State's guidance.

5. The Bank is a public-law legal person with administrative and financial autonomy.

6. The Bank's head office is in Country X.

7. The Rules stipulate the following responsibilities of the Bank:

a.            advise and support the Head of State in the formulation and conduct of the monetary, financial, exchange-rate, and insurance policies, by reporting and issuing opinions on the maters referred for its consideration.

b.            study and propose the measures required for the execution for the monetary, financial, exchange-rate and insurance policies and provide for their enforcement

c.            guide, coordinate and inspect the money, financial, foreign-exchange and insurance markets, providing for their smooth operation and supervising the relevant operators, in accordance with the Rules and the regulations applying to those activities.

d.            watch over the internal monetary stability and the external solvency of the local currency, ensuring its full convertibility within the context of the monetary, financial and exchange-rate policies.

e.            act as central depository and manager of foreign-exchange reserves, gold and other foreign assets.

f.            act as intermediary in the monetary and financial external relations of Country X.

g.            provide for the stability of the financial system, performing for this purpose the duty of lender of last resort, and

h.            carry out all other functions conferred upon by law.

8. For the supervisory role of the Bank, it is within its supervisory powers to guide, coordinate, monitor and supervise the money, financial, foreign-exchange and insurance markets of Country X. Its supervisory responsibilities include, but are not limited to:

a.            analysing applications of establishment of any persons or entities who wish to operate on the money, financial, foreign-exchange or insurance markets.

b.            analysing applications for amendments in licensing of these organisations or terminating activity of licensed operators.

c.            keeping registers of which licenced operators are subject under the regulations governing the activities concerned.

d.            set, and check compliance with, all the prudential ratios which licenced entities shall observe in order to ensure their liquidity and solvency.

9. With regard to the Bank's functions as a central depository and manager of foreign-exchange reserves, it has the following responsibilities:

a.            managing and ensuring full convertibility of the local currency, Country X's foreign assets.

b.            receiving and managing the cover of the currency issue.

c.            acquiring the foreign currency received by the Country X, public services and autonomous entities, as well as by concessionaries and other entities, whenever, under the law or the relevant contracts, they are under the obligations to deliver it.

10. The Bank may, amongst other things, make investments, open deposit accounts and buy and sell in foreign currencies, gold, securities and other instruments and assets usually traded on international money and financial markets. As well as carry out any other operation necessary for the performance of the function of the exchange of reserve management, namely short-term loans.

Exchange Reserve, Funding & Income

11. The exchange reserve is made up of the Bank assets denominated in freely convertible currencies and of other eligible assets according to law, contract or authorisation from the Head of State, even if held or managed by other entities.

12. The Bank's assets are made of the universality of property and rights, assets and liabilities, which it holds, receives or acquires for or in the exercise of its powers and functions.

13. The Bank's assets and financial management, effected through the implementation of its approved private plans and budgets, is governed by the corresponding regulations or the rules and of the internal regulations.

14. The private budgets are approved by decision from the Head of State and officially published, being part of the Country X general budget.

15. The Government of Country X provided the Bank's original funds to perform the functions of a central treasury depository and manage the territories currency reserves. However, as it has financial autonomy, it is now a self-funded entity.

16. The Bank has the following sources of income:

a.            the return on its assets and the proceeds from their disposal

b.            the earning from its operations and investments

c.            the fees paid by the entities subject to its supervision

d.            the earnings from the marketing and commemorative coins

e.            the fines enforced in proceedings of infringement to the legal provisions and regulations governing the areas falling under its competence

f.            the gifts, endowments, bequests or legacies that it may come to receive

g.            other income payable or assigned to it by law, regulation, contract, court or Head of State's decision.

17. Any profit made by the Bank is appropriated as approved by the Head of State.

18. A portion of the net revenue is distributed annually to the Government of Country X with the remainder to be incorporated into the accounts of the Bank.

Management

19. The Bank is overseen by a Board of Directors, a Supervisory Board and an Advisory Board.

20. The Board supervises all the Bank's activities. The Board also manages the assets of the Bank as well as approves internal regulations and submits these to the Head of State for approval.

Investment Activities of the Bank

21. The Bank has invested in Australian investments comprising of equity investments and debt securities, including those investments listed on the Australian Securities Exchange (ASX). These investments have the following characteristics:

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

b.             The Bank, and to the best of the Bank's knowledge, its sovereign entity group would hold collectively 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.

c.             Neither the Bank, and to the best of the Bank's knowledge, 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.

d.             Neither the Bank, and to the best of the Bank's knowledge, 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.

e.             Neither the Bank, and to the best of the Bank's knowledge, 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.

f.             Neither the Bank, and to the best of the Bank's knowledge, 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.

g.             The Bank only holds rights to vote in proportion to its equity interest in each investment.

h.             The Bank'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 make decisions that comprise the control and direction of the Test Entities' operations.

i.             The Bank's interests, and, to the best of the Bank's knowledge, 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.

j.             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, to the best of the Bank's knowledge, members of the Bank's sovereign entity group.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 880

Reasons for decision

Question 1

Is the ordinary and statutory income derived by the Bank from its interests in the investments not assessable and not exempt income under section 880-105 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

The ordinary and statutory income derived by the Bank from its interests in the investments is not assessable and not exempt income under 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 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.

Section 960-180 provides that an entity's total participation 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.

The Bank is the XXXX bank of Country X. The Bank acts as a XXXXl depository and manager of foreign exchange reserves, gold and other foreign assets and acts as a lender of last resort. The Bank guides, coordinates and inspect the money, financial, foreign-exchange and insurance markets as well as watches over the international monetary stability and the external solvency of local currency.

The Bank is a public law legal person with administrative and financial autonomy that will continue to report to the Head of State of Country X.

As the Bank is a central bank and is accountable to the Head of State of Country X, the Bank is considered to be an agency of a foreign government.

Therefore, the Bank is a sovereign entity.

The Bank 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] HC 35). This would ordinarily include general tax revenue, proceeds from the issue of government bonds, the proceeds of privatisations etc.

The Government of Country X provided the Bank's original funds to perform the functions of a central treasury depository and manage the territory's currency reserves. As the Bank is a public law legal person with administrative and financial autonomy with the status of a personalised public service, it is a now self-funded entity.

The Bank's sources of income are:

•         the return on its assets and the proceeds of their disposal

•         the earnings from its operations and investments

•         the fees paid by the entities subject to its supervision

•         the earnings from the marketing of commemorative coins

•         the fines enforced in proceedings of infringement to the legal provisions and regulations governing the areas falling under its competence

•         the gifts, endowments, bequests or legacies that may come to receive

•         other income payable or assigned to it by law, regulation, contract, court or Head of State's decision.

As such, the Bank is funded solely by public monies.

All returns of the Bank's investments are public monies

The net profit for each fiscal year is appropriated as approved by the Head of State.

The appropriation of revenues is disbursed by the Government of Country X or otherwise retained by the Bank.

As such, all returns on the Bank's investments are public monies.

The Bank is not a partnership

The Bank is a public law legal person with administrative and financial autonomy, and the status of a personalised public service.

The Bank is not a partnership. As such, it passes this condition.

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.

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.

As previously noted, the Bank acts as the central bank of Country X. The Bank satisfies the definition of a public financial entity provided for in subsection 880-130(2). However, 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 81 of Law Companion Ruling LCR 2020/3 The superannuation fund for foreign residents withholding tax exemption and sovereign immunity (LCR 2020/3) lists the following as being considered 'central banking activities':

•        monetary policy development

•        issuing national currency

•        acting as custodian of international reserves, and

•        providing baking services to government.

It is considered that the activities of the Bank listed in the Scheme description of this ruling are consistent with the Bank being a public financial entity that only carries on central banking activities. As such, the Bank satisfies the condition in paragraph 880-125(d) of the ITAA 1997.

As the Bank has met each of the requirements in paragraphs 880-125(a) to (d) of the ITAA 1997, 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 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 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 Bank holds either shares and/or units in each of the Test Entities (which meet the requirements of being membership interests as defined by the interaction of sections 960-135 and 960-130). The test entities are entities of which the Bank holds a membership interest and earns returns in the form of fund payments and/or dividends and/or interest. The Bank also hold debt interests in Australian entities from which a 'return on' would be provided.

As such, 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 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.

The Test Entities are Australian resident companies or managed investment trusts at the relevant times.

As such, the Bank's income is received from entities which satisfy the requirements of paragraph 880-105(c) of the ITAA 1997.

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

For an amount of ordinary income or statutory income of 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 through 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 and its sovereign entity group holds less than 10% of the total participation interest in each of the Test Entities and the Bank and its sovereign entity group collectively (including any entity directly or indirectly owned by the Government of Country X) would hold less than 10% of the total participation interests in the Test Entities in the circumstances detailed in paragraph 880-105(4)(b).

Therefore, the portfolio test is satisfied.

The Bank'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 of 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).

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.

The Bank has stated that to the best of their knowledge no other members of the Bank's sovereign entity group (including any entity directly or indirectly owned by Country X Government) hold interests in the Test Entities.

The Bank'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.

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.

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.

Based upon the above, the sovereign entity group of the Bank does not have influence of a kind described in subsection 880-105(6) and will, therefore, satisfy 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 to the effect that amounts of ordinary and statutory income derived by the Bank from its investments in the Test Entities are not assessable and not exempt income.

Question 2

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

Summary

Section 880-110 of the ITAA 1997 operates to deny the Bank a deduction for any loss it incurs in respect of its 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:

(i)              a membership interest;

(ii)              a debt interest

(iii)              a non-share equity interest; and

(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 Bank:

(a)             is covered by section 880-125,

(b)             holds membership interests or 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 Bank cannot deduct an amount if it is a loss in respect of its interests in the Test Entities.

Question 3

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

Summary

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

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, the Bank:

(a)             is covered by section 880-125

(b)             holds membership interests or 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 Bank will be required to disregard any capital gain or loss made in respect of its interests in the Test Entities.