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Edited version of private advice
Authorisation Number: 1052288551142
Date of advice: 29 August 2024
Ruling
Subject: Sovereign immunity and investment gains
Question 1
Is the ordinary and statutory income derived by the Bank from its investments held in the entities listed 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.
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?
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.
Question 4
Does paragraph 128B(3)(n) of the Income Tax Assessment Act 1936 (ITAA 1936) apply to exclude the Bank from liability to withholding tax on income from its interests in the Test Entities that is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997?
Answer
Yes.
Question 5
Does subsection 840-805(9) of the ITAA 1997 apply to exclude the Bank from liability to withholding tax on income from its interests in the Test Entities that is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997?
Answer
Yes.
Question 6
Will gains derived by the Bank from the disposal or redemption of Commonwealth Bonds be non-assessable non-exempt income under subsection 842-215(1) of the ITAA 1997?
Answer
Yes.
Question 7
Does subparagraph 128B(3)(h)(iv) of the ITAA 1936 apply to exclude the Bank from liability to withholding tax on interest income from Commonwealth Bonds?
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
The Bank
The Bank is the central bank of Country A.
The Bank does not have share capital and must repay its entire capital to the Government.
The Bank is not a partnership.
The Bank is not a resident of Australia for the purposes of subsection 6(1) of the ITAA 1936.
The Bank does not have a permanent establishment in Australia, and it does not carry on a trading business in Australia.
The Bank is controlled by a board of directors.
The Bank's activities are conducted primarily using funds belonging to the Government and/or its constituent entities, as well as funding from financial institutions licensed by the Bank. To the extent the Bank obtains funding from financial institutions licensed by the Bank, funds are received in the course of it carrying out functions of the Government Bank. The Bank's activities are not financed by any funds or assets belonging to or held for the benefit of any private individual or entity
Australian Investments
The Bank has appointed custodians to facilitate investing in Australian listed debt and equity securities issued by Australian resident companies or managed investment trusts (MITs). The Bank also owns Australian Government Bonds (Commonwealth Bonds) issued by the Commonwealth of Australia (the Commonwealth).
The Bank expects to derive interest income, dividend income, MIT fund payments, revenue gains and/or capital gains from its investments.
Any returns on the Australian investments will be for the benefit of the Bank and will remain public monies.
The Bank's Australian investments have the following characteristics:
(a) the Bank, and to the best of the Bank's knowledge, all members of 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, all members of 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, nor any members of its sovereign entity group, to the best of the Bank's knowledge, has involvement in the day to day management of the business of any of the Test Entities.
(d) Neither the Bank, nor any members of its sovereign entity group, to the best of the Bank's knowledge, has the right to appoint a director to the Board of Directors of any of the Test Entities.
(e) 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.
(f) Neither the Bank, nor any members of its sovereign entity group, to the best of the Bank's knowledge, has the ability to direct or influence the operation of the Test Entities outside of the ordinary rights conferred by the debt and/or 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.
Assumptions
All Commonwealth Bonds held by the Bank are issued in accordance with subsection 128F(3) and/or 128F(4) of the ITAA 1936, and
Subsection 128F(5) of the ITAA 1936 does not apply to the Commonwealth Bonds held by the Bank.
Relevant legislative provisions
Income Tax Assessment Act 1997 Division 880
Income Tax Assessment Act 1997 section 275-20
Income Tax Assessment Act 1997 section 842-215
Income Tax Assessment Act 1997 section 842-230
Income Tax Assessment Act 1936 section 128B
Reasons for decision
Question 1
Is the ordinary and statutory income derived by the Bank from its interests held in the entities listed in the Test Entities not assessable and not exempt income under 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. 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 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 isnot 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) 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.
Country A is a foreign country.
The Bank is an authority of the government of a foreign country. As such, it is a foreign government agency.
Therefore, the Bank meets the requirements of being a sovereign entity in accordance with section 880-15 of the ITAA 1936.
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] HCA 35). This would ordinarily include general tax revenue, proceeds from the issue of government bonds, the proceeds of privatisations etc.
The Bank is the central bank of Country A.
The Bank does not have share capital and must repay its entire capital to the government. Further, the Bank is required to undertake the functions of the Government bank.
The Bank is not permitted to finance or extend loans to any natural or legal persons, or to engage in commercial activities. The Bank's activities are conducted primarily using funds belonging to the Government and/or its constituent entities, as well as funding from financial institutions licensed by the Bank. To the extent the Bank obtains funding from financial institutions licensed by the Bank, funds are received in the course of it carrying out functions of the Government Bank. The Bank's activities are not financed by any funds or assets belonging to or held for the benefit of any private individual or entity.
As such, the Bank is funded solely by public monies.
All returns on the Bank's investments are public monies
The Bank does not have share capital and must repay its entire capital to the government.
Therefore, all returns on the Bank's investments are public monies.
The Bank is not a partnership
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.
It is noted that subparagraph 880-125(d)(ii) excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.
The Bank was established for the purpose of carrying on the business of central banking. 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 as 'central banking activities':
• monetary policy development
• issuing national currency
• acting as custodian of international reserves, and
• providing banking services to government.
The Bank carries out activities including the following:
• formulating and conducting monetary policy,
• issuing and regulating currency,
• managing and investing foreign currency reserves, and
• advising the Government on matters including banking and financial matters.
It is considered that the activities of the Bank are consistent with the Bank being an entity that only carries on central banking activities. As such, the Bank passes the condition in 880-125(d).
As the Bank 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).
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) 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 equity securities in which the Bank (via its Australian custodians) invests will be either 'membership interests' as defined in section 960-135 of the ITAA 1997 or 'non-share equity interests' as defined in subsection 995-1(1) of the ITAA 1997, and the debt securities in which the Bank (via its Australian custodians) invests will be 'debt interests' for the purposes of section 974-15 of the ITAA 1997. In addition, the Bank expects to derive interest income, dividend income, MIT fund payments, and revenue gains from such debt and equity securities.
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 issuers of the relevant equity and debt securities are Australian resident companies or MITs at the time the Bank derives any dividend income, interest income, MIT fund payments or revenue gains in relation to such securities.
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 entity/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, in combination with any other Government body politics, agencies, or other non-resident entities in which a Government body politic or agency holds a total participation interest (as defined in section 960-180 of the ITAA 1997) of 100%, has a total participation interest (including, for this purpose, treating any equity holders as shareholders, and the total amount contributed in respect of non-share equity interests in the total paid-up share capital) in the issuers of the relevant equity and debt securities, of less than 10% at both (i) the time the relevant payments are derived by the Bank, and (ii) throughout any 12 month period beginning no earlier than 24 months before such time and ended no later than such time.
Therefore, the portfolio test is satisfied.
The Bank's sovereign entity group does not have influence of a kind described in subsection (6) in relation to the Test Entities at the income time
For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(e), 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.
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. Furthermore, the Bank's interests, when combined with the other interests held within its sovereign entity group, do not provide an entitlement to either directly or indirectly determine the identity of any person who make decisions that comprise the control and direction of the Test Entities' operations.
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.
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.
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 such 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 debt interests in the Test Entities?
Detailed Reasoning
Section 880-110 provides that a sovereign entity cannot deduct an amount if:
(a) the sovereign entity is covered by section 880-125; and
(b) the amount is a loss in respect of any of the following kinds of interest that the sovereign entity holds in another entity:
(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, non-share equity 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 interests in the Test Entities disregarded under sections 880-115 and 880-120 of the ITAA 1997 respectively?
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 was 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, non-share equity 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.
Question 4
Does paragraph 128B(3)(n) of the ITAA 1936 apply to exclude the Bank from liability to withholding tax on income from its interests in the Tests Entities that is non-assessable non-exempt income due to the operation Division 880 of the ITAA 1997?
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 IT(TP)A 1997.
As established in Question 1, the ordinary and statutory income derived by the Bank as a return on its investments in the Test Entities is considered non-assessable non-exempt income under Division 880 of the ITAA 1997.
Therefore, the Bank 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 5
Does subsection 840-805(9) of the ITAA 1997 apply to exclude the Bank from liability to withholding tax on income from its interests in the Test Entities that is non-assessable non-exempt income due to the operation of Division 880 of the ITAA 1997?
Detailed reasoning
Subsection 840-805(1) of the ITAA 1997 imposes a liability for MIT withholding tax on amounts in accordance with subsections 840-805(2), (3) and (4) of the ITAA 1997.
Subsection 840-805(9) of the ITAA 1997 notes 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 the Bank as a return on its interests in the Test Entities is considered non-assessable non-exempt income under Division 880 of the ITAA 1997.
Therefore, the Bank 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.
Question 6
Will gains derived by the Bank from the disposal or redemption of its Commonwealth Bonds be non-assessable non-exempt income under subsection 842-215(1) of the ITAA 1997?
Detailed reasoning
Subdivision 842-I of the ITAA 1997 sets out the rules regarding the taxation of some foreign residents (known as IMR entities) that invest into or through Australia.
Subsection 842-215(1) of the ITAA 1997 relevantly states that where an entity is an 'IMR entity' relation to an 'IMR financial arrangement' for an income year, what would otherwise be the entity's assessable income for the year is non-assessable non-exempt income to the extent that it is attributable to a return or gain from the entity disposing of, ceasing to own or otherwise realising the IMR financial arrangement, provided that the requirements in subsection 842-215(3) of the ITAA 1997 are satisfied for that year.
The Bank's gains from the disposal or redemption of its Commonwealth Bonds will be non-assessable non-exempt income pursuant to section 842-215(1) of the ITAA 1997 if it meets the relevant requirements.
IMR Entity
Section 842-220 of the ITAA 1997 provides the meaning of the term 'IMR entity'. An entity will be an 'IMR entity' for an income year if the entity (i) is not an Australian resident at all times during the income year, and (ii) is not a resident trust for CGT purposes for the income year. As the Bank is not an Australian resident, and is also not a trust, it will be an IMR entity at all relevant times.
IMR Financial Arrangement
An 'IMR financial arrangement' is defined in section 842-225 of the ITAA 1997 to be a 'financial arrangement' (as defined in section 230-45 of the ITAA 1997) that is not and does not relate to 'taxable Australian real property' (being broadly Australian land or an Australian mining quarrying or prospecting right) or an 'indirect Australian real property interest' (being a membership interest in certain entities).
Subsection 842-215(3) requirements
The Bank must also meet the requirements of subsection 842-215(3) of the ITAA 1997 as stated below. The requirements of this subsection in relation to the year are that:
(a) during the whole of the year, the IMR entity is an IMR widely held entity; and
(b) during the whole of the year, the interest of the entity in the issuer of, or counterparty to, IMR financial arrangement does not pass the non-portfolio interest test (see section 960-195); and
(c) none of the returns, gains or losses for the year from the arrangement are attributable to:
i. if the entity is a resident of a country that has entered into an international tax agreement with Australia containing a permanent establishment article - a permanent establishment (within the meaning of the relevant international tax agreement) of the entity in Australia; or
ii. otherwise - a permanent establishment of the entity in Australia; and
(d) the IMR entity does not, during the year, carry on in Australia a trading business (within the meaning of section 102M of the Income Tax Assessment Act 1936) that relates (directly or indirectly) to the arrangement; and
(e) subsection 842-225(2) does not apply to the IMR financial arrangement.
Requirement (a) - IMR widely held entity
An 'IMR widely held entity' is relevantly defined in section 842-230 of the ITAA 1997 to include an entity that is covered by paragraph 275-20(4)(h) of the ITAA 1997.
Below considers whether the Bank is an entity under paragraph 275-20(4)(h) of the ITAA 1997, being:
An investment entity that satisfies all of these requirements:
i. The entity is wholly-owned by one or more foreign government agencies, or is wholly-owned subsidiary of one or more foreign government agencies;
ii. The entity is established using only the public money or the public property of the foreign government concerned;
iii. All economic benefits obtained by the entity have passed, or are expected to pass, to the foreign government concerned.
Each of these requirements are considered below:
An Investment Entity
Subsection 960-100(1) of the ITAA 1997 defines the term 'entity' as follows:
(1) Entity means any of the following:
a. An individual;
b. A body corporate;
c. A body politics;
d. A partnership;
e. Any other unincorporated associated or body persons;
f. A trust;
g. A superannuation fund;
Based on the facts and circumstances, the Bank satisfied the definition in subsection 960-100(1) of the ITAA 1997. The Bank engaged in investment activities and is considered an investment entity for the purposes of paragraph 275-20(4)(h) of the ITAA 1997.
Wholly Owned by Foreign Government Agencies
Subsection 995-1(1) of the ITAA 1997 states:
Foreign government agency means:
(a) The government of a foreign country or of part of a foreign country; or
(b) An authority of the government of a foreign country; or
(c) An authority of the government of part of a foreign country.
The Bank is created and governed by law. The Bank was incorporated pursuant to its Charter. The Government of Country A satisfies paragraph (a) of the definition of foreign government agency. The Bank receives all Government revenues and pays out funds in accordance with the Government's instructions. The Bank does not have share capital and it must repay its entire capital to the Government.
Therefore, the Bank is considered wholly owned by a foreign government agency and satisfies subparagraph 275-20(4)(h)(i) of the ITAA 1997.
Public Monies
The public monies condition requires that the entity must be established by using only public, or governmental, monies or property of the foreign government, rather than private money or property, or money or property accruing to the benefit of individuals or other entities in a private capacity.
The Bank does not have share capital and must repay its entire capital to the Government. Therefore, all economic benefits obtained by the Bank are established using only the public money or the public property of the government and satisfies subparagraph 275-20(4)(h)(ii) of the ITAA 1997.
Economic benefits pass to foreign government
The Bank does not have share capital and must repay its entire capital to the Government. Therefore, all economic benefits obtained by the Bank will pass or are expected to pass to the Government. Subparagraph 275-20(4)(h)(iii) of the ITAA 1997 is satisfied.
The Bank is therefore an entity that is covered by paragraph 275-20(4)(h) of the ITAA 1997 and is an 'IMR widely held entity' as defined in section 842-230 of the ITAA 1997. The Bank is an IMR widely held entity for the relevant income year, and it satisfies paragraph 842-215(3)(a) of the ITAA 1997.
Requirement (b) - It is not possible for either the Bank or its associates to hold a direct or indirect participation interest in the Commonwealth therefore it satisfies paragraph 842-15(3)(b) of the ITAA 1997.
Requirement (c) - The Bank does not have a fixed place at or through which it carries on business in Australia, nor does it have an agent in Australia with the general authority to negotiate or conclude contracts on its behalf. The Bank does not have a permanent establishment in Australia so none of the returns, gains or losses from the arrangement are attributable to a permanent establishment. It therefore satisfies paragraph 842-215(3)(c) of the ITAA 1997.
Requirement (d) - The Bank does not carry on trading business within the meaning of section 102M of the ITAA 1936. The Bank is not carrying on a business that relates to the Commonwealth Bonds. It therefore satisfies paragraph 842-215(3)(d) of the ITAA 1997.
Requirement (e) - The requirement in subsection 842-225(2) of the ITAA 1997 concerns whether certain underwriting arrangements that are not financial arrangements are considered to be 'IMR financial arrangements'. Paragraph 842-215(3)(e) of the ITAA 1997 does not apply to the Bank as the Commonwealth Bonds are not sub-underwriting arrangements.
As the requirements of subsection 842-215(3) of the ITAA 1997 are satisfied, any gain the Bank makes from the disposal or redemption of its Commonwealth Bonds that would otherwise be assessable income, will not be non-assessable non-exempt income pursuant to subsection 842-215(1) of the ITAA 1997.
Taxation of Financial Arrangements (TOFA)
Section 230-15 of the ITAA 1997 operates to make gains from financial arrangements assessable income and losses from financial arrangements deductible. In respect of section 230-15 of the ITAA 1997, it is noted that there is an explicit exemption from its operation in section 230-30 of the ITAA 1997. For completeness, it is noted that section 230-30 of the ITAA 1997 applies if the gain on disposal or redemption of the Commonwealth Bonds are non-assessable and non-exempt income.
As the gain on disposal or redemption of the Commonwealth Bonds would be treated or reasonably expected to be treated, as non-assessable non-exempt income under a provision of the Act, that being section 842-215 of the ITAA 1997, the gain is not assessable under section 230-15 of the ITAA 1997 due to the operation of section 230-30 of the ITAA 1997.
Conclusion
As the requirements of subsection 842-215(3) are satisfied, any gains the Bank makes from the disposal or redemption of its Commonwealth Bonds that would otherwise be assessable income under the ITAA 1936 or ITAA 1997 will instead be non-assessable non-exempt income pursuant to subsection 842-215(1) of the ITAA 1997.
Question 7
Does subparagraph 128B(3)(h)(iv) of the ITAA 1936 apply to exclude the Bank from liability to withholding tax on interest income from its Commonwealth Bonds?
Detailed Reasoning
All legislative references are to the ITAA 1936 unless otherwise specified.
Section 128B deals with liability to withholding tax for certain income including income that consists of interest paid by Australian residents to non-residents. Subsection 128B(3) lists certain types of income to which liability to withholding tax under section 128B does not apply. Subparagraph 128B(h)(iv) provides that section 128B does not apply to interest income that applies to which section 128F applies.
Section 128F provides an exemption from withholding tax for certain publicly offered company debentures or debt interests. The exemption applies if the conditions in subsection 128F(1) are satisfied and subsections (5) and (6) do not apply.
Subsection 128F(1) provides that section 128F applies to interest to paid by a company in respect of certain publicly offered debentures and debt interests if:
(a) the company was a resident of Australia when it issued the debenture or debt interest; and
(b) the company is a resident of Australia when the interest is paid; and
(c) for a debt interest other than a debenture - the debt interest:
i. is a non equity share; or
ii. consists of two or more related schemes (within the meaning of the Income Tax Assessment Act 1997) where one or more of them is a non-equity share; or
iii. is a syndicated loan; or
iv. is prescribed by the regulations of this section and
(d) either:
v. the issue of the debenture or debt interest satisfied the public officer test set out in subsection (3) or (4); or
vi. for a syndicated loan - the invitation to become a lender under the relevant syndicated loan facility satisfied the public offer test set out in subsection (3A).
Subsection 6(1) defines a debenture as:
'debenture' in relation to a company, includes debenture stock, bonds, notes and any other securities of the company, whether constituting a charge on the assets of the company or not.
The Commonwealth Bonds held by the Bank are debentures for the purposes of section 128F.
Subsection 128F(7) treats the Commonwealth or an authority of the Commonwealth as if the Commonwealth or authority were a company and a resident of Australia. Pursuant to subsection 128F(7), the Commonwealth Bonds held by the Bank will be deemed to be issued by, and interest on the Commonwealth Bonds will be deemed to be paid by, an Australian resident company.
It is assumed that all the Commonwealth Bonds held by the Bank are issued in accordance with 128F(3) and or 128F(4). Additionally, it is assumed that subsection 128F(5) does not apply.
The Bank is not an 'associate', as defined by subsection 128F(9), of the Commonwealth for the purposes of 128F(6). That is, the Bank nor any of its associates have influence or have a majority voting interest in the Commonwealth. The Commonwealth nor any of its associates have influence or have a majority voting interest in the Bank.
Conclusion
As subsection 128F(1) is satisfied and subsection (5) and (6) do not apply, section 128F applies to the interest paid to the Bank in respect of the Commonwealth Bonds. Therefore, no tax is payable under Division 11A pursuant to subsection 128F(2).
Therefore, the Bank is excluded from liability to withholding tax on interest that is paid to it from the Commonwealth Bonds pursuant to subparagraph 128B(3)(h)(iv).