Edited version of private advice

Authorisation Number: 1052291465817

Date of advice: 16 August 2024

Ruling

Subject: Sovereign immunity

Question

Is the ordinary and statutory income derived by companyA from returns on the loan notes to be issued by the Test Entity, 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 periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Foreign Government Agency ('FGA')

FGA was established by law.

FGA is a resident in the Foreign Jurisdiction for income tax purposes and is not subject to income tax in the Foreign Country.

FGA is recognised by law as a government authority of the Foreign Jurisdiction. FGA has its own legal personality and an independent budget.

FGA is managed by its own Board. The Board is accountable to the governing body of the Foreign Jurisdiction.

FGA was established using assets assigned to it by the governing body of Foreign Country. No personal monies of any individual have been contributed to FGA

The income generated by FGA is reinvested by FGA or distributed to the Government of the Foreign Jurisdiction.

No distributions of income or gains from FGA have been made or can be made to any person other than the Government of the Foreign Jurisdiction.

CompanyA

CompanyA is a wholly owned subsidiary company of FGA.

CompanyA was incorporated as a limited liability company.

CompanyA is not subject to income tax in the Foreign Jurisdiction.

CompanyA is a general investment vehicle established by FGA and is the intended holder of FGA's investment in the Test Entity.

CompanyA is entirely funded by FGA. The source of funds invested into companyA is from the Foreign Jurisdiction Government's sovereign reserves such that there is no third-party debt involved in the investment. No personal monies of any individual have been contributed to companyA.

The income generated by companyA on its investments is either reinvested directly by companyA or distributed to FGA. The funds are then either reinvested by FGA or distributed to the Government.

CompanyA is not a resident of Australia for tax purposes, nor is it a trust under Division 6 of the Income Tax Assessment Act 1936 ('ITAA 1936'). CompanyA does not have its central management and control in Australia, nor is its voting power controlled by Australian residents. CompanyA does not maintain an office in Australia or engage in any trade or business in Australia.

Test Entity

The Test Entity is an Australian tax resident special purpose vehicle established by the Test Entity's Group.

The Test Entity is managed by the Manager under a Management Agreement.

The FGA sovereign entity group does not hold any membership interests in the Test Entity's Group.

Overview of the Agreement

Under the Agreement, companyA intends to acquire loan notes ('Notes') issued by the Test Entity.

These Notes are to be issued in series where the proceeds from each series of Notes issued by the Test Entity (as borrower) is used to fund a single specific loan ('Portfolio Loan') extended by the Test Entity (as lender) to third party borrowers ('Borrowers').

Each series of Notes is collateralised by said associated Portfolio Loan.

The Agreement shall continue until such time as companyA provides notice to both the Test Entity and Manager that it wishes to cease the investment program.

Interest accrues on the Notes.

CompanyA has full discretion as to whether it will invest in a proposed series of Notes and the Test Entity is also free to invest in an investment regardless of whether companyA has agreed to subscribe to the relevant series of Notes which are issued by the Test Entity in connection with that investment.

Other Facts

CompanyA and all members of its sovereign entity group would hold collectively less than 10% of the total participation interests in the Test Entity in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997.

Neither companyA, nor any members of its sovereign entity group, has involvement in the day-to-day management of the business of the Test Entity.

Neither companyA, nor any members of its sovereign entity group, has the right to appoint a director to the Board of Directors of the Test Entity.

Neither companyA, nor any members of its sovereign entity group, has the ability to direct or influence the operation of the Test Entity outside of the ordinary rights conferred by the interest held.

CompanyA's interest in the Test Entity does not provide it with an entitlement to either directly or indirectly determine the identify of any person who make decisions that comprise the control and direction of the Test Entity's operations.

No person involved in the control and direction of the Test Entity's operations is accustomed or obliged to act in accordance with the directions, instructions or wishes of companyA or members of companyA's sovereign entity group.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 880-105

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Question 1

Is the ordinary and statutory income derived by companyA from returns on the loan notes to be issued by the Test Entity, not assessable and not exempt income under section 880-105 of the ITAA 1997?

Summary

Interest income received by companyA on loan notes to be issued by the Test Entity is not assessable and is 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) of the ITAA 1997:

(a) the sovereign entity is covered by section 880-125; and

(b) the amount is a return on any of the following kinds of interest that the sovereign entity holds in another entity (the test entity):

(i) a *membership interest;

(ii) a *debt interest;

(iii) a *non-share equity interest; and

(c) the test entity is:

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

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

(d) the *sovereign entity group of which the sovereign entity is a member satisfies the portfolio interest test in subsection (4) in relation to the test entity:

(i) at the income time; and

(ii) throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time; and

(e) the sovereign entity group of which the sovereign entity is a member does not have influence of a kind described in subsection (6) in relation to the test entity at the income time.

These conditions are considered below.

CompanyA is a covered sovereign entity

Section 880-125 of the ITAA 1997 states:

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

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

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

(c)          the entity is not a partnership;

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

(i)            a *public non-financial entity;

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

These conditions are considered below.

Sovereign Entity

For an entity to be covered by section 880-125 of the ITAA 1997, it must be a sovereign entity. Section 880-15 of the ITAA 1997 defines a sovereign entity to be any of the following:

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

(b)          a *foreign government agency;

(c)          an entity:

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

(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

(b)          an authority of the government of a foreign country; or

(c)          an authority of the government of part of a foreign country.

FGA was established by law for the purposes of investing and managing the reserve funds of the Foreign Jurisdiction. FGA is officially recognised as a government body under the Foreign Jurisdiction's law.

FGA meets the requirements of an agency of a foreign government.

CompanyA is a wholly owned subsidiary of FGA.

CompanyA is a subsidiary of FGA. CompanyA is not subject to income tax in the Foreign Jurisdiction. CompanyA is a special purpose vehicle established by FGA and holds its investment in the Test Entity, as well as several other investments.

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

As companyA is not an Australian resident and is not a resident trust estate for the purposes of Division 6 of Part III of the ITAA 1936, companyA will meet the definition of a 'sovereign entity' by virtue of the operation of paragraph 880-15(c) of the ITAA 1997.

Therefore, this requirement is satisfied.

CompanyA is funded solely by public monies and all returns on companyA's investment are 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.

FGA was established using public monies. Additionally, no personal monies of any individual have been contributed to FGA.

The income generated by FGA on the investment of reserve funds is reinvested by FGA or distributed to the Government of the Foreign Jurisdiction. No distributions of income or gains from FGA have been made or can be made to any person other than the Government of the Foreign Jurisdiction.

CompanyA is a wholly owned subsidiary of FGA. CompanyA is entirely funded by FGA. The source of funds invested into companyA is from the Foreign Jurisdiction's sovereign reserves.

The income generated by companyA on the investment of the reserve funds is either reinvested directly by companyA or distributed to FGA.

Given the way in which companyA is funded (i.e. by the Government of the Foreign Jurisdiction) and how companyA's returns are used (i.e. for the benefit of the Government of the Foreign Jurisdiction), companyA is funded solely by public monies and all returns on companyA's investments are public monies.

Therefore, this requirement is satisfied.

CompanyA is not a partnership

CompanyA is a limited liability company and is not a partnership for the purposes of section 880-125 of the ITAA 1997.

Therefore, this requirement is satisfied.

CompanyA is not a public non-financial entity or public financial entity

Subsection 880-130(1) of the ITAA 1997 defines the term public non-financial entity:

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

(a) producing or trading non-financial goods;

(b) providing services that are not financial services.

Subsection 880-130(2) of the ITAA 1997 defines the term public financial entity:

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

(a)          it trades in financial assets and liabilities;

(b)          it operates commercially in the financial markets;

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

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

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

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

CompanyA is a wholly owned subsidiary of FGA that was incorporated in the Foreign Jurisdiction. CpmpanyA will hold FGA's investment in the Test Entity, in addition to its other current investments.

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

CompanyA does not actively trade in financial assets and liabilities, operate commercially in financial markets, or provide any of the services listed in paragraph 880-130(2)(c) of the ITAA 1997.

Additionally, companyA is not a type of entity listed in paragraphs 76 or 79 of LCR 2020/3 (which detail common examples of public financial entities and public non-financial entities).

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

Conclusion

As companyA satisfies each of the requirements in paragraphs 880-125(a) through (d) of the ITAA 1997, it is a sovereign entity that is covered by section 880-125 of the ITAA 1997 for the purposes of paragraph 880-105(1)(a) of the ITAA 1997.

CompanyA's return is received on a relevant interest in the Test Entity

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(b) of the ITAA 1997, it must be a 'return on' a membership interest, debt interest or non-share equity interest held by the sovereign entity in the Test Entity.

As detailed in paragraph 4.37 of the Explanatory Memorandum to the Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2019 ('the EM'), a 'return on' a membership interest, debt interest or non-share equity for the purposes of paragraph 880-105(1)(b) of the ITAA 1997 will include:

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

2.          interest - including interest that passes through a MIT

3.          fund payments made by a MIT (other than fund payments that are attributable to non-concessional MIT income), and

4.          revenue gains made on the disposal of an interest in the test entity - including revenue gains that pass through a MIT.

CompanyA's investment in the Notes satisfies subparagraph 880-105(1)(b)(ii) of the ITAA 1997 as companyA will receive a return (interest income) on a debt interest (the Notes) in the Test Entity.

Therefore, this requirement is satisfied.

CompanyA's income is received from Australian resident companies or MITs

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(c) of the ITAA 1997, it must be received from an entity that is either:

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

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

CompanyA will receive interest income from its intended acquisition of the Notes in the Test Entity. The Test Entity is an Australian resident proprietary limited company and is expected to continue being so at the time of acquisition of loan notes and receipt of interest. CompanyA's income is therefore received from an entity that satisfies the requirements of subparagraph 880-105(1)(c)(i) of the ITAA 1997.

CompanyA's sovereign entity group satisfies the portfolio interest test

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(d) of the ITAA 1997, the sovereign entity and the sovereign entity group to which it belongs must satisfy the portfolio interest test in relation to the test 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) of the ITAA 1997, which states:

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

(a)          is less than 10%; and

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

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

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

Section 880-20 of the ITAA 1997 provides the definition of sovereign entity group. Broadly, sovereign entities of the same foreign government will be members of the same sovereign entity group and sovereign entities of the same part of a foreign government will be members of the same sovereign entity group.

In accordance with subsection 880-20(1), companyA will form part of a sovereign entity group including the Government of the Foreign Jurisdiction and any entities in which the Government of the Foreign Jurisdiction either directly or indirectly holds 100% of the participation interests (companyA's sovereign entity group includes FGA).

Neither companyA nor any member of its sovereign entity group holds a participation interest or an equity interest in the Test Entity, with the Test Entity being wholly owned by independent parties (satisfying paragraph 880-105(4)(a)).

The participation interest of the companyA sovereign entity group in the Test Entity is therefore less than 10% in the circumstances detailed in paragraph 880-105(4)(b) of the ITAA 1997.

Therefore, this requirement is satisfied.

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

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(e) of the ITAA 1997, at the income time the sovereign entity group to which the sovereign entity belongs must not have influence over the test entity of a kind described in subsection 880-105(6) of the ITAA 1997.

Subsection 880-105(6) of the ITAA 1997 states:

A *sovereign entity group has influence of a kind described in this subsection in relation to the test entity at a time if any of the following requirements are satisfied at that time:

(a)          a *member of the group:

(i)            is directly or indirectly able to determine; or

(ii)            in acting in concert with others, is directly or indirectly able to determine;

the identity of at least one of the persons who, individually or together with others, make (or might reasonably be expected to make) the decisions that comprise the control and direction of the test entity's operations;

(b)          at least one of those persons is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of a member of the group (whether those directions, instructions or wishes are expressed directly or indirectly, or through the member acting in concert with others).

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.

There are two distinct sub-tests within the influence test.

Sub-test 1

Sub-test 1 is contained in paragraph 880-105(6)(a) of the ITAA 1997 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 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.

CompanyA's interests in the Test Entity 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 Entity's operations. Furthermore, CompanyA'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 Entity's operations.

Therefore, companyA and its sovereign entity group do not have the level of influence described by paragraph 880-105(6)(a) of the ITAA 1997.

Sub-test 2

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 which might reasonably be expected to act, in accordance with the directions, instructions or wishes of the sovereign entity group.

Based on the relevant facts and circumstances of this Ruling, no person involved in the control and direction of the Test Entity's operations is accustomed or obliged to act in accordance with the directions, instructions or wishes of companyA or members of companyA's sovereign entity group. Therefore, companyA and its sovereign entity group do not have influence of a kind described in paragraph 880-105(6)(b) of the ITAA 1997.

Based upon the above, the sovereign entity group of companyA does not have influence of a kind described in subsection 880-105(6) of the ITAA 1997at the income time in the Test Entity and will therefore satisfy the requirements of paragraph 880-105(1)(e) of the ITAA 1997.

Conclusion

As all of the conditions listed in subsection 880-105(1) of the ITAA 1997 have been satisfied, section 880-105 of the ITAA 1997 will apply such that interest income received by companyA from the Notes is not assessable income and is not exempt income.