Edited version of private advice

Authorisation Number: 1052292691217

Date of advice: 28 August 2024

Ruling

Subject: International issues ~~ sovereign immunity

Question

Is the ordinary and statutory income derived by the Central Bank from its Australian investments (the Test Entities) not assessable income 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 ended 30 June 20YY

Year ended 30 June 20YY

Year ended 30 June 20YY

Year ended 30 June 20YY

Year ended 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

Central Bank

1.              Under Foreign Law, the Central Bank is the central bank of Country A.

2.              Under Foreign Law, the Central Bank is a state body that:

•                ensures the development and implementation of monetary policy

•                manages the functioning of payment systems

•                carries out currency regulation and currency control

•                contributes to the stability of the financial system

•                conducts state statistics, and

•                regulates, controls and supervises the financial market and financial organisations.

3.              Under Foreign Law, the Central Bank is accountable to the Head of State of Country A.

4.              Under Foreign Law, the Central Bank is a legal entity in organisational legal form of a state institution and has an independent balance sheet.

5.              Foreign Law outlines that the Central Bank, within its authority, granted to it by the laws of Country A, is independent in its activities. Under Foreign Law, the Central Bank is required to coordinate its activities with the Government of Country A and must inform each other about prospective activities.

6.              Under Foreign Law, the Central Bank acts as a bank, financial advisor and agent of the Government of Country A.

7.              The functions of the Central Bank include, but are not limited to:

•                Providing loans in the manner and under the conditions provided for by the Foreign Law, including standing loans, loans of last resort and short term loans to certain financial institutions carrying out certain types of banking operations that are participants of the payment systems of Country A.

•                Serving as trustee for a sovereign fund of Country A on the basis of the trust management agreement between the Central Bank and the Government of Country A.

•                Serving as a trustee and custodian of pension assets of a pension fund on the basis of the trust management agreement between the Central Bank and the Government of Country A.

8.              The capital of the Central Bank belongs to the state and shall be created in an amount specified under Foreign Law. Under Foreign Law, the Central Bank shall independently exercise the rights of possession, use, and disposition of property on its balance sheet on behalf of Country A.

9.              Foreign Law outlines the creation of reserve capital to provide compensation of losses and reimbursement of losses on certain operations of the Central Bank. It is replenished by the net income of the Central Bank.

10.          Under Foreign Law, any remaining undistributed net income of the Central Bank shall be transferred to the state budget. If the reserve capital fund is insufficient to compensate for the losses of the financial year, the uncovered losses shall be compensated at the expense of the state budget.

11.          The governing bodies of the Central Bank include an Executive Board, Monetary Policy Committee and Board of Directors.

Central Bank's investments

12.          The Central Bank or its external asset managers acting on behalf of the Central Bank invest in Australian investments.

13.          The Central Bank has investments in Australian fixed income securities.

14.          The debt investments are made up of corporate, securitised, and/or index linked bonds from which ordinary income is derived in the form of interest. The debt investments have the following characteristics:

•                All investments are listed on the Australian Securities Exchange (ASX).

•                The Australian debt issuers are an Australian resident company or managed investment trust (MIT).

•                The Central Bank and its sovereign entity group holds less than 10% of the total equity interests on issue of each Australian debt issuer.

•                Neither the Central Bank or any member of its sovereign entity group hold any right to appoint a person to a board, committee or similar, either directly or indirectly of the Australian debt issuer.

•                Neither the Central Bank or any member of its sovereign entity group entered into or received any side letters, arrangements or agreements with the Australian debt issuer.

•                Neither the Central Bank or any member of its sovereign entity group hold any veto rights on security holder votes for the debt interest held.

•                Neither the Central Bank or its sovereign entity group hold any ability to direct or influence the operation of the Australian debt issuer outside of the ordinary rights conferred by the debt interest held.

•                Neither the Central Bank or any member of sovereign entity group hold any other influence potentially of a kind described in subsection 880-105(6) of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 880-105

Reasons for decision

Issue

Question

Is the ordinary and statutory income derived by the Central Bank from its Australian investments (the Test Entities) not assessable income and not exempt income under section 880-105 of the ITAA 1997?

Summary

The Central Bank is a covered sovereign entity under section 880-125 of the ITAA 1997. The ordinary and statutory income derived by the the Central Bank from its Australian membership interests in the Test Entities is not assessable and not exempt income due to the operation of 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.

Central Bank 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.

Central Bank is a 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%; 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.

Relevantly, 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.

The term 'authority' is not defined and therefore takes its ordinary meaning. The Macquarie Dictionary states that 'authority' means:

noun (plural authorities)

1. the right to determine, adjudicate, or otherwise settle issues or disputes; the right to control, command, or determine.

2. a person or body with such rights.

...[1]

The Central Bank was established as the central bank of Country A in accordance with Foreign Law. The Central Bank is a state body that:

•                ensures the development and implementation of monetary policy

•                manages the functioning of payment systems

•                carries out currency regulation and currency control

•                contributes to the stability of the financial system

•                conducts state statistics, and

•                regulates, controls and supervises the financial market and financial organisations.

The Central Bank is a legal entity that is independent from the state. However, it must coordinate its activities with the Government of Country A and is accountable to the Head of State of Country A.

Therefore, the Central Bank meets the requirements of being a sovereign entity in accordance with subsection 880-15(b) of the ITAA 1997 as an authority of the government of a foreign country.

Central Bank is funded solely by public monies

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

In the context of Division 880 of the ITAA 1997, LCR 2020/3 provides at paragraph 54, that this phrase essentially means monies of a foreign government (or part of a foreign government) held for a public purpose which form part of the foreign government's (or part of the foreign government's) equivalent to Australia's Consolidated Revenue Fund (Roy Morgan Research Pty Ltd v FC of T & Anor [2011] HCA 35). This would ordinarily include general tax revenue, proceeds from the issue of government bonds, the proceeds of privatisations etc.

The Central Bank is funded solely by public monies. Foreign Law outlines that the capital of the Central Bank belongs to the state and is created in an amount specified under Foreign Law. Additionally, Foreign Law outlines the creation of reserve capital which is used to provide compensation of losses and reimbursement of losses on certain operations. The reserve capital is replenished by the net income of the Central Bank.

Under Foreign Law, any remaining undistributed net income of the Central Bank shall be transferred to the state budget. If the reserve capital is insufficient to compensate for the losses of the financial year, the uncovered losses shall be compensated at the expense of the state budget.

Therefore, the Central Bank is funded solely by public monies and satisfies this requirement.

All returns on the Central Bank's investments are public monies

The Central Bank will receive Australian interest income from its investment in Australian debt interests. Pursuant to Foreign Law, the capital and reserve capital of the Central Bank, which belong to the state, are created and replenished out of the net income of the Central Bank from its operations. Any remaining net income of the Central Bank is transferred to the state budget in accordance with Foreign Law.

Accordingly, the monies that are invested by the Central Bank are and will remain public monies.

Therefore, the Central Bank satisfies this requirement.

Central Bank is not a partnership

The Central Bank is the central bank of Country A established as a legal entity in organisational legal form of an of a state institution under Foreign Law.

Therefore, the Central Bank satisfies this requirement.

Central Bank 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.

Subparagraph 880-125(d)(ii) of the ITAA 1997 excludes public financial entities that only carry on central banking activities from being excluded as a covered sovereign entity.

Paragraph 76 of LCR 2020/3 provides the following examples of public non-financial entities:

•                airline corporations

•                postal authorities

•                state water corporations

•                port authorities

•                hospitals

•                schools

•                colleges

•                state electricity corporations, and

•                state mining corporations.

The Central Bank does not undertake activities which would be analogous to that of a public non-financial entity under subsections 880-130(1) of the ITAA 1997. Further, the Central Bank is not a type of entity listed in paragraph 76 of LCR 2020/3.

Paragraph 79 of LCR 2020/3 lists common examples of public financial entities which includes banks and deposit taking corporations. As the Central Bank is the central bank of Country A established under Foreign Law, it is a public financial entity. 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 LCR 2020/3 lists inclusively the following as 'central banking activities':

•                monetary policy development

•                issuing national currency

•                acting as custodian of international reserves, and

•                providing banking services to government.

The Central Bank was established as the central bank of Country A in accordance with Foreign Law. The Central Bank is a state body that:

•                ensures the development and implementation of monetary policy

•                manages the functioning of payment systems

•                carries out currency regulation and currency control

•                contributes to the stability of the financial system

•                conducts state statistics, and

•                regulates, controls and supervises the financial market and financial organisations.

Relevantly, the Central Bank acts as a bank, financial advisor and agent of the Government of Country A. The Central Bank also acts as trustee and custodian of a sovereign fund and pension fund on the basis of respective agreements with the Government of Country A.

The Central Bank provides loans in certain circumstances, being standing loans, loans of last resort and short term loans to certain financial institutions carrying out certain types of banking operations that are participants of the payment systems of Country A.

It is considered that all of the above activities are consistent with the Central Bank being an entity that only carries on central banking activities in accordance with paragraph 81 of LCR 2020/3. As such, the Central Bank passes the condition in paragraph 880-125(d) of the ITAA 1997.

Therefore, the Central Bank is not considered to be a public non-financial entity or public financial entity under subsections 880-130(1) and (2) of the ITAA 1997.

Conclusion

As the Central Bank 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 for the purposes of section 880-105 of the ITAA 1997.

Central Bank's return will be 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 entities.

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

1.              dividends - including non-share dividends and dividends that pass through a 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 Central Bank will receive Australian interest income from its investment in Australian debt interests in the Test Entities.

Therefore, amounts received by the Central Bank satisfy the requirements of paragraph 880-105(1)(b) of the ITAA 1997.

Central Bank's income will be 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; 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. While the investments at the time of this Ruling are made into Australian debt interests, it is noted that there is nothing precluding the Central Bank from investing in membership interests or non-share equity interests of Australian resident companies or MITs.

As such, the Central Bank will receive income from an entity which satisfies the requirements of paragraph 880-105(1)(c) of the ITAA 1997.

Central 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) 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 entity 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.

The Central Bank is part of the sovereign entity group of the Government of Country A. At the relevant times (as required by paragraph 880-105(1)(d) of the ITAA 1997), the Central Bank and its sovereign entity group collectively, will holds less than 10% of the total participation interests in each of the Test Entities and will hold less than 10% of the total participation interests in the Test Entities in the circumstances detailed in paragraph 880-105(4)(b).

As such, the requirements of paragraph 880-105(d) of the ITAA 1997 are satisfied.

Central Bank's sovereign entity group will not have influence of a kind described in subsection (6) in relation to the Test Entity at the income time

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.

As such, there are two distinct sub-tests within the influence test.

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.

The Central Bank's Australian debt interests will 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 Entity's operations. Furthermore, the Central Bank's interest, when combined with those of its sovereign entity group, will not provide its sovereign entity group with an entitlement to either directly or indirectly determine the identity of any person who makes decisions that comprise the control and direction of the Test Entity's operations.

Additionally, neither the Central Bank or any member of its sovereign entity group hold any veto or approval rights which go to the control or direction of the Test Entity.

Sub-test 2 of the influence test, as contained in paragraph 880-105(6)(b) 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 each of the Test Entities operations will be accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of the Central Bank or its sovereign entity group.

As such, the requirements of paragraph 880-105(e) of the ITAA 1997 are satisfied.

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 amounts of ordinary and statutory income derived by the Central Bank from its investments in the Test Entities are not assessable and not exempt income.

[1] Macquarie Dictionary (2024) www.macquariedictionary.com.au/, accessed 18 July 2024