Edited version of private advice

Authorisation Number: 1052293009904

Date of advice: 28 August 2024

Ruling

Subject: International issues ~~ sovereign immunity

Question

Is the ordinary and statutory income derived by the Sovereign Fund 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

Sovereign Fund

1.              The Sovereign Fund was founded in accordance with Foreign Law.

2.              The Sovereign Fund was established in order to ensure the stable social and economic development of the country, accumulate financial assets for future generations, reduce the economy's dependency on certain industries and reduce the impact of adverse external factors.

3.              According to Foreign Law, the Central Bank of Country B (Central Bank) serves as trustee for the Sovereign Fund on the basis of the Trust Management Agreement of the Sovereign Fund signed between the Government of Country B and the Central Bank (the Trust Management Agreement).

4.              Under Foreign Law, the powers of the Central Bank include in relation to the Sovereign Fund:

•                Approving the rules for selecting external asset managers and converting or reconverting assets of the Sovereign Fund.

•                Appointing an official of the Central Bank, to make decisions on the trust management of the Sovereign Fund.

5.              The source of the funds for the Sovereign Fund are stated in Foreign Law as:

•                Receipts for the Sovereign Fund which includes:

o        direct taxes from certain industry organisations

o        other income from operations, carried out by the organisations of certain industries, including income for violating the conditions of contracts

o        receipts from privatisation of certain state property

o        income from the sale of certain types of land.

•                Investment income from the management of the Sovereign Fund.

•                Other receipts and income, not prohibited by Foreign Law.

6.              The use of the funds of the Sovereign Fund is outlined in Foreign Law as follows:

•                The funds of the Sovereign Fund may be spent:

o        as a transfer from the Sovereign Fund to the state budget. A transfer consists of the revenue of Sovereign Fund and the size is determined in absolute fixed value by Foreign Law

o        for covering expenses associated with the management and annual audit of the Sovereign Fund

o        for targeted transfers to the state budget by decision of the Head of State of Country B for financing anti-crisis programs during economic downturn or economic slowdown periods, socially significant projects of national scale and strategically important infrastructure projects in the absence of alternative sources of their financing

o        in the form of payments of target requirements and covering the costs of paying for banking services related to transfers and payments of target savings.

•                The funds of Sovereign Fund may not be used for crediting individuals and legal entities, and as ensuring the performance of obligations.

•                The procedure for entering assets to the Sovereign Fund and the use of the Sovereign Fund is determined by the Government of Country B.

7.              Under Foreign Law, the assets of the National Fund form part of the state property of Country B.

8.              The assets of the Sovereign Fund are under the trust management of the Central Bank in accordance with the Trust Management Agreement and are accumulated on the account of the Government of Country B in the Central Bank in accordance with Foreign Law.

9.              Under Foreign Law, the consolidated state budget of Country B includes the receipts and expenses of the Sovereign Fund.

10.          In a letter from the Ministry of Finance of Country B (MoF) as a competent authority of Country B to the Commissioner (the MoF Letter), the MoF certifies the following:

•                The assets of the Sovereign Fund form part of the state property of Country B.

•                The assets of the Sovereign Fund are under the trust management of the Central Bank in accordance with the Trust Management Agreement.

•                The Central Bank, being trustee of the Sovereign Fund possesses the rights of holding, usage and disposal with respect to the assets of the Sovereign Fund.

•                Subject to Foreign Law, in respect to the assets given to the trust management, the execution of the tax liabilities associated with the entrusted property (i.e. the Sovereign Fund assets held by the Central Bank in trust management), including corporate income tax, is undertaken by the trust manager.

•                The assets of the Sovereign Fund invested in Australian securities are registered in the name of the Central Bank on behalf of Country B.

11.          A management council (the Management Council) was established under Foreign Law. The Management Council is an advisory body to the Head of State of Country B. It develops proposals for the effective use of funds and its placement in financial instruments. Its functions include:

•                Development of proposals to improve the formation and use of the Sovereign Fund.

•                Consideration and development of proposals for the volume and direction of use of the Sovereign Fund.

•                Development of proposals for the list of approved financial instruments, except for intangible assets, for placement of the Sovereign Fund.

12.          The decision to establish the Management Council, its composition and regulations are approved by the Head of State of Country B.

Sovereign Fund's investments

13.          The Sovereign Fund or its external asset managers acting on behalf of the Sovereign Fund invest in Australian investments.

14.          The Sovereign Fund has investments in Australian fixed income securities and equities.

15.          The Australian equity investments have the following characteristics:

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

•                All equity investments are in an Australian resident company or managed investment trust (MIT) form which ordinary income is derived in the form of dividends or fund payments.

•                The Sovereign Fund and its sovereign entity group hold less than 10% of the total equity interests on issue of each Australian company or MIT.

•                Neither the Sovereign Fund 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 company or MIT.

•                Neither the Sovereign Fund or any member of its sovereign entity group entered into or received any side letters, arrangements or agreements with the Australian company or MIT.

•                Neither the Sovereign Fund or any member of its sovereign entity group hold any veto rights on security holder votes for the equity interest held. The Sovereign Fund only hold rights to vote in proportion to their equity interest in each Australian company or MIT.

•                Neither the Sovereign Fund or its sovereign entity group hold any ability to direct or influence the operation of the Australian company or MIT outside of the ordinary rights conferred by the equity interest held.

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

16.          The debt investments have the following characteristics:

•                All investments are listed on the ASX.

•                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 Australian debt issuers are an Australian resident company or MIT.

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

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

•                Neither the Sovereign Fund 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 Sovereign Fund or any member of its 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

Question

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

Summary

The Sovereign Fund is a covered sovereign entity under section 880-125 of the ITAA 1997. The ordinary and statutory income derived by the Sovereign Fund from its Australian debt and 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.

Sovereign Fund 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 Fund 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 Sovereign Fund was founded under Foreign Law. It was established in order to ensure the stable social and economic development of the country, accumulate financial assets for future generations, reduce the economy's dependency on certain industries and reduce the impact of adverse external factors.

The Sovereign Fund does not have its own legal personality and forms part of the state property of Country B under Foreign Law, which includes forming part of the consolidated state budget of Country B. The Central Bank is the trustee for the Sovereign Fund in accordance with the Trust Management Agreement between the Central Bank and the Government of Country B. The assets of the Sovereign Fund are accumulated on the account of the Government of Country B in the Central Bank in accordance with Foreign Law.

The Management Council is the advisory body to the Head of State of Country B which develops proposals for the effective use of the funds of the Sovereign Fund and its placement in financial instruments. The decision to establish the Management Council, its composition and regulations are approved by the Head of State of Country B.

The Sovereign Fund is therefore considered to be a foreign government agency under paragraph 880-15(b) of the ITAA 1997 as it is an authority of the Government of Country B.

Therefore, Sovereign Fund meets the requirements of being a sovereign entity in accordance with subsection 880-15(b) of the ITAA 1997.

Sovereign Fund 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.

According to Foreign Law, the source of the funds of the Sovereign Fund are:

•                Receipts for the Sovereign Fund which includes:

o        direct taxes from certain industry organisations

o        other income from operations, carried out by the organisations of certain industries, including income for violating the conditions of contracts

o        receipts from privatisation of certain state property

o        income from the sale of certain types of land.

•                Investment income from the management of the Sovereign Fund.

•                Other receipts and income, not prohibited by Foreign Law.

The Sovereign Fund does not have its own legal personality and forms part of the state property of Country B, which includes forming part of the consolidated state budget of Country B. The assets of the Sovereign Fund are accumulated on the account of the Government of Country B in the Central Bank in accordance with Foreign Law.

Therefore, the Sovereign Fund is funded solely by public monies and satisfies this requirement.

All returns on the Sovereign Fund's investments are public monies

The Sovereign Fund will receive Australian interest income, dividend income, fund payments made by a MIT and/or revenue gains made on the disposal of an interest in the test entity from its investment in Australian debt and equity interests in the Test Entities.

As discussed above, the Sovereign Fund forms part of the state property of Country B, which includes forming part of the consolidated state budget of Country B. The assets of the Sovereign Fund are accumulated on the account of the Government of Country B in the Central Bank in accordance with Foreign Law.

In accordance with Foreign Law, the funds of the Sovereign Fund may be spent:

•                as a transfer from the Sovereign Fund to the state budget

•                for covering expenses associated with the management and annual audit of the Sovereign Fund

•                for targeted transfers to the state budget by decision of the Head of State of Country B for financing anti-crisis programs during economic downturn or economic slowdown periods, socially significant projects of national scale and strategically important infrastructure projects in the absence of alternative sources of their financing

•                in the form of payments of target requirements and covering the costs of paying for banking services related to transfers and payments of target savings.

Additionally, the funds of the Sovereign Fund may not be used for crediting individuals and legal entities, and as ensuring the performance of obligations. The procedure for entering assets to the Sovereign Fund and the use of the Sovereign Fund is determined by the Government of Country B.

Accordingly, the monies that are invested by the Sovereign Fund are and will remain public monies.

Therefore, the Sovereign Fund satisfies this requirement.

Sovereign Fund is not a partnership

The Sovereign Fund does not have its own legal personality and forms part of the state property of Country B, which includes forming part of the consolidated state budget of Country B. The Sovereign Fund is not a partnership.

Therefore, Sovereign Fund satisfies this requirement.

Sovereign Fund 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.

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.

Paragraph 79 of LCR 2020/3 lists common examples of public financial entities which includes:

•                banks

•                deposit taking corporations

•                captive financial institutions

•                pension/superannuation funds

•                insurance corporations

•                entities in the business of investment management

•                entities in the business of share trading, and

•                entities in the business of money lending.

The Sovereign Fund consists of public monies which are invested to ensure the stable social and economic development of Country B, accumulate financial assets for future generations, reduce the economy's dependency on certain industries and reduce the impact of adverse external factors.

The procedure for entering assets to the Sovereign Fund and the use of the Sovereign Fund is determined by the Government of Country B. The funds may only be used:

•                as a transfer from the Sovereign Fund to the state budget

•                for covering expenses associated with the management and annual audit of the Sovereign Fund

•                for targeted transfers to the state budget by decision of the Head of State of Country B for financing anti-crisis programs during economic downturn or economic slowdown periods, socially significant projects of national scale and strategically important infrastructure projects in the absence of alternative sources of their financing

•                in the form of payments of target requirements and covering the costs of paying for banking services related to transfers and payments of target savings.

The Sovereign Fund does not undertake other activities which would be analogous to that of a public non-financial entity or public financial entity under subsections 880-130(1) and (2) of the ITAA 1997. Further, the Sovereign Fund is not a type of entity listed in paragraphs 76 or 79 of LCR 2020/3.

Therefore, the Sovereign Fund 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 Sovereign Fund 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.

Sovereign Fund'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 Sovereign Fund will receive Australian interest income, dividend income, fund payments made by a MIT and/or revenue gains made on the disposal of an interest in the test entity from its investment in Australian debt and equity interests in the Test Entities.

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

Sovereign Fund'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 and MITs.

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

Sovereign Fund'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 Sovereign Fund is part of the sovereign entity group of the Government of Country B. At the relevant times (as required by paragraph 880-105(1)(d) of the ITAA 1997), the Sovereign Fund and its sovereign entity group collectively, will hold 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.

Sovereign Fund'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 Sovereign Fund's interests in the Test Entities 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 each Test Entity's operations. Furthermore, the Sovereign Fund'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 Sovereign Fund 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 Entity's 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 Sovereign Fund 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 Sovereign Fund 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