Edited version of private advice

Authorisation Number: 1052307656628

Date of advice: 7 November 2024

Ruling

Subject: Sovereign immunity

Question 1

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

Answer

Yes.

Question 2

Will Article 11 of the Foreign Convention between exempt Entity A, from liability to tax in Australia on interest income received from Commonwealth Government bonds and treasuries from which it ordinarily derives income in the form of interest when made within the parameters contained in the relevant facts and circumstances of this Ruling?

Answer

Yes.

This ruling applies for the following period:

XX July 20XX to XX0 June 20XX

The scheme commences on:

XX July 20XX

Relevant facts and circumstances

Entity A

1.    Entity A was established by Foreign Government legislation.

2.    Entity A forms part of the Foreign Government.

3.    Entity A is a resident of the Foreign Country and is exempt from taxation within the Foreign Country.

4.    Entity A is not engaged in a money lending business.

5.    Entity A has created and entrusted a fund (the Fund) to Entity B in accordance with Foreign Government Legislation. The profits from the Fund are reflected in Entity A's income. The purpose of the Fund is to trade in foreign exchange.

6.    The Fund is financed by the Foreign Government.

Entity B

7.    Entity B is a government agency assigned for Entity A's fund management.

8.    Entity B was established under the Foreign Legislation to manage the assets entrusted by Foreign Government.

9.    Entity B was established with a share capital of Xcontributed by Foreign Government.

10.  Entity B manages the assets entrusted to it and conducts research and surveys potential investments. Entity B will also exchange information with other overseas institutions to achieve its goals.

11.  Entity B under Foreign Legislation will only trade in specified financial securities.

12.  Under Foreign Legislation Entity B's accounts are to be treated separately from Entity A's accounts. Accordingly, the annual report of Entity B does not include the Assets or income, gains and losses from the management of those Assets held on trust for Entity A as the beneficial owner of the Assets.

13.  The profits from management of entrusted assets by Entity B belong to the trust institutions namely the Foreign Government. Thus, the profits from the management of the Assets by Entity B belong to Entity A, which is a part of the Foreign Government.

14.  Entity B have entered into an agreement with Entity A (the Agreement), under which Entity A entrusts assets of the Foreign Government (the Assets) to Entity B. Entity A manages the Assets for Entity A and Entity A is the beneficial owner. Entity B carries out all investment activities under the investment guidelines in the Agreement.

15.  Entity B acts as trustee for Entity A according to the Agreement.

16.  Entity A may demand payment of the profits from the asset management with prior notice to Entity B. If the Entity A does not make a demand for payment, the profits from the management of assets are reinvested by Entity B on behalf of Entity A.

The Agreement

17.  The Agreement is between the trustor Entity A and the trustee Entity B.

18.  Under the Agreement, Entity A entrusts its assets to Entity B. Entity B has a fiduciary duty to manage the entrusted assets in accordance with the Foreign Legislation and the Agreement.

19.  Entity B must separate the accounting of the entrusted assets from its own assets.

20.  Entity B cannot use the entrusted assets as collateral for Entity B or a third party.

21.  The Agreement may be terminated at any time and Entity A may recover the entrusted assets.

Other Relevant Facts

22.  Under Foreign Legislationno corporate tax is imposed on domestic corporations, including state and local governments.

Current Australian investments

23.  Entity A has equity and debt investments in Australian companies and units in Australian trusts.

24.  The Australian equity investments held by Entity A have the following characteristics:

a.    The shares in Australian-resident companies or units in Australian-resident managed investment trusts are listed on the Australian Securities Exchange (ASX).

b.    Entity A holds less than 10% of the total shares on issue of each Australian company and less than 10% of the total units on issue of each Australian trust.

c.     Entity A has no involvement in the day to day management of the business of any of the Australian companies or trusts.

d.    Entity A does not hold a right to appoint a person to a board, committee or similar, either directly or indirectly of any of the Australian companies listed in Appendix 1 and has no right to appoint a director to the Board of Directors of any of the trustee companies for the trusts listed in Appendix 1.

e.    Entity A has not entered into or received any side letters, arrangements or agreements.

f.      Entity A does not or has not held any veto rights on security holder votes.

g.    Entity A does not or has not held any other influence potentially of a kind described in subsection 880-105(6) of the ITAA.

25.  The Australian debt investments held by Entity A have the following characteristics:

a.    Entity A holds less than 10% of the total equity interests on issue of each Australian debt issuer.

b.    Entity A has no involvement in the day to day management of the business of any the Australian debt issuers.

c.     Entity A has not acquired the right to appoint a director to the Board of Directors of any issuing Australian debt issuer.

d.    Entity A has not acquired the right to representation on any investor's representative or advisory committee (or similar) of the Australian Debt Issuer.

e.    Entity A has no ability to direct or influence the operation of the Australian debt issuer outside of the ordinary rights conferred by the debt interest held.

f.      Entity A has no voting rights in respect of the debt investments held.

g.    There are no special relationships or arrangements between Entity A, and the issuers of the Australian debt investments held which affect the amount of interest income that is paid from those investments.

Relevant legislative provisions

Division 880 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Is the ordinary and statutory income derived by Entity A as a return on its Australian investments not assessable and not exempt income due to the operation of section 880-105 of the ITAA 1997?

Summary

Ordinary and statutory income derived by Entity A as a return on the investments 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) 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.

Entity A 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.

Entity A 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.

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.

Entity A is part of the Foreign Government and was created by Foreign Legislation.

Entity A has created a foreign exchange fund which it has entrusted to Entity B. Entity B was established under Foreign Legislation. The purpose of Entity B is to manage funds that is entrusted to it by the Foreign Government.

The Commissioner therefore determines that Entity B is also a foreign government agency and hence a sovereign entity as defined by section 880-15 of the ITAA 1997.

Entity A 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.

In accordance with Foreign Legislation, Entity B was capitalised with government monies.

Entity A and more specifically the Fund it has created is funded by government monies.

The fund entrusted to Entity B is therefore funded with public monies.

All returns on Entity A's investments are public monies

Entity A has entrusted its Assets for investment in Australia to Entity B. Under Foreign Legislation, Entity B is required to invest the Assets through the nominated financial instruments. The assets entrusted to Entity B by Entity A are to be accounted separately from Entity B's assets and other Foreign Government agencies. Additionally, profits from the management of the assets entrusted to Entity A are to be credited to the Foreign Government.

Therefore, the profits from Entity B's investments belong to the Entity A and consequently the Foreign Government and are considered to remain public monies.

Entity A is not a partnership

Entity A is a part of the Foreign Government. Whilst Entity B is a Foreign Government agency entrusted to invest the assets of the Fund created by Entity A, they are not a partnership. As such, it passes this condition.

Entity A 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.

It is noted that 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.

Entity B and the foreign exchange fund it is entrusted was created by Foreign Government to make and acquire investments for the benefit of the Entity A. The foreign exchange fund administered by Entity B is considered a function of the State, that is, to invest the funds of the State in a manner benefitting the obligations of the Entity A.

Entity A does not produce or trade non-financial goods and does not provide services that are not financial services. Entity A does not actively trade in financial assets and liabilities, operate commercially in financial markets or provide services listed in paragraph 880-130(2)(c) of the ITAA 1997. Additionally, the assets that it has entrusted to Entity B have been done so in accordance with the Foreign Government's foreign exchange laws. As such the activities of Entity A and Entity would be considered part of its central banking activities which are excluded from being a public financial entity.

As such, Entity A and Entity B are not considered public non-financial entities or public financial entities and pass the condition in paragraph 880-125(d) of the ITAA 1997.

As Entity A and Entity B satisfy each of the requirements in paragraphs 880-125(a) through (d) of the ITAA 1997 as they are considered sovereign entities that are covered by section 880-125 of the ITAA 1997 for the purposes of paragraph 880-105(1)(a) of the ITAA 1997.

Entity A'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) 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 membershipinterest for the purposes of paragraph 880-105(1)(b) of the ITAA 1997 will include:

1.    dividends - including non-share dividends and dividends that pass through a managed investment trust (MIT)

2.    interest - including interest that passes through a MIT

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

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

The Entity B holds interests in the Test Entities. They are Australian companies, MITs and corporate, securitised, index linked and Government bonds and treasuries from which it ordinarily derives income in the form of dividends, distributions from MITs and interest.

As such, the Entity A will receive amounts which satisfy the requirements of paragraph 880-105(1)(b) of the ITAA 1997.

Entity A'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) 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 listed, are Australian companies or MITs for Australian income tax purposes.

As such, Entity A's income is received from an entity which satisfies the requirements of paragraph 880-105(1)(c) of the ITAA 1997.

Entity A'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/ies 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.

Entity B's and Entity A's interest in the test entities is less than 10%.

As such, Entity B's interest in the investments listed satisfies the requirements of paragraph 880-105(d) of the ITAA 1997.

Entity A's sovereign entity group does not have influence of a kind described in subsection (6)

For an amount of ordinary income or statutory income of a sovereign entity to satisfy paragraph 880-105(1)(e) 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).

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) of the ITAA 1997, 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.

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.

As no other members of Entity A's sovereign entity group (including any entity directly or indirectly owned by the State) hold interests in the investments, the influence considerations are limited to the influence held by Entity B.

In respect of its investments, Entity A does or has not:

a)    have involvement in the day to day management of the business of any of the Australian companies or trusts

b)    hold a right to appoint a person to a board, committee or similar, either directly or indirectly of any of the Australian companies listed in Appendix 1 and has no right to appoint a director to the Board of Directors of any of the trustee companies for the trusts listed in Appendix 1

c)    entered into or received any side letters, arrangements or agreements.

d)    held any veto rights on security holder votes

e)    held any other influence potentially of a kind described in subsection 880-105(6) of the ITAA 1997.

In respect of its debt investments, Entity A does or has not:

a)    have involvement in the day to day management of the business of any the Australian debt issuers;

b)    acquired the right to appoint a director to the Board of Directors of any issuing Australian debt issuer;

c)    acquired the right to representation on any investor's representative or advisory committee (or similar) of the Australian Debt Issuer;

d)    have the ability to direct or influence the operation of the Australian debt issuer outside of the ordinary rights conferred by the debt interest held;

e)    have any voting rights in respect of the debt investments held.

f)     Have any special relationships or arrangements between the Entity A, and the issuers of the Australian debt investments held which affect the amount of interest income that is paid from those investments.

Based upon the above, the sovereign entity group of Entity A does not have influence of a kind described in subsection 880-105(6) of the ITAA 1997 and, therefore, satisfies the requirements of paragraph 880-105(1)(f) 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 amounts of ordinary and statutory income derived by Entity A from its investments, are not assessable and not exempt income.

Question 2

Will Article 11 of the Foreign Convention exempt the Entity A, from liability to tax in Australia on interest income received from Commonwealth Government bonds and treasuries from which it ordinarily derives income in the form of interest and when made within the parameters contained in paragraph 25 of the relevant facts and circumstances of this Ruling?

Summary

Article 11 of the Foreign Convention will exempt the Entity A from liability to tax in Australia on current and future interest income received from Commonwealth Government bonds and treasuries from which income will ordinarily be derived in the form of interest and made within the parameters contained in paragraph 25 of this Ruling.

Detailed reasoning

Non-resident taxpayers will generally be liable to pay income tax under section 4-1 of the ITAA 1997 or withholding tax under section 128B of the ITAA 1936 on Australian sourced income, unless an exemption or exclusion applies.

Australia has entered into treaties with many countries to avoid the incidence of double taxation and fiscal evasion. These treaties are commonly referred to as 'double tax agreements' (DTAs).

The primary legislation governing DTAs in Australia is the International Tax Agreements Act 1953 (Agreements Act). Subsection 4(1) of the Agreements Act incorporates the ITAA 1936 and the ITAA 1997 so that those acts are read as one with the Agreements Act. Subsection 4(2) of the Agreements Act effectively overrides the ITAA 1936 and the ITAA 1997 where there are inconsistent provisions (with some limited exceptions).

The DTA between Australia and Foreign Government is known as the Foreign Convention.

Article 11 of the Foreign Convention specifically deals with interest. The term 'interest' in the Article 11 of the Foreign Convention includes interest from Government securities or from bonds or debentures, whether or not secured by mortgage, interest from any other form of indebtedness, as well as income which is subjected to the same taxation treatment as income from money lent by the law of the Contracting State in which the income arises.

Entity A's has current Australian debt investments in Commonwealth Government bonds and treasuries. Article 11 of the Foreign Convention will apply to these current investments and any future investments when made with the parameters contained in paragraph 25 of this Ruling.

The Foreign Convention states that interest arising in Australia and beneficially owned by a resident of Foreign Country may not be taxed in Australia if the following applies:

Interest derived by the Government of a Contracting State or by any other body exercising governmental functions in or in a part of a Contracting State, or by a bank performing central banking functions in a Contracting State, shall be exempt from tax in the other Contracting State.

In accordance with the Foreign Legislation, Entity A forms part of the Foreign Government and is responsible for managing Foreign Country's national economic policy, finances, fiscal strategies and tax system. Entity A is exempt from taxation for the purposes of foreign taxation.

Entity A has created the Fund and entrusted the Fund to the Entity B in accordance with the Foreign Legislation. The purpose of the Fund is to trade in foreign exchange markets. The Fund is financed by the Foreign Government and the profits from the Fund are reflected in Entity A's income.

Where the current and future investments fall within the parameters contained in paragraph 25 of the relevant facts and circumstances of this Ruling, including that Entity A has no special relationships or arrangements with the issuers of any Australian debt investment and does not enter into the investment for the main purpose of obtaining an advantage by virtue of the operation of Article 11 of the Foreign Convention.

Consequently, interest derived by Entity A on these investments will not be taxable in Australia by virtue of the operation of paragraph 3 of Article 11 of the Foreign Convention.

Conclusion

Interest derived by Entity A from its investments in Commonwealth Government bonds and treasuries will be exempt from tax in Australia under Article 11 of the Foreign Convention.