ECONOMIC AND U.S. INCOME TAX ISSUES RAISED BY SOVEREIGN 

WEALTH FUND INVESTMENT IN THE UNITED STATES 

 

Prepared by the Staff 

of the 

JOINT COMMITTEE ON TAXATION 

 

June 17, 2008 

JCX-49-08 
i 

CONTENTS 

Page

INTRODUCTION ....................................................................................................................... 1 

I. U.S. CROSS-BORDER TRANSACTIONS AND INVESTMENTS ................................ 3 

A. Trade Deficits and Cross-Border Capital Flows......................................................... 3 

B. Trends in the U.S. Balance of Payments................................................................... 10 

C. Trends in the U.S. Financial Account....................................................................... 13 

D. Summary and Implications for Discussion of SWFs................................................ 19 

II. SOVEREIGN WEALTH FUNDS.................................................................................... 21 

A. Background Information........................................................................................... 21 

B. Recent Prominent SWF Investments in the United States........................................ 27 

C. Non-Tax Policy Concerns Raised by SWFs ............................................................. 30 

D. Non-Tax Policy Responses....................................................................................... 33 

III. CURRENT U.S. INCOME TAX RULES ........................................................................ 37 

A. U.S. Income Taxation of Foreign Persons................................................................ 37 

B. U.S. Income Taxation of Foreign Governments....................................................... 41 

C. Application of Income Tax Treaties to Foreign Governments and SWFs................ 56 

IV. TECHNIQUES USED BY SWFs TO INVEST IN UNITED STATES .......................... 63 

A. Mandatory Convertible Securities ............................................................................ 63 

B. Common and Convertible Preferred Stock............................................................... 69 

C. Other Investment Strategies...................................................................................... 71 

V. POLICY CONSIDERATIONS REGARDING THE CURRENT TAX TREATMENT 

OF U.S. INVESTMENT BY FOREIGN GOVERNMENTS .......................................... 73 

A. Economic Policy Considerations .............................................................................. 73 

B. Tax Policy Considerations ........................................................................................ 73 

VI. COMPARISON WITH FOREIGN LAW ........................................................................ 77 

APPENDIX ONE: FOREIGN LAW TAX TREATMENT OF GOVERNMENT 

INVESTMENT........................................................................................................................... A-1 
1 

INTRODUCTION 

This document,1

 prepared by the Staff of the Joint Committee on Taxation, describes the 

economic and U.S. income tax issues raised by sovereign wealth fund (“SWF”) investment in the 

United States. 

The United States has been a net importer of goods and services since 1982. Whenever a 

country imports more than it exports, the currency that its residents use to purchase those imports 

must ultimately return to that country, either as payment for that country’s exports or to purchase 

that country’s assets. Because the United States has been a net importer of goods and services 

for the last quarter century, this economic principle means that U.S. dollars that are used to 

purchase foreign goods and services (net of payments received for exports) must return to the 

United States to purchase U.S. assets. In fact, the relative share of U.S. assets owned by foreign 

investors has steadily increased during the last 25 years, indicating not only that dollars paid for 

net imports have been recycled into purchases of U.S. assets, but also that the rate of investment 

in the U.S. economy by foreign investors has grown in relation to the rate of investment by 

domestic investors. 

Recently, attention has focused on a particular source of cross-border investment in the 

United States—SWFs. In general, SWFs are actively managed, government-owned pools of 

capital originating in foreign exchange assets. SWFs are currently estimated to manage total 

assets of $3 trillion or more, with significant growth anticipated in the next five to 10 years. The 

largest SWFs are controlled by countries with substantial commodity exports or large current 

account surpluses. 

The increasing prominence of SWFs in global finance has raised some policy concerns, 

such as their perceived lack of transparency and the possibility that they may have political 

objectives. At the same time, SWFs are generally recognized as playing a useful role in the 

world economy. International organizations in which the United States participates are 

developing “best practices” guidelines for both SWFs and countries that are the recipients of 

SWF investments. 

In the United States, SWFs may benefit from a long-standing exemption from U.S. 

income tax that applies to certain passive income received by foreign governments. This 

exemption does not apply to income related to commercial activity. The exemption is not 

specifically directed at SWFs, and, in fact, first became part of the U.S. income tax laws in 1917, 

long before the first SWFs were created. 

In addition to existing law’s statutory (and, in respect of some sovereigns, treaty) 

exemption for passive income earned by foreign governments, the United States also exempts 

from income tax, or taxes at reduced rates, many important types of income earned by 

nongovernmental foreign investors. To the extent that a foreign government recognizes income 

 1

 This document may be cited as follows: Joint Committee on Taxation, Economic and U.S. 

Income Tax Issues Raised by Sovereign Wealth Fund Investment in the United States (JCX-49-08), June 

17, 2008. This document can also be found on the internet at www.jct.gov. 
2 

that is not exempt from U.S. income tax under the exception for passive income received by 

foreign sovereigns, the foreign government is treated as a corporate resident of its own country. 

As a result, the U.S. income tax treatment of foreign governments in many cases is 

similar to the U.S. income tax treatment of foreign persons generally. In each case, for example, 

portfolio interest income paid by U.S. obligors generally is exempt from U.S. income tax. Both 

foreign sovereigns and foreign private investors are subject to U.S. net income tax on 

commercial activities conducted directly in the United States. Moreover, the exception for 

passive income earned by foreign sovereigns is not available to a foreign government with 

respect to income that it derives from a controlled subsidiary conducting a commercial business 

in the United States. In that case, the foreign government must rely on the same statutory and 

treaty rules as would apply to a private foreign investor holding the same investment. In 

practice, some of the most important statutory U.S. income tax advantages that a foreign 

sovereign investor enjoys over a foreign private investor are: exemption from U.S. withholding 

tax on all U.S. source dividends paid by noncontrolled corporations; exemption from U.S. 

withholding tax on interest paid by a corporation where the foreign sovereign owns at least 10 

percent (so the general “portfolio interest” exemption is not available) but less than 50 percent 

(so the payor is not “controlled” by the foreign sovereign) of the payor; and exemption from U.S. 

tax on certain gains from real estate transactions. 

The economic analysis presented here suggests that investment in the United States by 

foreign sovereigns, like that of investment by foreign private investors, is a necessary and 

desirable consequence of the long-term trade deficit position of the United States. As noted 

earlier, investments by SWFs or foreign governments more generally raise nontax policy 

concerns, but these fall largely outside the expertise of the Staff of the Joint Committee on 

Taxation. Tax policy considerations addressed in this document include consistency between a 

foreign government’s exemption from U.S. income tax and a foreign country’s immunity from 

the jurisdiction of U.S. courts, the scope of the difference in the U.S. income tax treatment 

between foreign governments and other investors in the United States, and certain issues specific 

to the technical terms of the U.S. income tax exemption for foreign governments. 
3 

I. U.S. CROSS-BORDER TRANSACTIONS AND INVESTMENTS 

SWFs purchase U.S. assets (including stock of U.S. corporations) and make loans to U.S. 

owners of assets. They also may purchase U.S. government bonds. Each of these activities is a 

form of foreign investment in the United States. Such cross-border investment cannot be 

examined without also examining cross-border trade in goods and services and the domestic 

savings rate, as these economic activities are all interrelated. This section discusses the 

economic relationship between trade deficits, capital inflows, investment, and savings in the 

economy. In doing so, it also presents background data relating to the scope of the international 

trade sector in the United States economy, and briefly reviews trends in both the current account 

(the trade surplus or deficit) and the financial account (U.S. investment abroad and foreign 

investment in the United States).2

 

A. Trade Deficits and Cross-Border Capital Flows 

National income accounting

In popular discussion of trade issues, much attention is given to the trade deficit or 

surplus, that is, the difference between the economy’s exports and imports. In the late 1980s, 

just as at present, there was also attention given to inflows of capital from abroad. Capital 

inflows can take the form of foreign purchases of domestic physical (or “real”) assets, or of 

domestic financial assets, such as equity interests or debt instruments. 

These two phenomena, trade balances and capital inflows, are related to each other. 

More generally, trade deficits, capital inflows, investment, savings, and income are all connected 

in the economy. The connection among these economic variables can be examined through the 

“national income and product accounts,” which measure the flow of goods and services and 

income in the economy.3

 2

 Prior to 1999, the U.S. Department of Commerce, Bureau of Economic Analysis reported and 

described international transactions by reference to the “current account” and the “capital account.” 

Beginning in June 1999 the Bureau of Economic Analysis adopted a three-group classification to make 

U.S. data reporting more closely aligned with international guidelines. The three groups are labeled: 

current account; capital account; and financial account. Under this regrouping, the “financial account” 

encompasses all transactions that used to fall into the old “capital account,” that is, the financial account 

measures U.S. investment abroad and foreign investment in the United States. Under the new system, the 

“current account” is redefined by removing a small part of the old measure of unilateral transfers and 

including it in the newly defined “capital account.” The capital account consists of capital transfers and 

the acquisition and disposal of non-produced, non-financial assets. For example, the capital account 

includes such transactions as forgiveness of foreign debt, migrants’ transfers of goods and financial assets 

when entering or leaving the country, transfers of title to fixed assets, and the acquisition and disposal of 

non-produced assets such as natural resource rights, patents, copyrights, and leases. In practice, the 

Bureau of Economic Analysis believes that “capital account” transactions will be small in comparison to 

the current account and financial account. 

3

 The national income and product accounts measure the flow of goods and services (product) 

and income in the economy. The most commonly reported measure of national economic income is gross 
4 

The value of an economy’s total output must be either consumed domestically (by private 

individuals and government), invested domestically, or exported abroad. If an economy 

consumes and invests more than it produces, it must be a net importer of goods and services. If 

the imports are all consumption goods, in order to pay for those imports, the country must either 

sell some of its assets or borrow from foreigners. If the imports are investment goods, foreign 

persons must be the owners or lend money to the owners of these investments. Thus, an 

economy that runs a trade deficit must experience foreign capital inflows, as foreign persons 

purchase domestic assets, make equity investments, or lend funds (purchase debt instruments). 

In other words, if the economy is a net importer, it must attract capital inflows to pay for 

those imports. If the economy is a net exporter, it must have capital outflows to dispose of the 

payments it receives for its exports. For example, when the United States imports more than it 

exports, the United States pays for the imports with dollars. If foreigners are not buying U.S. 

goods or services with the dollars, then they will use the dollars to purchase U.S. assets. 

(Another way of viewing these relationships is that dollars flowing out of the U.S. economy in 

order to purchase goods or to service foreign debt must ultimately return to the economy as 

payment for exports or as capital inflows.) 

The connection between capital flows and the goods and services in the economy can 

also be understood by concentrating on the sources of funds for investment. Investment in the 

United States must come either from domestic saving (that is saving by U.S. persons) or from 

foreign investors. If domestic saving is less than investment in the United States, that difference 

must be attributable to net capital inflows from foreign persons. In government reporting, such 

net capital inflows from foreign persons are termed “net foreign borrowing” even though the 

capital inflows may take the form of either equity investments or loans. 

 

domestic product (“GDP”). Related to GDP is gross national product (“GNP”). GDP can be understood 

as the total annual value of goods and service produced by the U.S. economy, regardless of the nationality 

of the owners of the factors of production (land, labor, and capital) that are required to produce the goods 

and services. GNP, by contrast is the total annual value of goods and services produced anywhere in the 

world where the relevant factors of production are owned by U.S. persons. Thus, wages earned by a U.S. 

resident from temporary work abroad, or dividends received by a U.S. person from an investment in a 

foreign corporation, constitutes part of GNP but not GDP. 
5 

These relationships can be summarized as follows (the equation ignores relatively small 

unilateral transfers such as foreign aid and assumes, without loss of generality, that the 

government budget is balanced): 

Net Foreign Borrowing = Investment - Saving 

Net Foreign Borrowing = (Imports - Exports) - Net Investment Income 

Relation of Trade Deficits to Cross-Border Capital Flow 

In formal terms, the connection between trade deficits and cross-border capital flows is as follows. In 

the following it is useful to use GNP, which includes cross border returns to investment, rather than the more 

commonly reported GDP concept. 

One way to measure GNP is by expenditures on final product. By this measure, 

(1) GNP = C + I + G + (X-M) + NI. 

Equation (1) is an accounting identity which states that gross national product for a period equals the 

sum of private consumption expenditures (C), private investment expenditures on plant, equipment, inventory, 

and residential construction (I), government purchases of goods and services (G), net exports (exports less 

imports of goods and services and net interest payments to foreigners, or X-M), plus net investment income (the 

excess of investment income of U.S. persons received from abroad over investment income paid to foreign 

persons from investments located in the United States), denoted “NI” in equation (1). 

An alternative is to measure GNP by the manner in which income is spent. By this measure, 

(2) GNP = C + S + T. 

Equation (2) is another accounting identity which states that gross national product for a period equals 

the sum of private consumption expenditures (C), saving by consumers and businesses (S), and net tax payments 

to the government (T) (net tax payments are total tax receipts less transfer, interest, and subsidy payments made 

by all levels of government). 

Because both measures of GNP are simple accounting identities, the right hand side of equation (1) 

must equal the right hand side of equation (2). From this observation can be derived an additional national 

income accounting identity: 

(3) I = S + (T - G) + (M - X) - NI 

Equation (3) states that private investment equals private saving (S), plus public saving (T-G) and net 

imports (M - X), less net investment income. An intuitive interpretation of equation (3) is that it requires dollars 

to make investments in the United States and equation (3) identifies the sources of investment dollars. Equation 

(3) identifies private saving by U.S. persons, S, as one source of dollars and government saving, T - G, as 

another source of dollars. The next two terms in equation (3) identify dollars that result from cross-border 

transactions as yet additional sources of potential investment dollars. If imports, M, exceed exports, X, then, on 

net, dollars are in the hands of foreign persons and available for investment in the United States. If the earnings 

of foreign persons from their investments in the United States exceeds the earning of U.S. persons on their 

investments abroad, then NI is negative and, on net, dollars are in the hands of foreign person and available for 

investment in the United States. If the opposite is the case, NI is positive, there are not additional dollars 

available for investment. (If net investment income is reinvested in the economy then that reinvestment of 

course is reflected as savings, S.) 
6 

For this purpose, imports and exports include both goods and services, and net 

investment income is equal to the excess of investment income received from abroad over 

investment income sent abroad.4 The excess of imports over exports is called the “trade deficit” 

in goods and services. Net investment income can be viewed as payments received on 

previously-acquired foreign assets (foreign investments) less payments made to service previous 

net foreign borrowing. 

If the investment in an economy is larger than that country’s domestic saving, the country 

must be running a trade deficit, or the country must be increasing foreign borrowing, or both. 

Similarly, a country cannot run a trade surplus without also exporting capital, either by 

increasing its foreign investments, or by paying down (or reacquiring) previously acquired 

domestic assets or financial claims against the domestic economy held by foreign investors. 

Because the level of net investment income in any year is fixed by the level of previous foreign 

investment (except for changes in interest rates), changes in investment or saving that are 

associated with capital inflows will have a negative impact on a country’s trade balance. 

Economic implications of trade deficits

A trade deficit is not necessarily undesirable; what is important is the present and future 

consumption possibilities of the economy. Those consumption possibilities depend in part on 

whether the trade deficit is financing consumption or investment. 

For example, if a country uncovers profitable investment opportunities, then it will be in 

that country’s interest to obtain funds from abroad to invest in these profitable projects.5 If the 

economy currently does not have enough domestic savings to invest in these projects, it could 

reduce its consumption (generating more domestic saving) or look to foreign sources of funds 

(thus allowing investment without reducing current consumption). 

For example, suppose new oil reserves that could be profitably recovered through 

increased investment are discovered in the United States. The investment may be financed by 

foreigners. In order to invest in U.S. assets, foreigners will have to buy dollars, thus increasing 

the value of the dollar. This dollar appreciation makes U.S. goods more expensive to foreigners, 

thereby reducing their demand for U.S. exports. At the same time, the dollar appreciation makes 

foreign goods cheaper for U.S. residents, increasing the demand for imports and resulting in a 

trade deficit. Eventually, the flow of capital will be reversed, as the U.S. demand for new 

investment falls, and foreigners receive interest and dividend payments on their previous 

investments. 

 4

 This equation in the text can be derived from equation (3) in the text box on page 3 above if the 

government budget is assumed to be balanced, that is, if G = T. It follows that if the government runs a 

deficit, that is, if G>T, for a given level of investment, saving, and net investment income, net foreign 

borrowing must be greater. 

5

 This scenario describes the experience of the United States in the mid to late 1800s, when 

foreign capital inflows financed much of the investment in railroads and other assets. 
7 

The borrowing from foreign investors in the above example was used to finance 

investment. This borrowing did not reduce the living standards of current or future U.S. 

residents, because the interest and dividends that were paid to foreigners came from the return 

from the new investment. The increased capital investment led to increases in labor productivity, 

resulting in higher wages both at that time and in the future. 

If, by contrast, foreign borrowing finances consumption instead of investment, there are 

no new assets created to generate a return that can support the borrowing. When the debt 

eventually is repaid, the repayments will come at the expense of future consumption. 

For instance, consider a situation in which the domestic supply of funds for investment 

decreases because domestic saving rates fall. Foreign borrowing in this case is not associated 

with increased investment, but instead is devoted to investment that was previously financed 

with domestic savings. Because the foreign borrowing is not associated with increased 

investment, future output does not increase, and interest and dividends on the investment will be 

paid to foreign persons at the expense of future domestic consumption. In this case, there may 

be an increase in the standard of living for current U.S. residents at the expense of a decrease in 

the standard of living of future residents. 

The difference between the case where foreign investors fund incremental investment in 

the United States on top of domestic saving and the case where foreign investment simply 

replaces current domestic saving (which instead are currently consumed) can be summarized as 

follows. In the first case, the economy grows faster over time than it would without the 

incremental foreign investment and both U.S. and foreign persons share in that growth. In the 

second case, the economy continues to grow (but not as quickly as the first case) but all the 

future returns to the foreign investment belong to foreign persons. U.S. persons enjoy the 

immediate boost to their standard of living that comes from consuming money that they formerly 

saved, but future residents will not enjoy the returns from the money their predecessors 

consumed rather than saved. 

During the period that foreign borrowing finances U.S. consumption, the United States 

runs a trade deficit. Although the United States could service its growing foreign debt by 

increased borrowing, and thereby generating larger trade deficits, in the long run trade deficits 

cannot keep growing. In fact, the United States must eventually run a trade surplus. If the 

United States imported more goods than it exported every year, there also would be an inflow of 

foreign capital every year. As the capital inflow grew from year to year, so would costs of 

servicing the claims held by foreign investors (e.g., interest on U.S. debt instruments). 

Eventually, foreigners would be unwilling to continue investing in the United States, and the 

value of the dollar would fall. The fall in the dollar would eliminate the trade deficit, and the 

United States would eventually run a trade surplus, so that the current account deficit (the sum of 

the trade deficit in goods and services and the net interest on foreign obligations) would be small 

enough for foreigners to be willing to lend again to the United States.6

 6

 An alternative adjustment would require U.S. interest rates to rise to make it more attractive for 

foreigners to invest in the United States. The rise in interest rates could also encourage increased 
8 

Even when foreign investment finances domestic consumption, trade deficits and capital 

inflows themselves should not necessarily be viewed as undesirable, because the foreign capital 

inflows help to keep investment in the domestic economy, and hence labor productivity, from 

falling. (As noted in the preceding paragraph, however, this pattern cannot continue 

indefinitely.) For instance, the large inflow of foreign capital to the United States in the 1980s is 

widely viewed to have been a result of low U.S. saving rates. If the mobility of foreign capital 

had been restricted (through capital or import controls, for example), then the low saving rate 

could have led to higher domestic interest rates and lower rates of investment. That decreased 

investment would have led to decreases in future living standards because the lower growth rate 

of the capital stock would have resulted in lower growth rates of U.S. labor productivity. In this 

instance, the fact that foreign capital was not restricted and did finance U.S. investment helped 

mitigate some of the negative effects on economic growth of low domestic saving. 

The above observations support the argument that the trade deficit does not in itself 

provide a useful measure of international competitiveness, since trade deficits and trade 

surpluses can be either good or bad for the United States. The oil discovery example discussed 

above shows that even increases in a country’s stock of exportable goods can have ambiguous 

effects on the trade deficit. If the discovery of oil also increases the demand for investment, then 

the trade deficit may actually increase in the short run. Increases in natural resources, advances 

in technology, increases in worker efficiency, and other wealth-enhancing innovations have 

ambiguous effects on the trade deficit in the short and medium run. Because these innovations 

increase the productivity of U.S. workers and lower production costs, they increase the 

attractiveness of U.S. goods, and may result in increased exports. To the extent these 

innovations increase the demand for investment, however, they can have the opposite effect on 

the trade deficit. Nonetheless, each of these innovations increases the output of the economy, 

and hence the incomes of U.S. residents. 

The balance of payments accounts, presented in Table 1, are analogous to a sources and 

uses of funds statement of the United States with the rest of the world. As demonstrated above, 

the current account balance, which consists primarily of the trade balance, should be exactly 

offset by the capital account and financial account balances, which measure the net inflow or 

outflow of capital to or from the United States. The difference between the current account 

surplus or deficit and the capital and financial accounts deficit or surplus is recorded as a 

statistical discrepancy. Problems of measurement, which have been large in some years, cause 

the accounts to be somewhat mismatched in practice, but basic patterns are unlikely to be 

significantly distorted by these problems. The subsequent sections examine trends in the current 

account and financial account in more detail.

 

domestic savings, helping to reduce the need for foreign investment funds. Some combination of dollar 

devaluation and rising interest rates is also possible. 
9 

Table 1.–International Transactions of the United States, Selected Years, 

1975-2007 

(Dollars in Billions Nominal) 

 1975 1985 1995 2000 

Current Account Balance Exports of Goods and Services  Merchandise  Services  Receipts from U.S. assets abroad Imports of Goods and Services  Merchandise  Services  Payments on foreign-owned U.S. assets 

18.1 

157.9107.1 

25.5 25.4 

132.7

98.2 22.0 12.6 

-118.2 

387.6215.9 

73.2 98.5 

483.8338.1 

72.9 72.8 

-109.9 

1,005.9

575.2 219.2 211.5 

1,081.8

749.4 141.4 191.0 

-444.7 

1,418.6

772.2 293.5 352.9 

1,809.11,224.4 

217.0 367.7 

-

1,2,1,

Unilateral Transfers 7.1 22.0 34.1 54.1 Financial Account Balance Foreign Investment in the United States  Direct Investment  Private non-direct investment  Official 

-22.5 

17.2

2.6 7.5 7.0 

101.3 146.1

19.7 

127.5 

-1.1 

113.3 465.7

57.8 

298.0 109.9 

443.2 

1,024.2

287.7 700.2 

37.6 

1,

U.S. Investment Abroad  Direct Investment  Private non-direct investment  Increase in government assets 

39.714.2 21.1 

4.3 

44.818.9 19.1 

6.7 

352.4

98.8 

242.9 

10.7 

581.0152.4 427.3 

1.2 

Capital Account Transactions, net n.a. 0.3 0.4 0.7 Statistical Discrepancy 4.4 16.5 3.8 0.7 Source: Christopher L. Bach, “U.S. International Transactions in 2007,” Survey of Current Business, 88, April 2008, and earlier edition

Current Business. n.a. - not applicable. 

1 Preliminary Figures for 2007.
10 

B. Trends in the U.S. Balance of Payments 

Overview of U.S. balance of payments (current account)

Foreign trade has become increasingly important to the United States economy. Figure 1 

presents the value of exports from the United States and imports into the United States as a 

percentage of GDP for the period 1960-2007. As depicted in Figure 1, exports and imports each 

have risen from less than six percent of GDP in 1960 to more than 16 percent in 2007. Imports 

have consistently exceeded 15 percent of U.S. GDP since 1997. Figure 1 also shows that the 

United States generally was a net exporter of goods and services prior to 1982. Since that time, 

the United States has been a net importer of goods and services. 

Figure 1.–Exports and Imports as a Percentage of United States GDP,

1960-2007

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

19601962

19641966196819701972

197419761978

1980

1982

1984

1986

19881990

1992199419961998

2000

200220042006

Year

Percentage of GDP

Exports as a Percentage of GDP

Imports as a Percentage of GDP

Source: Department of Commerce, Bureau of Economic Analysis. 
11 

The net trade position of a country is commonly summarized by its current account. The 

U.S. current account as a whole, which compares exports of goods and services and income 

earned by U.S. persons on foreign investments to imports of goods and services and income 

earned by foreign persons on their investments in the United States (plus unilateral remittances), 

generally was positive from 1960 through 1981, but generally has been in deficit since 1982. 

Figure 2 reports the current account balance of the United States for the period 1960 through 

2007 as a percentage of GDP to eliminate the effect of inflation on reported nominal figures. 

Figure 2 reflects a substantial reduction in the current account deficit for 1992. In that year, the 

United States received substantial payments from abroad related to the Persian Gulf War. 

Figure 2.–United States Current Account as a Percentage of GDP,

1960-2007

-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

1960

1962

1964

1966

1968

1970

1972

1974

197619781980

1982

1984

1986

1988

1990

19921994

1996

1998

2000

20022004

2006

Percentage of GDP

Source: Department of Commerce, Bureau of Economic Analysis. 
12 

Components of the current account

Merchandise trade, trade in services, and income from investments

The aggregate data reported in Figure 1 and Figure 2 mask differences in the trade 

position of various sectors of the economy. As explained above, the current account compares 

exports of goods and services and payments of income earned by U.S. persons on foreign 

investments to imports of goods and services and payments of income earned by foreign persons 

on their investments in the United States. 

Several different trends are embedded within the data. Measuring the trade deficit in real, 

inflation adjusted year 2000 dollars, as has been widely reported, the merchandise (goods only) 

trade deficit has been over $400 billion per year since 2000 and over $650 billion per year the 

last three years. On the other hand, the United States has been a net exporter of services since 

the 1970s. This surplus in trade in services has averaged more than $60 billion per year (real, 

2000 dollars) since 2002. Also, throughout the entire period covered in Figure 2, U.S. receipts of 

income on investments abroad have exceeded payments of income to foreign persons on their 

U.S. investments (see Figure 3, below). 

Figure 3.–Receipts of Income from Investments Abroad and U.S. Payments

to Foreign Persons on Investments in the U.S., 1960-2007

(Millions of Real 2000 Dollars)

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Year

Dollars in Millions

U.S. receipts from abroad

U.S. payments to foreigners

Source: Department of Commerce, Bureau of Economic Analysis. 
13 

C. Trends in the U.S. Financial Account 

Overview of the United States’ financial account

As explained above, when the United States imports more than it exports, the dollars the 

United States uses to buy the imports must ultimately return to the United States as payment for 

U.S. exports or to purchase U.S. assets. As Figure 2 and Table 1 document, the U.S. current 

account has been in deficit since the early 1980s. As a direct result, the United States changed 

from being a modest exporter of capital in relation to GDP to being a large importer of capital. 

In addition, the domestic saving rate has declined. As a consequence of both of these trends, net 

foreign investment has become a larger proportion of the economy and a more significant 

proportion of total domestic investment than in the past. In 2007, gross investment in the United 

States was $2.59 trillion and net foreign investment was $712 billion, or 27.5 percent of gross 

domestic investment. In 1993, net foreign investment comprised 6.1 percent of gross domestic 

investment. 

Net foreign investment in the United States is measured by the U.S. financial account. 

The financial account measures the increase in U.S. assets abroad compared to the increase in 

foreign assets in the United States. Figure 4 plots the annual increase of U.S. assets abroad and 

of foreign assets in the United States in constant dollars for the period 1960-2007 in constant 

2000 dollars. Foreign assets in the United States increased by $1.20 trillion in 2005, $1.86 

trillion in 2006, and $1.86 trillion in 2007 in nominal dollars. At the same time, foreign assets 

owned by U.S. persons increased by $427 billion in 2005, $1.06 trillion in 2006, and $1.21 

trillion in 2007 (nominal dollars). 

Figure 4.–Annual Increase in U.S. Assets Abroad and in Foreign Assets

in U.S., 1960-2007, in Constant 2000 Dollars

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

19801982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Year

Dollars in Millions

increase in U.S. owned assets abroad

increase in foreign owned assets in the U.S.

Source: Department of Commerce, Bureau of Economic Analysis. 
14 

Growth in foreign-owned assets in the United States and U.S.-owned assets abroad

Overview

Measured in nominal dollars, the amount of foreign-owned assets in the United States 

grew at an annual rate of more than 13 percent per year between 1981 and 2006. The total 

amount of foreign-owned assets in the United States exceeded $16 trillion by the end of 2006.7

 

The recorded value of U.S.-owned assets abroad grew less rapidly during the same period. The 

Department of Commerce reports that in 1976 the amount of U.S.-owned assets abroad exceeded 

foreign-owned assets in the United States by $165 billion. By the mid-1980s, however, the 

situation had reversed, so that the amount of foreign-owned assets in the United States exceeded 

U.S.-owned assets abroad. By 2006, the amount of foreign-owned assets in the United States 

exceeded U.S.-owned assets abroad by $2.5 trillion.8 The value of investments abroad by private 

U.S. persons has grown from $693 billion in 1980 to $12.23 trillion in 2006.9

 The rate of growth 

of private U.S. investment abroad has not been as rapid as the rate of growth in the value of 

investments by foreign persons in the United States. Foreign non-official holdings of U.S. assets 

has grown from $393 billion in 1980 to $12.35 trillion in 2006. 

These investments are measured at their so-called “current cost.”10 Some argue that the 

market value of U.S.-owned assets abroad is similar to, or greater than, the market value of 

foreign-owned assets in the United States, if market values were measured accurately.11 Figure 5 

and Figure 6 display the value of U.S.-owned assets abroad and foreign-owned assets in the 

United States for selected years measured in constant dollars under both current cost and based 

on estimates of current market values. Regardless of whether this argument is correct with 

respect to the current net investment position, it is clear that foreign-owned U.S. assets are 

growing more rapidly than U.S.-owned assets abroad, as depicted in Figure 6. 

 7

 U.S. Department of Commerce, Bureau of Economic Analysis, “International Investment 

Position of the United States at Year-End, 1976-2006.”

8

 Ibid. 

9

 This figure values the direct investment at current cost. Both the 1980 and 2006 values are 

reported in nominal dollars. 

10 The Bureau of Economic Analysis estimates the values of U.S. foreign direct investment 

abroad and foreign direct investment in the United States using three different bases: historical cost, 

current cost, and market value. Using the historical cost base, assets are measured according to values 

carried on taxpayers’ books. Thus, investments reflect the price level of the year in which the asset was 

acquired. Under the current cost measure, a parent’s share of its affiliates’ tangible assets (property, 

plant, and equipment and inventories) is revalued from historical cost to replacement cost. Under the 

market value measure, an owner’s equity in foreign assets is revalued to current market value using 

indexes of stock prices. 

11 The distinction between book valuation and market valuation is only relevant for the category 

of investment labeled “direct investment,” not for “portfolio investment.” The distinction between direct 

and portfolio investment is explained in the text below. 
15 

Figure 5.–International Investment Position of the United States,

1982, 1994, and 2006 in Constant 2000 Dollars

(Direct Investment at Current Cost)

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

1982 1994 2006

Year

Millions of Dollars

U.S. owned assets abroad Foreign owned in the U.S.

Figure 6.–International Investment Position of the United States,

1982, 1994, 2006 in Constant 2000 Dollars

(Direct Investment at Market Value)

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

1982 1994 2006

Year

Millions of Dollars

U.S. owned assets abroad Foreign owned in the U.S.

Source: Department of Commerce, Bureau of Economic Analysis. 
16 

Direct investment, non-direct (portfolio) investment, and official investment

Foreign-owned assets in the United States (and U.S.-owned assets abroad) can be 

categorized as direct investment, non-direct investment, and official assets. Direct investment 

constitutes assets over which the owner has direct control. The Department of Commerce 

defines an investment as direct when a single person owns or controls, directly or indirectly, at 

least 10 percent of the voting securities of a corporate enterprise or the equivalent interests in an 

unincorporated business. 

The largest category of outbound and inbound investment is non-direct investment held 

by private (non-governmental) foreign investors, commonly referred to as portfolio investment. 

For most of the past decade, foreign portfolio investment annually has exceeded foreign direct 

investment, making portfolio investment responsible for the majority of growth in foreign 

ownership of U.S. assets. Foreign portfolio investment consists mostly of holdings of corporate 

equities, corporate and government bonds, and bank deposits. The portfolio investor generally 

does not have control over the assets that underlie the financial claims. Foreign investment in 

bonds, corporate equities, and bank deposits, like other types of financial investment, provide a 

source of funds for investment in the United States but also represent a claim on future U.S. 

resources. 

The final category of foreign-owned U.S. assets or U.S.-owned foreign assets is official 

assets: in the former case, for example, U.S. assets held by governments, central banking 

systems, and certain international organizations. The foreign currency reserves of other 

governments and banking systems, for example, are treated as official assets. Figure 7, below 

reports the value of these different categories as estimated for the close of 2006. 

Figure 7.–International Investment Position by Type of Investment

Trillions of Dollars

2006

0.0

2.0

4.0

6.0

8.0

10.0

12.0

U.S. Holdings of Foreign Assets Foreign Holdings of U.S. Assets

Trillions in Dollars

Direct Investment Portfolio Investment Official Reserve Assets

Source: Department of Commerce, Bureau of Economic Analysis. 
17 

Foreign persons held direct investments of $2.1 trillion in the United States in 2006, 

having grown from $127 billion in 1980.12 In 2006, portfolio assets of foreign persons in the 

United States were more than four times the recorded value of direct investment, $10.2 trillion 

compared to $2.1 trillion, respectively. Bank deposits account for nearly one-third of this total 

($3.3 trillion), and reflect, in part, the increasingly global nature of banking activities. Levels of 

foreign-held official assets have grown substantially since 2002. In 2002, foreign official assets 

were estimated to be $1.25 trillion. In 2006, foreign official assets were estimated to be $2.77 

trillion. 

As has been the case for foreign investors in U.S. assets, over the past decade U.S. 

investors’ portfolio holdings of foreign assets has increased more rapidly than U.S. foreign direct 

investment. At year-end 2006, U.S. foreign direct investment constituted approximately onequarter of U.S. ownership of foreign assets, with foreign direct investment valued at $2.89 

trillion and portfolio investment valued at $9.34 trillion (with direct investment measured at 

current cost). Measured at current cost, the value of U.S. direct investment abroad has remained 

above the value of foreign direct investment in the United States. (See Figure 8.) Measured at 

market value, the value of foreign direct investment in the United States and the value of U.S. 

direct investment abroad were estimated to have been comparable for 1998-2002, but recent 

preliminary estimates place the value of U.S. owned foreign direct investment in excess of 

foreign owned direct investments in the United States. (See Figure 9.) 

 12 This values the direct investment at current cost. The Bureau of Economic Analysis estimate 

for 2006, when valued at market value, is $3.2 trillion. 
18 

Figure 8.–Year-End Value of Foreign Direct Investment in the United States

and U.S. Direct Investment Abroad, 1982-2006

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Year

Millions of Dollars

U.S. Direct Investment Foreign Direct Investment

Figure 9.–Year-End Value of Foreign Direct Investment in the United States

and U.S. Direct Investment Aborad, 1982-2006

(Millions of Real 2000 Dollars at Maket Value)

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Year

Millions of Dollars

U.S. Direct investment abroad Foreign direct investment in the U.S.

Source: Department of Commerce, Bureau of Economic Analysis. 
19 

D. Summary and Implications for Discussion of SWFs 

As explained in Section I.A, above, when domestic saving is less than investment in the 

United States, investment dollars flow into the United States from abroad. Between 1960 and 

the present, the rate of investment in the United States has ranged from 17.1 percent to 22.7 

percent of GDP, and has exceeded 18.4 percent for the past decade. Over the same period, the 

domestic saving rate, which was never less than 20 percent of GDP in the 1960s, has not exceed 

14.5 percent of GDP since 2002. The result, as documented in Figure 10, below, has been an 

increase in the country’s annual net foreign borrowing to finance investment in the United States. 

(In this regard, remember that the term “annual net foreign borrowing” includes equity 

investments.) 

Figure 10.–Saving, Investment, and Net Foreign Borrowing as a Percentage of U.S. GDP 

1960-2007

-10%

-5%

0%

5%

10%

15%

20%

25%

1960196219641966196819701972197419761978198019821984198619881990199219941996

19982000200220042006

Year

Percentage of GDP

savings

investment

net foreign borrowing

Source: U.S. Department of Commerce, Bureau of Economic Analysis, “Saving and Investment 2007.” 

 As must be the case, and as documented in Figure 2, an increasing current account 

(trade) deficit has accompanied the increases in net foreign borrowing, thereby supplying foreign 

persons with dollars that are returned to the United States as investment dollars. In short, the 

declining domestic saving rate and increasing trade deficit dictate that the dollar depreciate or 

foreign investment in the United States increase, or both. 

SWFs are one source of foreign investment dollars, but this observation does not mean 

that the declining U.S. saving rate or large annual U.S. trade deficits necessarily cause SWFs to 

acquire U.S. assets. Even if the U.S. did not have a trade deficit and the U.S. were a net foreign 
20 

investor (as was the case prior to 1982), rather than a net foreign borrower, SWFs, like other 

foreign investors, might well acquire U.S. assets for multiple economic reasons, such as global 

diversification of investment risk. The current economic climate does, however, require that 

dollars held abroad by foreigners return to the United States as capital inflows. 

The data presented above document that foreign persons are increasing their ownership of 

U.S.-based assets more rapidly that U.S. persons are increasing ownership of foreign assets. 

These ownership claims by foreigners take the form of directly controlled assets and portfolio 

assets, with portfolio assets the dominant share. As discussed in Section II, SWFs make 

portfolio and directly controlled investments. In this respect, SWFs are making investment 

choices similar to other private foreign investors in U.S. assets. 
21 

II. SOVEREIGN WEALTH FUNDS 

A. Background Information 

This section provides background information on SWFs, including common definitions 

of a SWF, the largest SWFs, the size of SWF assets in relation to other major sources of 

investment capital, and the principal non-tax policy concerns raised by SWF investment. The 

staff of the Joint Committee on Taxation has consulted multiple publicly available sources of 

data about SWFs but has not conducted independent research to verify the accuracy of the data 

presented below. 

During the second half of 2007 and in early 2008, SWFs based in Asian and Middle 

Eastern countries made a series of significant investments in United States financial institutions. 

These investments have attracted considerable attention, both in the financial and mainstream 

media and among policymakers in Congress and the Administration. The Senate Committee on 

Banking, Housing, and Urban Affairs (“Senate Banking Committee”) has held two hearings on 

SWF investment in the United States, one in November 2007 and one in April 2008.13 In 

February 2008 the Joint Economic Committee held a hearing on the same topic.14 More 

recently, the Senate Committee on Foreign Relations convened a hearing on foreign relations 

issues related to SWF activities.15 At the request of Senator Richard Shelby, ranking member of 

the Senate Banking Committee, the Government Accountability Office is conducting an 

investigation into the size and scope of SWFs, whether SWF investment in the United States is 

effectively monitored, and the application of existing U.S. law to that investment.16 The 

International Monetary Fund (“IMF”) and Organisation of Economic Co-operation and 

Development (“OECD”) have also undertaken significant policy initiatives in response to the 

rapid growth of SWFs in recent years. 

SWF defined

There is no single, widely agreed upon definition of a SWF. Broadly speaking, however, 

SWFs are actively managed, government-owned pools of capital originating in foreign exchange 

 13 U.S. Senate Committee on Banking, Housing, and Urban Affairs, “Sovereign Wealth Fund 

Acquisitions and Other Foreign Government Investment in the U.S.: Assessing the Economic and 

National Security Implications,” Nov. 14, 2007; “Turmoil in U.S. Credit Markets: Examining the U.S. 

Regulatory Framework for Assessing Sovereign Investments,” Apr. 24, 2008. 

14 U.S. Congress, Joint Economic Committee, “Do Sovereign Wealth Funds Make the U.S. 

Economy Stronger or Pose National Security Risks,” Feb. 13, 2008. 

15 U.S. Senate Committee on Foreign Relations, “Sovereign Wealth Funds: Foreign Policy 

Consequences in an Era of New Money,” June 11, 2008. 

16 See “Proliferation of Multibillion-Dollar Foreign Investments in US Banks Raises Concerns,” 

International Herald Tribune, Jan. 15, 2008. 
22 

assets. Two more specific definitions developed by the U.S. Department of the Treasury and the 

IMF focus, respectively, on the sources and objectives of SWF investment. 

The Treasury Department has described SWFs as government investment vehicles that 

are funded by foreign exchange assets and that are managed separately from official reserves.17 

The Treasury Department divides SWFs into two categories based on the source of a fund’s 

foreign exchange assets. One category is composed of commodity funds, and the other category 

is composed of non-commodity funds. A commodity fund’s assets are generated by exports of 

commodities owned or taxed by the government (for example, state-owned crude oil). A noncommodity fund’s assets are produced by transfers from the government’s official foreign 

exchange reserves. These transfers have been made possible by large current account surpluses 

in non-commodity exporting countries, Asian countries in particular. A distinction between 

SWFs and traditional reserve assets, according to the Treasury Department, is that SWFs 

typically are invested in assets that have higher expected rates of return than are the traditional 

reserves. 

Like the Treasury Department, the IMF defines SWFs as government-owned investment 

funds established for a variety of purposes and funded by foreign exchange assets. The IMF, 

however, distinguishes among SWFs based on the funds’ objectives. 18 The IMF has identified 

five categories of SWFs. Stabilization funds are intended to insulate an economy against 

commodity price changes. Savings funds invest capital from nonrenewable commodity assets in 

diversified portfolios designed to benefit future generations. Reserve investment corporations 

are funded by assets that are counted as official reserve assets, and those assets are invested in a 

manner intended to increase returns above ordinary returns on reserves. Development funds are 

established to promote socio-economic projects or industrial policies intended to increase a 

country’s economic growth. Contingent pension reserve funds are organized to satisfy 

contingent government pension liabilities (from sources other than individual pension 

contributions).19

 17 U.S. Department of the Treasury, Office of International Affairs, Semiannual Report on 

International Economic and Exchange Rate Policies, June 2007, Appendix 3: Sovereign Wealth Funds. 

18 International Monetary Fund, Monetary and Capital Markets Policy Development and Review 

Departments, “Sovereign Wealth Funds – A Work Agenda” 4-6 (Feb. 29, 2008) [hereinafter IMF Work 

Agenda]. 

19 Observers classify some but not all government pension funds as SWFs. A report published 

by the OECD divides government pension funds (which it refers to as “public pension reserve funds” or 

“PPRFs” rather than as contingent pension reserve funds) into two categories, social security reserve 

funds (“SSRFs”) and sovereign pension reserve funds (“SPRFs”). In this categorization, an SSRF is part 

of a government’s overall social security system and is funded by payroll taxes, and an SPRF is 

established by the government but is completely apart from the government’s social security system and 

instead is funded by direct fiscal transfers by the government. Unlike SSRFs, SPRFs are organized to 

finance public pension expenditures at a designated future date and in some cases are not permitted to 

make payouts for decades. SPRFs established for future pension expenditures may, in this view, be 

considered SWFs. A prominent example of an SPRF that is widely considered to be an SWF is Norway’s 
23 

Existing SWFs

According to various publicly available data sources, the size of SWF holdings is large in 

absolute terms and in comparison with the size of global hedge fund and private equity fund 

holdings but is small relative to the amount of assets managed by private institutional investors 

and relative to the amount of financial assets worldwide. Based on information available as of 

February 2008, the IMF has estimated that the amount of total assets under management by 

SWFs ranges from $2.093 trillion to $2.968 trillion.20 A more recent study by analysts at JP 

Morgan Chase Bank estimates SWF assets under management at the end of 2007 as in the range 

of $3.0 trillion to $3.7 trillion.21 By comparison, global financial assets (bonds, equities, and 

bank assets) in 2006 amounted to $190 trillion.22 The chart below shows the composition of 

these financial assets. 

Figure 11.–Global Capital Markets, 2006 

U.S. Dollars in Billions

Commercial Bank Assets 

$70,860.5 

Stock Market Capitalization 

$50,826.6 

Public Debt Securities 

$25,634.7 

Private Debt Securities 

$43,099.7 

Source: International Monetary Fund, “Global Financial Stability Report” 139 (Oct. 2007). 

 

Government Pension Fund - Global. Adrian Blundell-Wignall, Yu-Wei Hu, & Juan Yermo, “Sovereign 

Wealth Fund and Pension Issues,” Financial Market Trends, OECD (2008). 

20 IMF Work Agenda at 7. 

21 David G. Fernandez & Bernhard Eschweiler, JP Morgan Research, “Sovereign Wealth Funds: 

A Bottom-Up Primer” 7 (May 22, 2008) [hereinafter JP Morgan Report]. 

22 International Monetary Fund, “Global Financial Stability Report” 139 (Oct. 2007). 
24 

The amount of SWF assets is dwarfed by the amount of assets held in insurance, mutual 

funds, and pensions, but is greater than the amount of assets managed by private equity firms and 

hedge funds. The chart below provides a comparison.23

Figure 12.–Global Assets Under Management, 2006

$25,967

$21,765

$17,392

$2,800

$1,460 $800

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

Pension Assets Mutual Funds Insurance Companies Sovereign Wealth

Funds

Hedge Funds Private Equity

U.S. Dollars in Billions

Source: International Financial Services, London. The $800 billion estimate for private equity is as of 2007, not 2006. 

Although SWFs are small relative to overall global financial assets and in comparison 

with certain classes of assets, commentators have projected that SWF assets will grow rapidly. 

According to the IMF, foreign assets under SWF management could increase to $6 trillion to $10 

trillion by 2013.24 The recent JP Morgan study mentioned previously makes roughly similar 

 23 The data in the chart are from the following reports of International Financial Services, 

London: Pension Markets 2008, Jan. 2008, available at 

http://www.ifsl.org.uk/upload/PB_Pension_markets_2008.pdf; Fund Management 2007, Oct. 2007, 

available at http://www.ifsl.org.uk/upload/CBS_Fund_Management_2007.pdf; Sovereign Wealth Funds 

2008, Mar. 2008, available at http://www.ifsl.org.uk/upload/CBS_Sovereign_Wealth_Funds_2008.pdf; 

and Hedge Funds 2007, Apr. 2007, available at 

http://www.ifsl.org.uk/upload/CBS_Hedge_Funds_2007.pdf. 

24 IMF Work Agenda at 6. 
25 

projections, ranging from $5.0 trillion to $9.3 trillion in 2012.25 The chief currency economist at 

Morgan Stanley has forecast that SWF assets could reach $12 trillion by 2015 and could surpass 

the amount of official foreign currency reserves by 2011.26 A Standard Chartered Bank 

projection has found that SWF assets could total $13.4 trillion within the next decade.27

With limited exceptions, the largest SWFs are held by commodity exporting countries 

and by Asian countries with large current account surpluses. The following table shows the 

largest SWFs and estimates of the amount of assets managed by the funds.28 This table is based 

on publicly-available data the accuracy of which has not been independently verified by the staff 

of the Joint Committee on Taxation. 

 25 JP Morgan Report at 11. 

26 Stephen Jen, Morgan Stanley Global Economic Forum, “How Big Could Sovereign Wealth 

Funds Be By 2015,” available at http://www.morganstanley.com/views/gef/archive/2007/20070504-

Fri.html#anchor4840. 

27 Gerard Lyons, Standard Chartered Bank, “State Capitalism: the Rise of Sovereign Wealth 

Funds” 5 (Oct. 15, 2007). 

28 No Latin American country appears in the table. According to the IMF, Venezuela has a SWF, 

the Macroeconomic Stabilization Fund, with $800 million in assets, and Chile has two SWFs, the 

Economic and Social Stabilization Fund and the Pension Reserve Fund, with $14.9 billion and $1.5 

billion in assets, respectively. IMF Work Agenda at 7. A recent news article reports that the government 

of Brazil intends to organize a SWF with assets generated by newly discovered coastal oil reserves in the 

South Atlantic Ocean. The fund could have as much as $200 billion to $300 billion in three to five years 

and is intended to limit inflation and to prevent the Brazilian currency from becoming overvalued. 

Jonathan Wheatley & Richard Lapper, “Brazil in $200bn Sovereign Fund Plan,” Financial Times, June 9, 

2008, at 6. 
26 

Table 2.–Largest SWFs 

FUND Assets 

(Dollars in Billions) 

Abu Dhabi Investment Authority $650 - $7001

Norway Government Pension Fund Global $3822

Saudi Arabia Public Investment Fund $289 - $3803

Singapore Government Investment Corporation $100 - $3304

Kuwait Reserve Fund for Future Generations/General 

Reserve Fund $2255 

China Investment Corporation $2006

Russia Reserve Fund/National Wealth Fund $1627

Singapore Temasek Holdings $1088

Australian Future Fund $579

Libyan Investment Corporation $5010

Algeria Reserve Fund/Revenue Regulation Fund $4311

Qatar State Reserve Fund/Stabilization Fund $30 - $5012

Alaska Permanent Fund $3713

1

 Landon Thomas Jr., “Cash-Rich, Publicity-Shy, Abu Dhabi Fund Draws Scrutiny,” New York Times, Feb. 28, 2008, at C1 

(citing bankers, former employees, and analysts familiar with the fund). A widely cited estimate is that the Abu Dhabi 

Investment Authority may have as much as $875 billion in assets under management. See Stephen Jen, Morgan Stanley 

Research, “Sovereign Wealth Funds” 8 (Mar. 2008) [hereinafter Morgan Stanley SWF Estimates]. Jen called this figure and 

figures for other funds his “guesstimates as of February 2008.” 2

 Norges Bank, available at http://www.norges-bank.no/Pages/Article____41397.aspx?print=true. The $382 billion amount was 

the size of the fund on March 31, 2008 based on the U.S. dollar-Norwegian krone exchange rate on that day. The Norwegian 

government’s revised national budget for 2007 forecasts that the fund will grow to $484 billion by January 1, 2009 (based on the 

March 31, 2007 exchange rate). Id. 3

 The Saudi Arabian capital consists of the government’s official foreign exchange reserves and therefore is considered under 

some definitions (such as the Treasury Department’s) not to be a SWF. The $289 billion figure is from IMF Work Agenda at 7. 

The $380 billion number is from Andrew England, “Saudis to Launch $5.3 Billion Sovereign Fund,” Financial Times, Apr. 28, 

2008. England notes that the Public Investment Fund is forming a SWF that will be managed separately from the government’s 

official reserves and will make portfolio investments similar to those undertaken by other SWFs. 4

 The web site of the Government Investment Corporation states that the company manages “well above US$100 billion.” See 

http://www.gic.com.sg/aboutus.htm. The $330 billion estimate is from Morgan Stanley SWF Estimates. 5

 Reuters, Factbox, “Kuwait’s KIA: History, Holdings, and Strategy,” Jan. 15, 2008, available at 

http://www.reuters.com/articlePrint?articleID=USL1517206420080115. 6

 “China Launches US$200 Billion Government Investment Fund,” International Herald Tribune, Sept. 28, 2007. 7

 Gregory L. White, Bob Davis, and Marcus Walker, “Russian Fund Rattles West,” Wall Street Journal, May 7, 2008, at A1. 8

 Temasek Holdings, http://www.temasek.com.sg. The $108 billion amount is as of March 31, 2007 and is calculated using the 

Singapore dollar-U.S. dollar exchange rate on that day. 

9

 Australian Government Future Fund, http://www.futurefund.gov.au. The $57 billion amount is as of April 30, 2008 and is 

calculated using the Australian dollar-U.S. dollar exchange rate on that day. 10 IMF Work Agenda at 7. 

11 Id. 12 Id. 13 Alaska Permanent Fund, http://www.apfc.org.
27 

B. Recent Prominent SWF Investments in the United States 

In the midst of a weak economy, a serious downturn in the housing market, and severe 

credit market problems, U.S. firms received a large volume of investments from abroad in 2007, 

in significant part from SWFs.29 According to news reports, foreign investors invested $414 

billion in 2007 in U.S. companies, including both private deals and purchases of publicly-traded 

stock.30 SWFs accounted for at least $21.5 billion of that investment. 

Much of this SWF investment was in U.S. financial institutions, and a large portion of 

that financial institution investment occurred in a series of high-profile transactions announced in 

November and December 2007.31 Two large transactions also were announced in January 2008. 

On November 26, Citigroup Inc. announced that Abu Dhabi Investment Authority was investing 

$7.5 billion for a 4.9 percent stake in the company.32 On December 19, Morgan Stanley 

announced that the China Investment Corporation would pay $5 billion for a 9.9 percent share of 

the company.33

Five days later, Merrill Lynch & Co. Inc., Inc. announced it was selling up to $6.2 billion 

in stock to Singapore’s Temasek Holdings and Davis Selected Advisers.34 Temasek’s share of 

the deal was a $4.4 billion initial stock purchase plus an option to buy $600 million in additional 

stock by March 28.35

 29 Peter S. Goodman & Louise Story, “Overseas Investors Buy Aggressively in U.S.,” New York 

Times, Jan. 20, 2008, at A1. 

30 Id.

31 Non-U.S. financial firms also received SWF investment. The largest announced transaction 

was a $9.7 billion investment in Swiss bank UBS AG by the Government of Singapore Investment 

Corporation. Mark Landler & Julia Werdigier, “UBS Records a Big Write-Down and Sells a Stake,” 

New York Times, Dec. 11, 2007, at C1. The $9.7 billion investment represented a nine percent stake in 

UBS. An unnamed Middle Eastern investor also made a $1.8 billion investment in the bank. 

32 See Citigroup Inc., Current Report on Form 8-K, filed with the Securities Exchange 

Commission on November 27, 2007, available at 

http://www.sec.gov/Archives/edgar/data/831001/000114420407064349/v095633_ex99-1.htm. 

33 See Morgan Stanley, Current Report on Form 8-K, filed with the Securities Exchange 

Commission on December 27, 2007, available at 

http://www.sec.gov/Archives/edgar/data/895421/000115752307012287/a5568797ex991.htm. 

34 See Merrill Lynch & Co. Inc., Current Report on Form 8-K, filed with the Securities Exchange 

Commission on December 27, 2008, available at 

http://www.sec.gov/Archives/edgar/data/65100/000095012307017127/y45445exv99w1.htm. 

35 Id.
28 

On January 15, 2008, two large deals were announced: Citigroup Inc. announced that it 

would receive $12.5 billion from a group of investors including the Government of Singapore 

Investment Corporation Pte. Ltd. and the Kuwait Investment Authority, and Merrill Lynch & 

Co., Inc. received $6.6 billion from a group that includes the Kuwait Investment Authority and 

the Korean Investment Corporation.36

The structures of the recent SWF investments in U.S. financial institutions, and their U.S. 

federal income tax consequences, are described in Section IV below. 

One recent analysis identified 420 publicly-reported equity investments made by SWFs 

since 2000, totaling $114 billion.37 Of these investments, 87 percent involved purchasing equity 

interests of 10 percent or greater in the target company. Both this recent analysis and other news 

reports emphasize, however, that SWF equity investments in the United States may involve less 

visible stakes. Some recent news reports, for example, have concluded that SWFs, fearing losses 

on financial institution investments and concerned about political backlash in recipient countries, 

have been reluctant to make highly publicized investments and have instead engaged in lowerprofile activity such as investment through private equity funds.38 The lower-profile activity has 

included equity investment in a fund that bought distressed mortgage debt from UBS; 

acquisitions of stakes in U.S. real estate investment trusts; and possible direct investment in U.S. 

real estate by the Kuwait Investment Authority, the Qatar Investment Authority and other 

SWFs.39 In this vein, the recent JP Morgan report referred to above forecasts that SWFs will 

allocate increasingly large amounts of capital to alternative investment vehicles such as private 

equity funds and hedge funds and by the end of 2012 could account for as much as 17 percent of 

 36 See Citigroup Inc., Current Report on Form 8-K, filed with the Securities Exchange 

Commission on January 15, 2008, available at 

http://www.sec.gov/Archives/edgar/data/831001/000110465908002663/a08-1948_1ex99d1.htm; Merrill 

Lynch & Co., Inc., Current Report on Form 8-K, filed with the Securities Exchange Commission on 

January 15, 2008, available at 

http://www.sec.gov/Archives/edgar/data/65100/000095012308000429/y46693exv99w1.htm. 

37 William Miracky et al, Monitor Group, “Assessing the Risks: The Behaviors of Sovereign 

Wealth Funds in the Global Economy” (June 2008). See also Bob Davis, “Sovereign-Wealth Funds Seek 

Control,” Wall Street Journal, June 6, 2008, at C2. 

38 Henny Sender, “Sovereign Funds Fuel Black Rock’s UBS Deal,” Financial Times, May 31, 

2008, at 1 [hereinafter FT, Black Rock]; Henny Sender, “Temasek Refused to Rescue Bear Days Before 

its Sale to Morgan,” Financial Times, June 5, 2008, at 1. 

39 FT, Black Rock. A very recent article reports on negotiations over a higher profile real estate 

acquisition – the possible $800 million purchase of a 90-percent stake in the Chrysler Building in New 

York by the Abu Dhabi Investment Corporation. See Daniel Pimlott, “Abu Dhabi Fund Sets Sights on 

Chrysler Building,” Financial Times, June 12, 2008, at 19. In May, real estate developer Harry 

Macklowe agreed to sell the General Motors Building and three other New York buildings for $3.95 

billion to Boston Properties and investors that were expected to include the Kuwait Investment Authority 

and the Qatar Investment Authority. See Daniel Pimlott & Justin Baer, “Macklowe Sells GM Building,” 

Financial Times, May 25, 2008. 
29 

the amount of capital in those alternatives.40 A very recent example of this investment is the 

reported agreement by China’s State Administration of Foreign Exchange (which oversees most 

of China’s $1.6 trillion in official foreign exchange reserves) to invest more than $2.5 billion in a 

fund sponsored by the private investment firm Texas Pacific Group, Inc.41

 40 JP Morgan Report at 16. 

41 Henny Sender, “$2.5bn China Investment in TPG Could Be Private Equity Landmark,” 

Financial Times, June 11, 2008, at 1. 
30 

C. Non-Tax Policy Concerns Raised by SWFs 

SWFs have emerged as prominent participants in global finance. Some of the funds 

provide little information to the public about their holdings, investment strategy and 

performance, management, or size, while others are more transparent.42 The prominence of 

SWFs and their lack of uniform information disclosure have caused policymakers to express 

three related concerns about the effects of SWF investment in the United States and in other 

countries that receive SWF investment. These concerns are described below.43

Political objectives

The lack of transparency regarding SWF investment activities has given rise to a concern 

that the funds may pursue objectives that are not strictly commercial. Although SWFs have 

stated investment goals – for example, fiscal stabilization or saving for future generations – 

because they are instruments of sovereign nations, it is possible that they will consider foreign 

policy goals as well when making foreign investments. Governments might see opportunities to 

use large pools of capital managed by SWFs to secure access to strategic assets such as natural 

resources or defense-related technologies. Policymakers therefore have stated that SWFs might 

pose perceived or actual problems for national security in the United States and other countries 

that receive SWF investment.44

 42 See IMF Work Agenda at 8. The Norway Government Pension Fund Global is widely seen as 

very transparent, while the Abu Dhabi Investment Authority is considered opaque. For an evaluation of 

how much information various SWFs provide, see Gerard Lyons, Standard Chartered Bank, “State 

Capitalism: the Rise of Sovereign Wealth Funds” 7-8 (Oct. 15, 2007). The president and chief 

investment officer of the China Investment Corporation, which has been viewed as secretive, has 

indicated that the corporation is attempting to become more transparent. John Thornhill, “Chinese Fund 

Tries to Calm West’s Fears,” Financial Times, June 4, 2008. 

43 Reports in the mainstream media also have described private and official expressions of 

concern. See, e.g., “The World’s Most Expensive Club,” The Economist, May 26, 2007, at 40; 

“Sovereign Wealth Funds: Asset-Backed Insecurity,” The Economist, Jan. 17, 2008, at; Gregory L. 

White, Bob Davis, & Marcus Walker, “Russian Wealth Fund Rattles West,” Wall Street Journal, May 7, 

2008, at A1. 

44 See, e.g., Under Secretary for International Affairs David H. McCormick, testimony before the 

Joint Economic Committee, Feb. 13, 2008, press release HP-823, available at 

http://www.treas.gov/press/releases/hp823.htm [hereinafter McCormick JEC Testimony]; U.S. 

Department of the Treasury, Office of International Affairs, Semiannual Report on International 

Economic and Exchange Rate Policies, Dec. 2007, Appendix 2: Sovereign Wealth Funds, at 2 

[hereinafter Treasury Seminannual Report]; Organisation for Economic Co-operation and Development, 

Investment Committee Report, “Sovereign Wealth Funds and Recipient Country Policies” 2-3 (Apr. 4, 

2008) [hereinafter OECD Recipient Country Report]; IMF Work Agenda at14-15. 
31 

Effects on markets and governance

SWFs have large amounts of capital, often seek long-term rather than short-run returns, 

and, by contrast with hedge funds and other private investment vehicles, to date have not relied 

on extensive leverage. Consequently, they are well-positioned to increase stability in financial 

markets, particularly in times of market stress. Policymakers have recognized this stabilizing 

role,45 a role evident in connection with the significant SWF investments in U.S. financial 

institutions made in late 2007 and early 2008 (described in Section II.C. above) at a time when 

credit concerns were acute. 

Although SWFs recently have helped stabilize markets, policymakers have expressed 

concern that because of their sheer size, SWFs could invest in ways that cause volatility in 

markets and disruptions in economies.46 Even rumors of SWF transactions could cause market 

volatility as other participants react to news.47 Policymakers also have argued that SWFs might 

be able to use their status as instrumentalities of governments to compete unfairly with private 

actors, perhaps through explicit or perceived government guarantees of their financial 

commitments.48 There has, however, been little or no evidence that SWFs have caused market 

volatility or economic disruptions or have gained unfair competitive advantages.49

The form of SWF investments also has raised concerns relating to corporate governance. 

Where SWFs take large but purely passive stakes in portfolio companies, and, perhaps because 

of concern about hostile responses to perceived SWF activism, choose not to exercise voting 

right or other mechanisms of shareholder control, governance of the portfolio companies could 

be weakened.50

Finally, SWF investment activities may have global macroeconomic effects involving 

monetary conditions, balance of payments, and stability of current and capital accounts. These 

effects have been described elsewhere.51

 45 McCormick JEC Testimony; Treasury Semiannual Report, at 2; IMF Work Agenda, at 12-13. 

46 See, e.g., McCormick JEC Testimony; Treasury Semiannual Report, at 2-3; IMF Work 

Agenda, at 13. 

47 Id.

48 See IMF Work Agenda at 15. 

49 But see news reports about the Norway Government Pension Fund Global selling short 

Icelandic bank bonds and causing protest in Iceland. “Sovereign Wealth Funds: Asset-Backed 

Insecurity,” The Economist, Jan. 17, 2008, at 12. 

50 IMF Work Agenda, at 15. 

51 Id. at 10-12. 
32 

Protectionist reactions

SWFs’ perceived or actual strategic behavior and their potential effects on markets has 

prompted concern among policymakers that the United States and other countries that receive 

SWF investments might consider adopting broad protectionist financial markets policies.52 

Restrictions on foreign investment in the United States could have harmful effects on the 

economy and foreign relations. 

Economic harm would be possible because the United States relies on foreign capital.53 

As described in Section I, the United States is a net importer of goods and services. It must pay 

for those goods and services by attracting foreign capital. This foreign capital either finances 

consumption or is used for investment in the United States. Restrictions on foreign capital could 

result in decreased current or future living standards in the United States. Living standards could 

be reduced if, among other possible scenarios, a continued low U.S. savings rate and reductions 

in foreign investment resulted in less total investment in the United States and a reduction in the 

rate of growth of U.S. productivity. 

Restrictions on foreign capital could damage foreign relations as well as the U.S. 

economy. Restrictions could prompt U.S. trading partners to adopt their own protectionist 

policies. These protectionist policies would exacerbate economic and political harms. 

 52 See, e.g., McCormick JEC Testimony; Treasury Semiannual Report, at 2; OECD Recipient 

Country Report. 

53 Economic harm could occur even if the United States were a net capital exporter. Retaliation 

by foreign governments in the form of investment restrictions could reduce income growth in the United 

States if otherwise available foreign investment opportunities were foreclosed. 
33 

D. Non-Tax Policy Responses 

Countries that receive SWF investments and countries that have SWFs in recent months 

have extensively discussed the non-tax policy issues related to SWF investment. Although few 

countries have adopted rules that specifically address the treatment of foreign government 

investment,54 there have been numerous unilateral expressions of policy views.55 In addition, the 

OECD has recently developed guidance on recipient country policies toward SWF investment, 

and the IMF has undertaken a project to develop guidance on best practices for SWFs. These 

efforts are described below. First, existing U.S. rules and recent U.S. policy responses are 

summarized. 

U.S. rules and recent activity

In the United States, rules of general application in various substantive areas may apply 

to investments by SWFs. These rules include securities regulations; rules applicable to regulated 

financial industries such as banking and insurance; antitrust laws; and market structure and 

behavior rules in strategic industries such as defense, energy, media, and telecommunications.56 

More targeted rules apply to U.S. investment by foreign persons. In particular, the 

Committee on Foreign Investment in the United States (“CFIUS”), which is chaired by the 

Treasury Department, reviews certain foreign direct investments in the United States, including 

investment by SWFs, that raise national security issues. CFIUS review has been made more 

stringent by the Foreign Investment and National Security Act of 2007 (“FINSA”).57 Among 

other changes, FINSA (1) formally establishes CFIUS by statute (whereas previously, CFIUS 

had existed only by executive order) and specifies certain high-ranking government officials 

(such as the Attorney General and the Secretaries of Homeland Security, Commerce, Defense, 

 54 The OECD has found that four of the 30 OECD members have laws restricting foreign 

government controlled investment. Several member countries have broad investment review procedures 

that may consider foreign government control as a relevant factor. Two member countries specifically list 

this control as a criterion in investment review procedures. One member country considers foreign 

government control to be a relevant factor in antitrust reviews of proposed mergers. OECD Recipient 

Country Report, p. 4. For a general discussion of the rules in selected jurisdictions governing foreign 

investment, including an overview of the U.S. rules, see U.S. Government Accountability Office, Report 

to the Honorable Richard Shelby, Ranking Member, Committee on Banking, Housing, and Urban Affairs, 

U.S. Senate, “Foreign Investment: Laws and Policies Regulating Foreign Investment in 10 Countries 

(GAO-08-320), Feb. 2008. 

55 For a summary of recent policy expressions by American and European officials, see Martin 

A. Weiss, “Sovereign Wealth Funds: Background and Policy Issues for Congress,” CRS Report for 

Congress, Mar. 26, 2008, at 15-18. 

56 See Alan W. Granwell & Akemi Kawano, “Sovereign Wealth Funds: Tell Me More . . . and 

More” (slide presentation), American Bar Association Section of Taxation, May Meeting, Washington, 

DC, May 9, 2008. 

57 Pub. L. No. 110-49, July 26, 2007. 
34 

State, and Energy) as members of CFIUS; (2) formalizes a CFIUS national security review 

process for any transaction that might result in foreign control of persons engaged in interstate 

commerce in the United States; (3) provides, as part of the formal review process, a 30-day 

CFIUS review of any covered transaction to determine the effects of the transaction on national 

security and to address any threat to national security; (4) subject to certain exceptions, requires 

an additional 45-day investigation in certain cases, including when a transaction involves a 

foreign government controlled company or would result in foreign control over critical 

infrastructure; (5) requires that certain high-level officials certify to Congress that for any 

transaction for which CFIUS has completed a review, CFIUS has determined there are no 

unresolved national security concerns; (6) adds to the list of factors that CFIUS should consider 

in its reviews and investigations the potential effect a transaction could have on critical 

infrastructure, energy assets, or critical technologies; and (7) requires annual reporting to 

Congress on the activities of CFIUS, including information about the transactions that have been 

reviewed during the preceding 12 months. In April 2008 the Treasury Department issued 

proposed rules to implement FINSA.58 Among other rules, these regulations define control in 

functional terms as the ability to exercise certain powers over important matters affecting a 

business, and they provide that a foreign person does not control an entity if it owns 10 percent 

or less of the voting interest in the entity and holds the interest solely for the purpose of 

investment. 

On March 19, 2008 the Treasury Department reached an agreement with the governments 

of Singapore and Abu Dhabi on policy principles for SWFs and for countries receiving SWF 

investment.59 These principles are intended to support the OECD and IMF initiatives described 

below. For SWFs, the principles include basing investment decisions only on commercial 

grounds; greater information disclosure; strong governance structures; fair competition with the 

private sector; and respect for host-country rules. For recipient countries, the principles include 

avoidance of protectionist barriers to portfolio or direct investment; predictable investment 

frameworks; nondiscrimination among investors; lack of intrusion into investor decisions; and a 

narrow scope for restrictions based on national security concerns. 

In public statements, Treasury Department and other government officials have 

emphasized the general importance of keeping the United States open to foreign investment and, 

more specifically, the receptiveness of the United States to SWF investment.60

 58 Regulations Pertaining to Mergers, Acquisitions, and Takeovers by Foreign Persons, 73 Fed. 

Reg. 21861-02 (Apr. 23, 2008). 

59 See “Treasury Reaches Agreement on Principles for Sovereign Wealth Fund Investment with 

Singapore and Abu Dhabi,” press release HP-881, Mar. 20, 2008, available at 

http://www.treas.gov/press/releases/hp881.htm. See also U.S. Department of the Treasury, Office of 

International Affairs, “Semiannual Report on International Economic and Exchange Rate Policies,” May 

2008, Appendix: Sovereign Wealth Funds. 

60 E.g., McCormick JEC Testimony. In a Treasury Department press release announcing the 

agreement with the Abu Dhabi and Singapore governments, Treasury Secretary Henry M. Paulson, Jr. is 

quoted as saying, “The U.S. welcomes sovereign wealth fund investment.” 
35 

OECD guidance on recipient country policies

In the fall of 2007 the G7 Finance ministers and the other OECD member countries asked 

the OECD to develop guidance for recipient countries’ policies toward SWF investment. The 

OECD has responded to this request by undertaking work through the OECD Investment 

Committee’s ongoing project entitled, “Freedom of Investment, National Security, and 

‘Strategic’ Industries.” Discussions under the Freedom of Investment project occur three times a 

year. One of the discussions in the next year will include a session on government-controlled 

investors. 

In April, the Investment Committee issued a report that describes agreed principles for 

recipient countries’ treatment of SWF investment.61 The report acknowledges recipient 

countries’ concerns about national security, but it catalogs the potential economic benefits of 

SWFs for home and recipient countries. The agreed principles for the treatment of SWF 

investment are based on established and more broadly applicable OECD investment policy 

principles. In brief, the principles are the following: 

• Non-discrimination: This principle calls on governments to provide measures of 

general application that treat similarly situated investors in a similar manner. Any 

measures taken to address national security concerns raised by individual investments 

should be narrowly tailored. 

• Transparency and predictability: Regulatory goals and practices should be as open as 

possible so that outcomes are predictable. Transparency includes, among other 

features, codification and easy accessibility of rules and regulations; public notice of 

intended changes in investment policies; consultation with interested parties when 

governments are considering policy changes; time limits on review of foreign 

investments; and public disclosure of investment policy actions. 

• Regulatory proportionality: Investment restrictions and conditions on transactions 

should be no broader than necessary to protect national security and should be 

avoided when other measures can address security concerns. 

IMF work on SWF best practices

In October 2007, the IMF’s International Monetary and Financial Committee (“IMFC”) 

asked the IMF to establish a dialogue on identifying a set of best practices for the management of 

SWFs.62 The IMF has since taken several steps toward the goal of producing best practices 

guidelines. In November 2007 the IMF convened a “Roundtable of Sovereign Asset and 

 61 OECD Recipient Country Report. The existing principles are embodied in two OECD 

investment documents, the OECD Code of Liberalisation of Capital Markets (1961) and the OECD 

Declaration on International Investment and Multinational Enterprises (1976, revised 2000). 

62 Communiqué of the International Monetary and Financial Committee of the Board of 

Governors of the International Monetary Fund, Oct. 20, 2007. 
36 

Reserve Managers” that was attended by representatives of central banks, finance ministries, and 

SWFs from 28 countries. The roundtable included a discussion of policy, institutional, and 

operational issues related to SWFs. A February 2008 IMF paper sets forth an agenda for 

developing best practices.63 At a March meeting the IMF Executive Board conducted its first 

policy discussion of SWFs and approved the agenda.64 The agenda calls for the establishment of 

an international working group of SWFs and an April 2008 roundtable to start technical 

discussions and drafting work related to best practices guidelines. This international working 

group (the “IWG”) was organized, and the roundtable was held on April 30 and May 1, 2008. 

The IWG is comprised of representatives from 25 IMF member countries, and one of the cochairmen is an official with the Abu Dhabi Investment Authority.65 According to the agenda 

approved in March, a draft of best practices could be prepared by August 2008 for discussion 

over the following two months and could be submitted to the Executive Board for discussion in 

advance of the IMF’s 2008 annual meeting.

 63 IMF Work Agenda. 

64 IMF Survey Magazine: In the News, “IMF Board Endorses Work Agenda on Sovereign 

Funds,” Mar. 21, 2008, available at 

http://www.imf.org/external/pubs/ft/survey/so/2008/NEW032108A.htm. 

65 International Monetary Fund, “International Working Group of Sovereign Wealth Funds is 

Established to Facilitate Work on Voluntary Principles,” Press Release No. 08/97, May 1, 2008, available 

at http://www.imf.org/external/np/sec/pr/2008/pr0897.htm. 
37 

III. CURRENT U.S. INCOME TAX RULES 

A. U.S. Income Taxation of Foreign Persons 

U.S. persons (i.e., citizens and residents) generally are subject to U.S income taxation on 

their worldwide income, without regard to whether the income is U.S. or foreign source. In 

contrast, foreign persons (i.e., nonresident alien individuals or foreign corporations) are taxable 

only on (i) U.S.-source income and limited categories of foreign-source income that is 

effectively connected with the conduct of a U.S. trade or business and (ii) other U.S.-source 

income that is fixed or determinable annual or periodic (“FDAP”) income. 

The Code provides rules for determining the source of income.66 For example, interest 

and dividends paid by a U.S. citizen or resident or by a U.S. corporation generally are considered 

U.S.-source income. Conversely, dividends and interest paid by a foreign corporation generally 

are treated as foreign-source income. Special rules apply to treat as foreign-source income (in 

whole or in part) interest paid by certain domestic corporations with foreign businesses and to 

treat as U.S.-source income (in whole or in part) dividends paid by certain foreign corporations 

with U.S. businesses. Rents and royalties paid for the use of property in the United States are 

considered U.S.-source income. 

Income effectively connected with a U.S. trade or business

Income of a foreign person that is effectively connected with the conduct of a trade or 

business in the United States67 generally is subject to U.S. tax in the same manner and at the 

same rates as income of a U.S. person.68 Deductions are allowed to the extent that they are 

related to effectively connected income.69 Generally, only U.S.-source income is treated as 

effectively connected with the conduct of a U.S. trade or business. However, certain limited 

categories of foreign-source income are treated as effectively connected if the income is 

attributable to an office or other fixed place of business maintained by the foreign person in the 

United States.70

 66 Secs. 861-863, 865. Unless otherwise provided, all section references are to the Internal 

Revenue Code of 1986, as amended (the “Code”). 

67 Partners in a partnership and beneficiaries of an estate or trust are treated as engaged in the 

conduct of a trade or business within the United States if the partnership, estate, or trust is so engaged. 

Sec. 875. In addition, the activities of a foreign person’s agents may be imputed to the foreign person 

such that the foreign person will be treated as engaged in a U.S. trade or business. See, e.g., Lewenhaupt 

v. Commissioner, 20 T.C. 151 (1951), aff’d per curiam, 221 F.2d 227 (9th Cir. 1955). Whether an agent’s 

activities are imputed to a principal for this purpose depends, to a large extent, on the degree of control 

the principal exercises over the agent. 

68 Secs. 871(b)(1), 882(a)(1). 

69 Secs. 873(a), 882(c)(1)(A). 

70 Sec. 864(c)(4). 
38 

The Code includes provisions intended to ensure that a foreign corporation operating a 

U.S. trade or business in branch form is subject to two levels of U.S. income tax, just as a foreign 

corporation operating a U.S. trade or business as a domestic subsidiary would be. Thus, a 

foreign corporation is subject to a flat 30-percent branch profits tax on its “dividend equivalent 

amount,” which is a measure of the effectively connected earnings and profits of the corporation 

that are removed in any year from the conduct of its U.S. trade or business.71 In addition, a 

foreign corporation is subject to a flat 30-percent branch-level excess interest tax on the excess 

of the amount of interest that is deducted by the foreign corporation in computing its effectively 

connected income over the amount of interest that is paid by its U.S. trade or business.72

The question whether a foreign person is engaged in a U.S. trade or business has 

generated a significant body of case law. Basic issues involved in the determination include 

whether the activity constitutes business rather than investing, whether sufficient activities in 

connection with the business are conducted in the United States, and whether the relationship 

between the foreign person and persons performing functions in the United States with respect to 

the business is sufficient to attribute those functions to the foreign person. 

Income from disposition of U.S. real property interests

Special U.S. tax rules apply to gains and losses of foreign persons attributable to 

dispositions of interests in U.S. real property.73 For this purpose, U.S. real property includes 

both (a) an interest in real property located in the United States or the Virgin Islands and (b) an 

interest in a U.S. real property holding corporation (“USRPHC”).74 An interest in a USRPHC is 

an interest in a domestic corporation in which the value of its U.S. real property interests is equal 

to at least 50 percent of the value of the sum of its worldwide real property interests and its other 

assets used or held for use in its trade or business. 

In effect, the FIRPTA rules treat the ownership of U.S. real property interests as a U.S. 

trade or business. Thus, these rules generally provide that gain or loss of a foreign person from 

the disposition of a U.S. real property interest is taken into account for U.S. tax purposes as if 

such gain or loss were effectively connected with a U.S. trade or business during the taxable 

year.75 Accordingly, foreign persons generally are subject to U.S. tax on any gain from a 

 71 Sec. 884(a). 

72 Sec. 884(f). 

73 The rules governing the imposition and collection of tax on such dispositions are contained in 

a series of provisions that were enacted in 1980 and that are collectively referred to as the Foreign 

Investment in Real Property Tax Act (“FIRPTA”). Secs. 897, 1445, 6039C, 6652(f). Prior to the 

enactment of the FIRPTA provisions, foreign persons could invest in U.S. real property without being 

subject to U.S. income tax upon the eventual disposition of such property. 

74 Sec. 897(c)(1). 

75 Sec. 897(a). 
39 

disposition of a U.S. real property interest at the same rates that apply to similar income received 

by U.S. persons.76

Interests in certain real estate investment trusts (“REITs”), which would otherwise 

constitute USRPHCs, are excluded from the definition of U.S. real property interest.77 This 

exception applies if a REIT is domestically controlled (i.e., less than 50 percent of the value of 

its outstanding stock is held (directly or indirectly) by foreign persons during the relevant testing 

period—typically, the five-year period ending on the date of the transaction at issue). The 

consequence of this exclusion is that sales of the REIT interests by foreign persons generally are 

not subject to U.S. income tax. 

A look-through rule provides that any distribution by a qualified investment entity 

(“QIE”), including a REIT, to a nonresident alien individual, foreign corporation, or other QIE 

shall, to the extent attributable to gain from sales or exchanges by the QIE of U.S. real property 

interests, be treated as gain recognized by such nonresident alien individual, foreign corporation, 

or other QIE from the sale or exchange of a U.S. real property interest.78 This rule does not 

apply to any distribution to a nonresident alien individual or a foreign corporation with respect to 

any class of stock that is regularly traded on an established U.S. securities market if such 

individual or corporation owns no more than five percent of such class of stock at any time 

during the one-year period ending on the date of such distribution. 

As a general rule, nonrecognition provisions apply under the FIRPTA provisions only in 

the case of an exchange of a U.S. real property interest for an interest the sale of which would be 

taxable under the Code (for example, another U.S. real property interest). The Code generally 

imposes a withholding obligation on the transferee when a U.S. real property interest is acquired 

from a foreign person.79

Income not effectively connected with a U.S. trade or business

A foreign person’s FDAP income (including, for example, interest, dividends, rents, 

royalties, salaries, and annuities) that is not effectively connected with the conduct of a U.S. 

trade or business is subject to U.S. tax at a rate of 30 percent of the gross amount paid.80 These 

rules generally do not apply to gain from the sale, exchange, or other disposition of property.81 

 76 In the case of foreign corporations, the gain from a disposition of a U.S. real property interest 

may also be subject to the branch profits tax at a 30-percent rate (or a lower treaty rate). 

77 Sec. 897(h)(2). 

78 Sec. 897(h)(1) 

79 Sec. 1445. 

80 Secs. 871(a), 881(a). 

81 See T.D. 8734, 1997-2 C.B. 109, 128 (stating that the “only clear exception” from FDAP is for 

gain from the disposition of property); see also Treas. Reg. sec. 1.1441-2(b)(2)(i) (excepting such gains 
40 

The tax on FDAP income generally is collected by means of withholding by the person making 

the payment to the foreign person receiving the income.82 A foreign person’s foreign-source 

income and non-FDAP income, not effectively connected with the conduct of a U.S. trade or 

business, are not subject to U.S. tax. 

Specific statutory exemptions from the 30-percent withholding tax on FDAP income are 

provided. The most significant of these is the exemption for certain interest paid on portfolio 

obligations.83 Portfolio interest generally is defined as any U.S.-source interest (including 

original issue discount), not effectively connected with the conduct of a U.S. trade or business, 

(1) on an obligation that satisfies certain registration requirements or specified exceptions 

thereto, and (2) that is not received by a 10-percent shareholder. This exception is not available 

for any interest received either by a bank on a loan extended in the ordinary course of its 

business (except in the case of interest paid on an obligation of the United States), or by a 

controlled foreign corporation from a related person. Moreover, this exception is not available 

for certain contingent interest payments. 

In addition to the portfolio interest exemption, certain original issue discount and certain 

interest on deposits with banks or savings institutions are exempt from the 30-percent 

withholding tax.84 Original issue discount on obligations maturing in six months or less is also 

exempt.85

An income tax treaty between the United States and a foreign country may reduce or 

eliminate the 30-percent gross-basis withholding tax on certain payments, including certain 

dividends and interest. A tax treaty also may permit the United States to tax a foreign person’s 

income from business operations only to the extent the income is attributable to that person’s 

permanent establishment in the United States. 

 

from the withholding rules). As noted above, however, gains from the disposition of interests in U.S. real 

property generally are taxed as effectively connected with the conduct of a U.S. trade or business. 

82 Secs. 1441, 1442. 

83 Secs. 871(h), 881(c). 

84 Secs. 871(i)(2)(A), 881(d). 

85 Sec. 871(g)(1)(B)(i). 
41 

B. U.S. Income Taxation of Foreign Governments 

The Code exempts from U.S. income tax certain income of foreign governments under 

section 892 and foreign central banks of issue under section 895. Longstanding regulations 

provide additional guidance with respect to the scope of these exemptions. U.S. income tax 

treaties provide additional relief from U.S. income tax in certain circumstances. 

History of the exemption

Sovereign immunity principle

It is a well-established principle of international law that one country is immune from the 

jurisdiction of the courts of another country.86 The scope of that immunity evolved in the 

twentieth century from an absolute theory of immunity to a restrictive theory of immunity. 

Under an absolute theory of immunity, a country enjoys immunity in all cases; under a restrictive 

theory of immunity, a country is denied immunity in certain cases, such as those arising out of 

the commercial activities of that country. This evolution in the theory of immunity reflected the 

fact that governments were increasingly engaging in commercial activities. 

The U.S. Supreme Court recognized the principle of sovereign immunity as early as 

1812.87 In The Schooner Exchange, the Court stated that each nation has exclusive and absolute 

jurisdiction within its own territory and that all exceptions thereto must derive from the consent, 

either express or implied, of that nation. The Court further stated that: 

One sovereign being in no respect amenable to another; and being bound . . . not 

to degrade the dignity of his nation, by placing himself or its sovereign rights 

within the jurisdiction of another, can be supposed to enter a foreign territory only 

under an express license, or in the confidence that the immunities belonging to his 

independent sovereign station, though not expressly stipulated, are reserved by 

implication, and will be extended to him.88

Throughout the remainder of the nineteenth century and into the twentieth century, U.S. 

courts generally applied an absolute theory of immunity. In the 1940s, the Supreme Court stated 

that it was a guiding principle for courts, in determining whether to exercise or surrender 

 86 See Restatement (Third) of the Foreign Relations Law of the United States 390 (1987). This 

immunity from jurisdiction is not the same as immunity from local law. “In general, unless otherwise 

provided by special agreement, activities of a foreign state, whether they are ‘governmental’ or 

‘commercial’ in character, are subject to local law, though as to the former the foreign state is immune 

from enforcement of that law by domestic courts, administrative bodies, or police action.” Id. at 439. As 

a practical matter, immunity from jurisdiction may make it difficult for one state to enforce its local law 

with respect to another state. However, a state may still give effect to its laws by certain nonjudicial 

measures, the most widespread of which is withholding of tax. Id. at 440; see also id. at 325. 

87 The Schooner Exchange v. McFaddon, 11 U.S. (7 Cranch) 116 (1812). 

88 Id. at 137. 
42 

jurisdiction in a case involving a foreign country, that the courts should not act in a way that 

would embarrass the executive branch in its conduct of foreign affairs.89 “It is therefore not for 

the courts to deny an immunity which our government has seen fit to allow, or to allow an 

immunity on new grounds which the government has not seen fit to recognize.”90

In 1952, the U.S. Department of State announced that it would follow a restrictive theory 

of immunity.91 The Department of State acknowledged that a shift in the policy of the executive 

branch could not control the judicial branch, but stated that it was the Department’s belief “that 

the courts are less likely to allow a plea of sovereign immunity where the executive has declined 

to do so.”92 From that point forward, and consistent with the Supreme Court’s recognized 

deference to executive branch authority in this area, a restrictive theory of immunity prevailed in 

the United States. 

The United States statutorily adopted a restrictive theory of immunity with the enactment 

of the Foreign Sovereign Immunities Act of 1976 (“FSIA”).93 FSIA generally provides that: 

“Subject to existing international agreements to which the United States is a party at the time of 

enactment of this Act a foreign state shall be immune from the jurisdiction of the courts of the 

United States and of the States.”94 Consistent with a restrictive theory of immunity, FSIA further 

provides that immunity does not apply to a foreign state in any case in which the action is based 

(i) upon a commercial activity carried on in the United States by the foreign state; (ii) upon an 

act performed in the United States in connection with a commercial activity of the foreign state 

elsewhere; or (iii) upon an act outside the territory of the United States in connection with a 

commercial activity of the foreign state elsewhere and the act causes a direct effect in the United 

States.95 Certain other exceptions to immunity are provided, including any case in which rights 

to immovable property situated in the United States are in issue.96

 89 Mexico v. Hoffman, 324 U.S. 30, 35 (1945); see also Ex parte Peru, 318 U.S. 578, 587-88 

(1943). 

90 Mexico, 324 U.S. at 35.

91 Letter from Jack B. Tate, Acting Legal Adviser, U.S. Department of State, to Philip B. 

Perlman, Acting Attorney General, in 26 Dep’t St. Bull. 984 (1952). The Department of State noted three 

reasons for this decision: with limited exception, few countries were continuing to follow an absolute 

theory of immunity; it was inconsistent for the United States to subject itself to suit in U.S. courts while 

granting immunity to foreign governments; and, as governments increasingly engaged in commercial 

activities, people doing business with them should be able to utilize the courts to determine their rights. 

92 Id. at 985. 

93 Pub. L. No. 94-583, 90 Stat. 2891. 

94 28 U.S.C. sec. 1604. 

95 Id. sec. 1605(a)(2). 

96 Id. secs. 1605, 1607. 
43 

U.S. income tax provisions

An exemption from U.S. income tax for certain income received by foreign governments 

first appeared in the War Revenue Act of 1917.97 That Act exempted from tax “the income of 

foreign governments received from investments in the United States in stocks, bonds, or other 

domestic securities, owned by such foreign governments, or from interest on deposits in banks in 

the United States of moneys belonging to foreign governments.”98 The provision was modified 

in 1918 to provide that gross income did not include “[t]he income of foreign governments 

received from investments in the United States in stocks, bonds, or other domestic securities, 

owned by such foreign governments, or from interest on deposits in banks in the United States of 

moneys belonging to such foreign governments, or from any other source within the United 

States.”99

The next change occurred in 1945, when the scope of the exemption was expanded to 

include international organizations in addition to foreign governments.100 In 1954, the provision 

was recodified as section 892 without further change.101

In 1957, regulations were first adopted under section 892.102 The regulations provided 

that the exemption was available to both foreign governments and their political subdivisions, 

but was not available with respect to income from investments loaned to, but not actually owned 

by, foreign governments. 

In response to uncertainty over the status of separately incorporated foreign central banks 

under section 892, Congress enacted section 895 in 1961.103 The provision provided that income 

 97 This exemption followed a 1916 Treasury Decision that concluded that certain passive, U.S.-

source income received by foreign governments was subject to U.S. income tax. T.D. 2425, 18 Treas. 

Dec. Int. Rev. 276 (1917). 

98 War Revenue Act of 1917, Pub. L. No. 65-50, sec. 1211, 40 Stat. 300, 337. 

99 Revenue Act of 1918, Pub. L. No. 65-254, sec. 213(b)(5), 40 Stat. , 1057, 1066. The provision 

was recodified in 1928, but otherwise remained unchanged. Revenue Act of 1928, Pub. L. No. 70-562, 

sec. 116(c), 45 Stat. 791, 823. 

100 International Organizations Immunities Act, Pub. L. No. 79-291, sec. 4, 59 Stat 669, 670-71 

(1945). For this purpose, “international organizations” are public international organizations in which the 

United States participates with the sanction of Congress and that are designated by the President as 

entitled to enjoy the privileges, exemptions, and immunities provided in the International Organizations 

Immunities Act. 

101 Internal Revenue Code of 1954, Pub. L. No. 83-591, sec. 892, 68A Stat. 1, 284. 

102 T.D. 6258, 1957-2 C.B. 368, 413-14. 

103 Pub. L. No. 87-29, 75 Stat. 64. In 1920, the Bureau of Internal Revenue (the predecessor to 

the Internal Revenue Service (the “IRS”)) ruled that the Commonwealth Bank of Australia, an Australian 

corporation wholly owned by the Australian government, was nevertheless entitled to the exemption from 
44 

earned by a foreign central bank of issue from obligations of the United States was exempt from 

U.S. income tax unless those obligations related to the conduct of commercial activities.104 

Section 895 was amended for the first and only time in 1966 to allow additional income to 

qualify for the exemption.105 Current section 895 is discussed in more detail below. 

In 1980, the section 892 regulations were amended in a manner that generally narrowed 

the scope of the exemption.106 As amended, the regulations defined foreign government to 

include only integral parts and controlled entities of a foreign government and provided that the 

exemption did not apply with respect to income derived from commercial activities in the United 

States.107

The Tax Reform Act of 1986 (the “1986 Act”) made significant revisions to section 892, 

particularly with respect to the treatment of income derived from commercial activities.108 The 

1980 regulations had specified that certain income from commercial activities did not qualify as 

investment income and therefore was not exempt from U.S. income tax. Congress identified 

 

U.S. income tax under the predecessor to section 892. O.D. 628, 3 C.B. 124 (1920). That decision was 

revoked in 1946. I.T. 3789, 19461-1 C.B. 100. The revocation was a response to the objection of the 

staff of the Joint Committee on Internal Revenue Taxation (later renamed the Joint Committee on 

Taxation) to an income tax refund filed by a New York corporation wholly owned by a foreign 

government and engaged in commercial activities in the United States. S. Rep. No. 87-163 (1961). In 

1950, however, the Tax Court held that a corporation wholly owned by a foreign government might 

nevertheless constitute part of the foreign government for U.S. income tax purposes. Louis Vial, 15 T.C. 

403 (1950), acq. 1952-1 C.B. 4. In 1955, the IRS again ruled that the Commonwealth Bank of Australia 

was entitled to exemption under section 892. The staff of the Joint Committee on Internal Revenue 

Taxation objected to the bank’s refund claim and recommended that the claim be rejected. S. Rep. No. 

87-163 (1961). The IRS revoked its 1955 ruling. However, due to concerns over anticipated financial 

repercussions from foreign central banks shifting their investments, the ruling revocation was suspended 

to the extent a foreign central bank was not engaged in commercial activities. Id.

In 1966, the IRS issued a Revenue Ruling stating its position that an organization separate in 

form and wholly owned by a foreign government would qualify for the section 892 exemption in certain 

circumstances. Rev. Rul. 66-73, 1966-1 C.B. 174. In 1975, the IRS issued a Revenue Ruling that refined 

its position on this issue and revoked the 1966 ruling. Rev. Rul. 75-298, 1975-2 C.B. 290, obsoleted by

Rev. Rul. 2003-99, 2003-2 C.B. 388. 

104 Regulations under section 895 were adopted in 1963. T.D. 6636, 1963-1 C.B. 122. 

105 Pub. L. No. 89-809, sec. 102(a)(4)(A), 80 Stat. 1539, 1543. The regulations were amended in 

1975 to reflect the statutory changes. T.D. 7378, 1975-2 C.B. 272. 

106 T.D. 7707, 1980-2 C.B. 213 (deleted by T.D. 8211, 1988-2 C.B. 214). 

107 By excluding income earned from commercial activities from the exemption, the regulations 

paralleled the limitations on sovereign immunity statutorily adopted in the FSIA. 

108 Pub. L. No. 99-514, sec. 1247, 100 Stat. 2085, 2583-84. A detailed discussion of section 892, 

as revised in 1986 and 1988, is found below. 
45 

several problems with the existing exemption.109 First, nationalized industries were favored over 

privately owned industries because certain investment income earned by wholly governmentowned entities was exempt (even if the corporations were engaged in commercial activities). 

Second, Congress found inappropriate that under the law, interest and dividend income received 

by foreign governments that controlled U.S. businesses was exempt from shareholder-level tax. 

Third, Congress intended to make clear that the exemption applied only to specific income items, 

despite the fact that a literal reading of the existing statutory language suggested a broader scope 

to the exemption. 

The Technical and Miscellaneous Revenue Act of 1988 (the “1988 Act”) made further 

changes to section 892.110 Those changes provided that the exemption did not apply to the 

disposition of any interest in a controlled commercial entity or to any income received indirectly 

from a controlled commercial entity. In addition, the 1988 Act provided that, for purposes of the 

Code, a foreign government is treated as a corporate resident of its country and that, for income 

tax treaty purposes, a foreign government is treated as a corporate resident of its country if such 

government grants equivalent treatment to the U.S. government. 

In 1988, the prior section 892 regulations were deleted and temporary regulations were 

issued.111 Those regulations are described in conjunction with the more detailed description of 

current section 892 provided below. 

Current section 892

In its current form, section 892 exempts from U.S. income tax certain income of foreign 

governments. In addition, section 892 provides that, for purposes of Title 26, a foreign 

government is treated as a corporate resident of its country. Furthermore, a foreign government 

is treated as a corporate resident of its country for income tax treaty purposes if such government 

grants equivalent treatment to the U.S. government. 

Definition of foreign government

For purposes of section 892, a foreign government is the integral parts and controlled 

entities of a foreign sovereign.112 “Integral part” is broadly defined and includes, inter alia, any 

person, body of persons, organization, agency, bureau, or fund that constitutes a governing 

 109 Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986 (JCS-10-

87), at 1058-59, May 4, 1987; see also S. Rep. No. 99-313, at 416 (1986). 

110 Pub. L. No.100-647, sec. 1012(t), 102 Stat. 3342, 3527-28. 

111 T.D. 8211, 1988-2 C.B. 214. In 2002, the regulations were revised to provide that a 

partnership may be a controlled commercial entity and to reflect other minor changes. T.D. 9012, 2002-2 

C.B. 389. 

112 Temp. Treas. Reg. sec. 1.892-2T(a)(1). The rules that apply to a foreign sovereign also apply 

to the political subdivisions of a foreign country and to transnational entities. Temp. Treas. Reg. sec. 

1.892-2T(d). 
46 

authority of a foreign country, but does not include any individual who is acting in a private or 

personal capacity. Moreover, no portion of the earnings of the governing authority may inure to 

the benefit of any private person.113

A “controlled entity” is any entity separate in form from a foreign sovereign that satisfies 

four requirements.114 The separate entity must (1) be wholly owned and controlled (directly or 

indirectly) by the foreign sovereign; (2) be organized under the laws of the foreign sovereign by 

which it is owned; (3) have its net earnings credited to its own account or to the accounts of the 

foreign sovereign, with no portion inuring to the benefit of any private person; and (4) have its 

assets vest in the foreign sovereign upon dissolution.115

A separately organized pension trust qualifies as a controlled entity if it satisfies four 

requirements. The pension trust must (1) be established exclusively for the benefit of current or 

former employees of a government or for current or former nongovernmental employees who 

perform or performed governmental or social services; (2) have its funds managed by people 

who are employees of, or appointed by, the foreign government; (3) provide for retirement, 

disability, or death benefits in consideration of prior services rendered; and (4) have its income 

satisfy the obligations of the foreign government to participants under the plan. 

As discussed above, there is no single, generally accepted definition of what constitutes a 

SWF. Absent unusual circumstances, however, SWFs will generally constitute either an integral 

part or a controlled entity of a foreign sovereign for purposes of section 892. 

Scope of exemption

In general, section 892(a)(1) provides that the income of foreign governments received 

from (1) investments in the United States in stocks, bonds, or other securities owned by such 

foreign governments, (2) investments in the United States in financial instruments held in the 

execution of governmental financial or monetary policy, or (3) interest on deposits in banks in 

 113 Income does not inure to the benefit of a private person if such person is the intended 

beneficiary of a government program that is carried on by the foreign sovereign and the activities of 

which constitute governmental functions. Temp. Treas. Reg. sec. 1.892-2T(b). This rule also applies for 

purposes of the definition of “controlled entity” described below. 

Not specifically addressed by the regulations, however, is whether there is impermissible private 

inurement when, for example, a SWF compensates a private investment manager, who is providing 

advisory services to the SWF, based on the investment performance of the SWF. 

114 Temp. Treas. Reg. sec. 1.892-2T(a)(3). Some taxpayers may take the position that an entity 

separate in form from a foreign sovereign is nevertheless an integral part of the foreign sovereign. 

115 Under the entity-classification regulations (i.e., the “check-the-box rules”), any business 

entity wholly owned by a foreign government (including its integral parts or controlled entities) is a per se 

corporation, and is thus ineligible to elect to be treated as a disregarded entity. Treas. Reg. sec. 301.7701-

2(b)(6). 
47 

the United States of moneys belonging to such foreign governments, is exempt from U.S. tax.116 

For this purpose, the term “other securities” includes any note or other evidence of indebtedness 

(e.g., an annuity contract or a mortgage); the term generally does not include commodity forward 

or future contracts, commodity options, trust interests, or partnership interests (with the 

exception of interests in publicly traded partnerships as defined in section 7704).117 Income from 

investments in stocks, bonds, or other securities includes gain from their disposition and income 

from engaging in securities lending transactions described in section 1058.118

As discussed in more detail above, the Code contains special rules addressing the taxation 

of interests in U.S. real property (including direct ownership and interests in USRPHCs). 

Income from an interest in a USRPHC that a foreign sovereign does not control is generally 

exempt from U.S. tax under section 892 as income from an investment in a U.S. security; 

however, section 892 does not apply to exempt income from interests in other U.S. real property 

(i.e., direct ownership).119 The section 892 regulations do not specifically address how the 

section 892 exemption interacts with the FIRPTA look-through rule that treats certain 

distributions as gain from the disposition of a U.S. real property interest. The IRS has stated that 

Treasury and the IRS will clarify this interaction in regulations.120

Importantly, the section 892 exemption does not apply to income (1) derived from 

conducting any commercial activity (whether within or outside the United States), (2) received 

by or from (directly or indirectly) a controlled commercial entity, or (3) derived from the 

disposition of any interest in a controlled commercial entity. A “controlled commercial entity” is 

any entity engaged in commercial activities (whether within or outside the United States) in 

which a foreign government (1) holds (directly or indirectly) any interest that (by vote or value) 

is 50 percent or more of the total interests in such entity, or (2) holds (directly or indirectly) any 

 116 Section 892(c) provides a similar exemption from U.S. tax for income of international 

organizations. In addition, section 893 provides an exemption from U.S. tax for certain compensation of 

qualifying employees of foreign governments and international organizations. 

117 Treas. Reg. sec. 1.892-3T(a)(3). 

118 Because trust and partnership interests (other than publicly traded partnerships) are not treated 

as other securities, gain from their disposition is not exempt under section 892. 

119 Temp. Treas. Reg. sec. 1.892-3T(a)(1), -3T(b) Example 1. 

120 Notice 2007-55, 2007-27 I.R.B. 13. In Notice 2007-55 the IRS also stated its intention to 

challenge, as inconsistent with relevant statutory and regulatory language, assertions regarding the 

application of section 892 made by some foreign governments with respect to certain investments they 

made in privately held, domestically controlled REITs. In the investments at issue, the foreign 

government took the position that distributions received from a domestically controlled REIT (including 

liquidating distributions) attributable to gain realized by the REIT from an actual or deemed sale or 

exchange of an interest in real property located in the United States were exempt under section 892. 

Although the statutory analysis is complex, in effect, the issue presented by Notice 2007-55 is whether a 

foreign government’s exemption under section 892 should shelter gain realized by the REIT, rather than 

gain realized by the foreign government from a direct sale of its interest in the REIT. 
48 

other interest in such entity that provides the foreign government with effective control of the 

entity. A central bank of issue is treated as a controlled commercial entity only if it is engaged in 

commercial activities in the United States. 

“Commercial activity” generally means all activity, whether conducted within or outside 

the United States, that is ordinarily conducted by the taxpayer or other persons with a view 

towards the current or future production of income.121 USRPHCs, and foreign corporations that 

would be USRPHCs if they were domestic corporations, are treated as engaged in commercial 

activity.122 Five types of activities are specifically identified as not constituting commercial 

activities. Those five types of activities are (1) investments in stocks, bonds, and other 

securities; loans; investments in financial instruments held in the execution of governmental 

financial or monetary policy; the holding of net leases on real property or land that is not 

producing income; the holding of bank deposits in banks; and trading for a foreign government’s 

own account; (2) certain amateur athletic and cultural events; (3) activities that are not 

customarily attributed to or carried on by private enterprise for profit; (4) governmental 

functions; and (5) the mere purchasing of goods for the use of a foreign government.123

Commercial activities engaged in by one entity may be attributed to related controlled 

entities for purposes of section 892.124 Commercial activities of a partnership (other than a 

publicly traded partnership) are attributed to its (limited and general) partners. In addition, 

commercial activities of a parent controlled entity are attributed to that entity’s subsidiaries. 

However, no attribution is made of commercial activities from a controlled entity to that entity’s 

parent. Similarly, no attribution is made of commercial activities from a controlled entity to that 

entity’s other brother-sister related entities. 

Partnerships

When a foreign government invests in an entity that is treated for U.S. income tax 

purposes as a partnership, the partnership is treated as a mere conduit in determining the 

character of the partnership income received by the foreign government partner.125 Thus, the 

foreign government partner’s distributive share of the partnership’s income is exempt from tax 

under section 892 to the same extent that the partnership’s income would have been exempt if 

received directly by the foreign government partner. If a partnership engages in commercial 

activity, some or all of the foreign government partner’s distributive share of the partnership 

 121 Temp. Treas. Reg. sec. 1.892-4T(b). Activity may constitute commercial activity even if it 

does not constitute the conduct of a trade or business in the United States under section 864(b). Id.

122 Temp. Treas. Reg. sec. 1.892-5T(b)(1). 

123 Temp. Treas. Reg. sec. 1.892-4T(c). 

124 Temp. Treas. Reg. sec. 1.892-5T(d). 

125 Secs. 702-703; Treas. Reg. sec. 1.702-1(a)(8)(ii). 
49 

income will not be exempt from tax under section 892.126 If the partner is the foreign sovereign 

itself, or an integral part of the foreign sovereign, then the partnership’s commercial activities do 

not taint the partnership’s other income (i.e., the income that would otherwise be exempt from 

tax under section 892 continues to be exempt from tax), although the partnership’s income from 

the commercial activities is not exempt from tax under section 892. If, by contrast, the partner is 

a controlled entity, then the partnership’s commercial activities are attributable to the controlled 

entity, and the controlled entity becomes a controlled commercial entity. At that point, the 

partner’s entire share of partnership income is tainted (i.e., no portion of the income is exempt 

from tax under section 892), and any other income received by the partner (i.e., any 

nonpartnership income) is similarly tainted by the attributed commercial activities. 

Tax treatment if not exempt

Income that is not exempt under section 892 is treated in the same manner as such 

income would be treated if received by a foreign corporation. The U.S. tax treatment of foreign 

corporations is described in more detail above. In general terms, however, certain income that is 

exempt under section 892 would also be exempt under the Code if received by a foreign 

corporation—for example, portfolio interest and gains from the sale of stock. Nevertheless, there 

are certain differences. For example, dividends and income from stock in a USRPHC are 

generally exempt under section 892 but are subject to tax when received by a foreign 

corporation. Finally, there are certain categories of income that are neither exempt under section 

892 nor escape U.S. taxation when received by a foreign corporation. For example, U.S.-source 

royalty income is generally subject to U.S. tax whether it is received by a foreign government or 

a foreign corporation. Similarly, income that is effectively connected with the conduct of a U.S. 

trade or business generally is subject to U.S. tax in the same manner and at the same rates as 

income of a U.S. person, without regard to whether that income is earned by a foreign 

government or a foreign corporation. 

As discussed in more detail below, U.S. income tax treaties may reduce or eliminate 

residual U.S. taxation of income received by foreign governments and/or foreign corporations in 

certain cases. 

Foreign central banks of issue (section 895)

In addition to the exemption available under section 892, section 895 provides a special 

rule that exempts from U.S. tax certain income derived by a foreign central bank of issue from 

U.S. government obligations or from interest on deposits with persons carrying on the banking 

business.127 For purposes of section 895, a foreign central bank of issue is a bank, which by law 

or government sanction, is the principal authority, other than the government itself, issuing 

 126 See, e.g., Treas. Reg. sec. 1.892-5T(d)(4) Example 4(a)-(b). 

127 An entity that qualifies for the section 895 exemption from U.S. income tax might also qualify 

for the broader section 892 exemption. 
50 

instruments intended to circulate as currency.128 The exemption applies to an instrumentality 

that is separate from a foreign government, whether or not owned in whole or in part by a foreign 

government.129

The exemption does not apply (1) if the foreign central bank of issue does not own the 

obligations or bank deposits, or (2) if the obligations or deposits are held for, or used in 

connection with, the conduct of commercial banking functions or other commercial activities. 

Withholding and reporting

Sections 1441 and 1442 generally impose withholding requirements on the payors (or 

other withholding agents) of certain types of income, although no withholding is required if the 

income is exempt under section 892 or 895.130 To establish that no withholding is required, a 

foreign government claiming exemption from tax under section 892 or a foreign central bank of 

issue claiming exemption from tax under section 895 may file, under penalties of perjury, a Form 

W8-EXP with the payor (or other withholding agent).131 A payor who relies on such a claim of 

exemption, absent actual knowledge or other reason to know that it is inaccurate, is excused from 

any potential liability for failure to withhold. A Form W8-EXP provided by a person claiming to 

be a foreign government, an integral part of a foreign government, or a foreign central bank of 

issue remains valid indefinitely (unless there is a change of circumstance that makes any of the 

information on the form incorrect); if the person claims to be a controlled entity of a foreign 

government for section 892 purposes, then the form remains valid for three calendar years 

(unless there is a change of circumstance that makes any of the information on the form 

incorrect).132 Payors (or other withholding agents) are required to report on Forms 1042 and 

1042-S all payments made to foreign governments, even if not subject to withholding, to the 

same extent as if paid to a nongovernment foreign person.133

 128 Treas. Reg. sec. 1.895-1(b)(1). The Bank for International Settlements is treated as though it 

were a foreign central bank of issue for purposes of obtaining the section 895 exemption. Sec. 895; 

Treas. Reg. sec. 1.895-1(b)(3). 

129 In contrast, section 892 does not apply to an entity separate from the foreign sovereign unless 

the foreign sovereign wholly owns and controls the entity. Temp. Treas. Reg. sec. 1.892-2T(a)(3)(i). 

130 Temp. Treas. Reg. sec. 1.892-7T(e); Treas. Reg. sec. 1.1441-8(a), (c). Section 1445 generally 

imposes a withholding obligation on the buyer of a USRPI (which serves to satisfy the seller’s tax 

liability under FIRPTA). However, no withholding is required if, as discussed above, the seller is exempt 

from tax on the transaction under section 892 and furnishes the buyer with a notice of nonrecognition 

treatment. Temp. Treas. Reg. sec. 1.1445-10T(b)(1). 

131 Treas. Reg. sec. 1.1441-8(b), (c); Instructions for Form W8-EXP. 

132 Treas. Reg. sec. 1.1441-1(e)(4)(ii). 

133 Treas. Reg. sec. 1.1461-1(b), (c). 
51 

Comparison to the U.S. income tax treatment of other persons

Foreign corporations

There are only limited differences between the U.S. income tax treatment of income 

derived by foreign governments from U.S. investments and income derived by other foreign 

investors from U.S. investments. As discussed above, section 892 exempts only certain income 

earned by foreign governments from U.S. income tax; income that is not exempt under section 

892 is subject to U.S. income tax in the same manner, and to the same extent, as that income 

would be if earned by a foreign corporation. Thus, the only possible difference in tax treatment 

of foreign governments and foreign corporations arises from situations in which section 892 

provides an exemption to a foreign government and another provision of the Code does not 

provide a similar exemption to a foreign corporation.134

There are three principal categories of income for which foreign governments receive 

better U.S. income tax treatment than foreign corporations: portfolio dividends; interest income 

from noncontrolled, but at least 10 percent owned, commercial entities; and income from the 

disposition of interests in certain noncontrolled USRPHCs.135 In each instance, the income is 

generally exempt under section 892 when received by a foreign government but taxable when 

received by a foreign corporation. 

As discussed in more detail above, U.S.-source dividends not effectively connected with 

the conduct of a U.S. trade or business are FDAP income subject to a 30 percent tax when 

received by a foreign person.136 In contrast, section 892 generally exempts dividends, other than 

those from controlled commercial entities, from U.S. income tax. 

U.S.-source interest not effectively connected with the conduct of a U.S. trade or business 

is FDAP income subject to a 30 percent tax when received by a foreign person. However, there 

is an important exemption for portfolio interest (generally, interest paid on an obligation that 

satisfies certain registration requirements, or exceptions thereto, and is received by someone who 

owns less than 10 percent of the payor). In contrast, section 892 generally exempts interest 

income from U.S. income tax; this exemption is not available if the interest is received from a 

 134 As discussed below, U.S. income tax treaties might also provide favorable tax treatment to 

foreign governments and foreign corporations with respect to certain income, although, as a general 

matter, foreign corporations will fare at least as well as foreign governments under such treaties. 

135 Other categories of income may also result in this same outcome. For example, the contract 

payments received as part of certain mandatory convertible securities transactions, such as those 

discussed in Section IV, may be subject to U.S. income tax if received by a foreign corporation but 

exempt from tax if received by a foreign government. 

136 In certain cases, a foreign person may be able to avoid U.S. taxation by structuring its 

investment as an equity swap. For a discussion of equity swaps and related tax considerations, see Joint 

Committee on Taxation, Present Law and Analysis Relating to the Tax Treatment of Derivatives (JCX21-08), Mar. 4, 2008. 
52 

controlled commercial entity (i.e., an entity engaged in commercial activity in which the foreign 

government owns at least 50 percent of the total interests, or a lesser percentage if the foreign 

government effectively controls the entity). The U.S. income tax treatment of foreign 

corporations and foreign governments resulting from the interaction of these rules is best 

understood by dividing the possible payors of interest into three categories: (1) neither a foreign 

corporation nor a foreign government is subject to U.S. income tax on interest received from 

payors in which they own less than 10 percent of the interests; (2) a foreign government, but not 

a foreign corporation, is exempt from U.S. income tax on interest received from an entity in 

which it owns at least 10 percent of the interests, but less than 50 percent; and (3) both a foreign 

corporation and a foreign government are subject to U.S. income tax on interest received from a 

commercial entity in which they own at least 50 percent of the interests.137

Under the FIRPTA rules, a foreign corporation generally will not be subject to U.S. 

income tax on any gain from the disposition of interests in domestically controlled REITs. 

However, a foreign corporation’s gain from the disposition of an interest in any other USRPHC, 

including a REIT that is not domestically controlled, will be subject to U.S. income tax. In 

contrast, section 892 generally exempts all such income from U.S. income tax when derived by a 

foreign government, so long as the foreign government does not control the USRPHC whose 

interests are sold. (If the USRPHC is controlled by the foreign government, the USRPHC is a 

controlled commercial entity, with the consequence that the section 892 exemption is unavailable 

and any gain that results from the foreign government’s disposition of interests in the USRPHC 

is subject to U.S. income tax to the same extent as if derived by a foreign corporation.) 

Nonfederal U.S. sovereigns

The limited U.S. income tax exception afforded foreign governments and foreign central 

banks of issue under sections 892 and 895 is significantly less favorable than the U.S. income tax 

treatment afforded nonfederal sovereigns, specifically U.S. States and Indian tribes. States are 

not subject to U.S. income tax on any income that they earn directly, even if from commercial 

activities.138 Moreover, States are specifically exempt under the Code from tax on certain 

 137 A fourth possible category of payor is a noncommercial entity in which a foreign corporation 

or foreign government owns at least 50 percent of the interests. In such a case, a foreign government, but 

not a foreign corporation, is exempt from U.S. income tax on interest received from the entity. This 

fourth category, however, is unlikely to be significant in practice. 

138 The Code does not specifically address the question of whether States and their political 

subdivisions are subject to U.S. income tax on income that they earn directly. However, the IRS has long 

taken the position that States and political subdivisions are not subject to U.S. income tax on such 

income. See, e.g., Rev. Rul. 87-2, 1987-1 C.B. 18 (providing that income earned by a lawyer trust 

account fund created and controlled by a State Supreme Court is not taxable); Rev. Rul. 71-132, 1971-1 

C.B. 29 (providing that income derived by a State from the operation of liquor stores is not taxable); Rev. 

Rul. 71-131, 1971-1 C.B. 28 (same); G.C.M. 14,407, XIV-1 C.B. 103 (1935) (same), superseded by Rev. 

Rul. 71-131. At least one Circuit Court of Appeals, relying on Supreme Court precedents, has also 

addressed this specific issue and arrived at the same conclusion as the IRS. State of Michigan v. United 

States, 40 F.3d 817 (6th Cir. 1994). 
53 

income that they earn indirectly, if the income is derived from a public utility or the exercise of 

an essential governmental function.139 This exemption may apply to income derived from 

commercial activities. 

Indian tribes and wholly owned tribal corporations chartered under Federal law are 

similarly not subject to U.S. income tax, even if the income is from commercial activities and 

even if the activity is conducted off the tribe’s reservation. No specific Code provision governs 

the U.S. income tax liability of Indian tribes. However, the IRS has long taken the position that 

Indian tribes and wholly owned tribal corporations chartered under Federal law are not taxable 

entities for U.S. income tax purposes.140

Tax-exempt organizations

There are certain differences in the U.S. income tax treatment of tax-exempt 

organizations and foreign governments that sometimes favor tax-exempt organizations and other 

times favor foreign governments. Since the inception of the U.S. income tax, Congress has 

exempted certain types of entities from income taxation. The main exemption provision of the 

Code, section 501(a), generally provides a tax exemption for qualified pension, profit-sharing, 

and stock bonus plans described in section 401(a), religious and apostolic organizations 

described in section 501(d), and organizations described in section 501(c).141 Section 501(c) lists 

28 different types of organizations, including groups as diverse as charitable organizations, social 

welfare organizations, title holding companies, fraternal organizations, small insurance 

companies, credit unions, cooperative organizations, and cemetery companies.142 In addition, 

other subsections treat certain organizations as described in section 501(c).143

Notwithstanding the general tax exemption available to these organizations, the Code 

imposes a tax, at ordinary corporate rates, on the income that a tax-exempt organization obtains 

 139 Sec. 115. 

140 See, e.g., Rev. Rul. 94-65, 1994-2 C.B. 14; Rev. Rul. 94-16, 1994-1 C.B. 19; Rev. Rul. 81-

295, 1981-2 C.B. 15; Rev. Rul. 67-284, 1967-2 C.B. 55. 

141 In addition to the tax exemption provided in section 501, other Code provisions provide tax 

exemption. See, e.g., secs. 220 (Archer MSAs), 223 (health savings accounts), 408(e) (individual 

retirement accounts), 457(g) (deferred compensation plans of state and local governments and tax-exempt 

organizations), 521 (farmers’ cooperatives), 526 (shipowners’ protection and indemnity associations), 527 

(political organizations), 528 (certain homeowners associations), 529 (qualified tuition programs), and 

530 (Coverdell education savings accounts). 

142 Section 501(c) has 28 subsections, although the exemption provided for section 501(c)(20) 

organizations (qualified group legal plan organizations or trusts) expired for taxable years beginning after 

June 30, 1992. Sec. 120(e). 

143 Secs. 501(e) (cooperative hospital service organizations), 501(f) (cooperative service 

organizations of operating educational organizations), 501(k) (certain child care organizations), and 

501(n) (charitable risk pools). 
54 

from an “unrelated trade or business . . . regularly carried on by it.”144 Most exempt 

organizations are subject to the tax with respect to at least a portion of their income.145 Passive 

income, such as dividends, interest, royalties, certain rents, and certain gains and losses from the 

sale or exchange of property, is exempt from the unrelated business income tax.146 In general, 

the exemption for such passive income applies unless the income is derived from debt-financed 

property147 or is in the form of certain payments from certain 50-percent controlled 

subsidiaries.148 Organizations liable for tax on unrelated business taxable income may be liable 

for alternative minimum tax determined after taking into account adjustments and tax preference 

items. 

The tax exemption afforded tax-exempt organizations is narrower in some respects and 

broader in others than the tax exemption afforded foreign governments. For example, the 

exemption afforded tax-exempt organizations is somewhat broader in that tax-exempt 

organizations generally may derive income from commercial activities that are related to the 

organization’s tax-exempt purpose without that income being subject to U.S. income tax; the 

exemption provided to foreign governments under section 892 does not include any income 

derived from a commercial activity. On the other hand, tax-exempt organizations lose their tax 

exemption with respect to passive income derived from debt-financed property; the exemption 

 144 Secs. 512(a)(1), 511(a)(1). Generally, “unrelated trade or business” is “any trade or business 

the conduct of which is not substantially related . . . to the exercise or performance by such organization 

of its charitable, educational, or other purpose.” Sec. 513(a). 

145 Organizations subject to the unrelated business income tax include all organizations described 

in section 501(c) (except for U.S. instrumentalities and certain charitable trusts), religious and apostolic 

organizations described in section 501(d), qualified pension, profit-sharing, and stock bonus plans 

described in section 401(a), and certain State colleges and universities. Sec. 511(a)(2). 

146 Sec. 512(b)(1)-(3), (5). Other exemptions from the unrelated business income tax are 

provided for activities in which substantially all the work is performed by volunteers, for income from the 

sale of donated goods, and for certain activities carried on for the convenience of members, students, 

patients, officers, or employees of a charitable organization. Sec. 513(a)(1)-(3). In addition, special 

unrelated business income tax provisions exempt from tax certain activities of trade shows and State fairs, 

income from bingo games, and income from the distribution of certain low-cost items incidental to the 

solicitation of charitable contributions. Sec. 513(d), (f), (h). 

147 In general, income produced by debt-financed property is treated as unrelated business 

income in proportion to the acquisition indebtedness on the income-producing property. Secs. 512(b)(4), 

514(a). Acquisition indebtedness generally means the amount of unpaid indebtedness incurred by an 

organization to acquire or improve the property and indebtedness that would not have been incurred but 

for the acquisition or improvement of the property. Sec. 514(c). 

148 Sec. 512(b)(13). 
55 

provided to foreign governments under section 892 is available without regard to whether it is 

derived from debt-financed property.149

 149 In practice, however, a foreign government, and, in particular, a SWF, may not have any 

income derived from what would be debt-financed property for purposes of the unrelated business income 

tax. Thus, the ability to derive tax-exempt income from debt-financed property may not represent a 

meaningful tax benefit for foreign governments when compared to tax-exempt organizations. 
56 

C. Application of Income Tax Treaties to Foreign Governments and SWFs 

Applicability of tax treaties to SWFs in general

In general, a foreign person may obtain benefits from the United States under a U.S. tax 

treaty with a foreign country if the foreign person (i) is a “resident” of the foreign country, as 

defined in such treaty, (ii) meets the requirements contained in any limitation-on-benefits 

provision of such treaty, and (iii) meets any other requirements for the particular benefit 

specified in the treaty. The question whether the United States will provide tax treaty benefits to 

a foreign government or a SWF with respect to particular income arises only if section 892 does 

not provide complete relief with respect to such income. This result may occur where the 

recipient of the income does not meet the statutory or regulatory requirements for the section 892 

exemption. Treaties may be relevant, for example, where section 892 does not apply due to the 

nature of the payor, such as in the case of dividends or interest received from a U.S. controlled 

commercial entity. Treaty protection might also be relevant to items of income paid to an entity 

that is owned by a foreign government, but is not a “controlled entity” under the Treasury 

Regulations because it is not organized under the laws of the foreign government that owns it, or 

because it is an entity that is engaged in commercial activities.150 

Finally, the availability of a tax treaty may be relevant if the both the payor and recipient 

of the income are not disqualified under section 892, but the general type of income is not 

exempt under section 892. Examples include noncommercial income, such as royalties from a 

patent held for investment by a controlled entity, or income earned through a U.S. trade or 

business conducted directly by the foreign sovereign that does not have a permanent 

establishment in the United States. 

Foreign governments and SWFs as residents for treaty purposes

In sum, it would appear that it is the official view of the Treasury Department that the 

condition of section 892(a)(3) relating to treaties is satisfied (i) in the case of a tax treaty that 

follows the reciprocal language of the United States Model Income Tax Convention of 

September 20, 1996 (“1996 Model treaty”) or its equivalent, (ii) with the possible caveat noted 

below with respect to controlled entities, in the case of a tax treaty that follows the language of 

the United States Model Income Tax Convention of November 15, 2006 (“2006 Model treaty”) 

or its equivalent, and (iii) under the general authority of the language of the Department of the 

Treasury Technical Explanation to the 1996 Model treaty, in the case of a tax treaty between the 

United States and another country (particularly an OECD country) that does not follow the 

language of either of those U.S. Model treaties, unless that other country has announced a 

contrary interpretation of such treaty provision (or has such an overriding contrary interpretation 

in its domestic law). The next several pages explain the basis for these conclusions. 

 150 Temp. Treas. Reg. sec. 1.892-2T(a)(1) provides that “the term ‘foreign government’ means 

only the integral parts or controlled entities of a foreign sovereign.” Temp. Treas. Reg. sec. 1.892-

2T(a)(3) defines the term “controlled entity.” 
57 

Effect of section 892(a)(3)

As discussed above, there is no single, generally accepted definition of what constitutes a 

SWF. Absent unusual circumstances, however, a SWF generally will constitute either an 

integral part or a controlled entity of a foreign sovereign for purposes of section 892. Section 

892(a)(3), enacted in 1988,151 provides that “[f]or purposes of this title, a foreign government 

shall be treated as a corporate resident of its country. A foreign government shall be so treated 

for purposes of any income tax treaty obligation of the United States if such government grants 

equivalent treatment to the Government of the United States.” 

The legislative history indicates that section 892(a)(3) was an attempt to clarify the law 

by plugging a technical gap in many treaties existing at the time of its enactment. That 

legislative history illustrates the two key principles that whether the United States allows tax 

treaty benefits to a foreign government depends on whether the foreign government does the 

same, and that a foreign government should be treated no worse (but may be treated better) than 

comparable private investors resident in the country of that foreign government.152 In order to 

determine whether a foreign government is treated as a resident of its country for purposes of its 

treaty with the United States, therefore, one must look (i) first to see whether the treaty includes 

language expressly granting such reciprocal residency status or, (ii) if there is no such express 

language, to the foreign government’s interpretation of the treaty, with due regard to the foreign 

government’s domestic tax law. As discussed below, however, the Department of the Treasury 

appears to interpret treaties which include no such express language, such as the United States 

Model Income Tax Conventions of May 17, 1977 and June 16, 1981, as including such language. 

Residency of foreign sovereigns under treaties that follow the 2006 Model treaty

The 2006 Model treaty represents the current official U.S. treaty policy. The 2006 Model 

treaty expressly provides that a resident of a treaty country includes that treaty country as well as 

any political subdivision or local authority of that country.153 A resident of a country also 

includes a “pension fund” (whether public or private) established in that country.154 Under the 

2006 Model treaty, a pension fund is any person established in a treaty country that is generally 

tax exempt in that country and which operates, inter alia, to provide pension or retirement 

benefits.155 That definition appears to be sufficiently broad to cover both foreign governments’ 

 151 The actual statutory provision was added as a technical correction to the Tax Reform Act of 

1986 by the Technical and Miscellaneous Revenue Act of 1988, Pub. L. No. 100-647, sec. 1012(t)(3), 

generally effective for amounts received on or after July 1, 1986. 

152 S. Rep. No. 99-313, at 416-17 (1986) (Senate Finance Committee Report on Tax Reform Act 

of 1986); see also S. Rep. No. 100-445, at 306-07 (1988) (Senate Finance Committee Report on 

Technical Corrections Act of 1988). 

153 2006 Model treaty, art. 4, par. 1. 

154 2006 Model treaty, art. 4, par. 2. 

155 2006 Model treaty, art. 3, par. 1(k). 
58 

pension funds and pension trusts, as defined under the section 892 regulations.156 U.S. income 

tax treaties that follow the 2006 Model treaty reciprocally treat the integral parts of governments 

of the two treaty partners as residents of their respective countries, including SWFs that are 

integral parts. 

Residency under treaties that preceded the 1996 Model treaty, or that follow the 

language of the 1996 Model treaty

It appears from the 1986 legislative history quoted above that many of the bilateral 

income tax treaties in force in the 1980s did not expressly provide that the treaty countries were 

residents of their respective countries for treaty purposes. The 1996 Model treaty, which was 

superseded by the 2006 Model treaty described above, remedied this omission for subsequent 

treaties and clarified the effect of the omission in earlier treaties. The 1996 Model treaty 

provides that a “qualified governmental entity is to be treated as a resident of the Contracting 

State where it is established.”157 A “qualified governmental entity” is defined in the 1996 Model 

treaty as: 

(i) any person or body of persons that constitutes a governing body of a 

Contracting State, or of a political subdivision or local authority of a Contracting 

State; 

(ii) a person that is wholly owned, directly or indirectly, by a Contracting 

State or a political subdivision or local authority of a Contracting State, provided 

(A) it is organized under the laws of the Contracting State, (B) its earnings are 

credited to its own account with no portion of its income inuring to the benefit of 

any private person, and (C) its assets vest in the Contracting State, political 

subdivision or local authority upon dissolution; and 

(iii) a pension trust or fund of a person described in subparagraph (i) or (ii) 

that is constituted and operated exclusively to administer or provide pension 

benefits described in Article 19; 

provided that an entity described in subparagraph (ii) or (iii) does not carry 

on commercial activities.158

Thus, the language of the 1996 Model treaty generally tracks the definitional rules of the 

section 892 Temporary Treasury Regulations relating to integral parts of foreign sovereigns (in 

the case of clause (i)), controlled entities (in the case of clause (ii)), and pension trusts.159 

 156 Temp. Treas. Reg. sec. 1.892-2T(c). 

157 1996 Model treaty, art. 4, par. 1(c). 

158 1996 Model treaty, art. 3, par. 1(i). 

159 Temp. Treas. Reg. sec. 1.892-2T(a). Compare Temp. Treas. Reg. sec. 1.892-2T(c), which 

provides that a separate pension trust (but not a pension fund that is an integral part or controlled entity of 
59 

Therefore, SWFs of foreign countries with U.S. treaties that include the concept of qualified 

governmental entities will be treated as foreign corporations resident in the treaty country. 

The Department of the Treasury Technical Explanation of the 1996 Model treaty states 

that “[a]lthough this [i.e., the qualified governmental entities] provision is not contained in 

previous U.S. Models, it is generally understood that such entities are to be treated as residents 

under all of those Model treaties. The purpose of including the rule in the Model is to make this 

understanding explicit.” The Technical Explanation to the 1996 Model treaty also observes that 

article 4 of the Organisation for Economic Co-operation and Development Model Tax 

Convention on Income and Capital (“OECD Model treaty”) was amended in 1995 to adopt a 

similar approach.160 Thus, the Department of the Treasury would deem this language to be part 

of the earlier U.S. Model treaties, and therefore, would generally consider the exemption to be 

reciprocal under these treaties. The underlying assumption in this case appears to be that the 

deemed language would override any contrary rule of the domestic law of the treaty partner. In 

the unlikely event that the treaty partner announced a contrary interpretation of the treaty 

provision, or had a contrary rule in its domestic law that overrode the deemed treaty language, 

there would be no reciprocity, and the foreign government presumably would be denied U.S. 

residency under the principles of section 893(a)(3). However, these would be extraordinary 

circumstances. 

Although due to their noncontemporaneous nature the above-quoted statements in the 

Technical Explanation may not be controlling authority regarding those pre-1996 treaties that are 

silent regarding the residency of these entities, the Technical Explanation implies that, absent the 

extraordinary circumstances described above, the Treasury Department will continue to treat 

such entities as treaty residents under those in-force treaties that follow the language of the pre1996 Model treaties. 

Treatment of controlled entities under treaties that follow the 2006 Model treaty

At least on their face, the technical rules of the 2006 Model treaty are different than those 

of the 1996 Model treaty. The general category of “qualified governmental entity” in the 1996 

 

a foreign sovereign) is subject to the rules of section 1.892-5T(b)(3) regarding controlled commercial 

entities. Although a pension trust or fund that carries on commercial activities would not be a qualified 

governmental entity under a treaty that follows the language of the 1996 Model treaty quoted above, such 

a trust or fund might qualify as a resident of the foreign country under the more general pension provision 

in article 4, paragraph 1(b)(ii), which provides that “[a] legal person organized under the laws of a 

Contracting State and that is generally exempt from tax in that State and is established and maintained in 

that State...(ii) to provide pensions or other similar benefits to employees pursuant to a plan is to be 

treated for purposes of this paragraph as a resident of that Contracting State.” 

160 Paragraph 8.1 of the commentary on article 4 of the OECD Model treaty states that “[i]t has 

been the general understanding of most Member countries that the government of each State, as well as 

any political subdivision or local authority thereof, is a resident of that State for purposes of the 

Convention. Before 1995, the Model did not explicitly state this; in 1995, article 4 was amended to 

conform the test of the Model to this understanding.” 
60 

Model treaty that corresponds to a controlled entity does not appear in the 2006 Model treaty.161 

Thus, although the Department of the Treasury has not issued any pronouncement or comment 

on this change, it appears that the 2006 Model treaty may have narrowed this exemption.162 If 

the exemption has, in fact, been narrowed, some of a controlled entity’s income, of a type not 

within the scope of section 892, that would have qualified for treaty benefits as income of a 

qualified governmental entity under a treaty with language similar to that of the 1996 Model 

treaty may not qualify for benefits under a treaty with language similar to that of the 2006 Model 

treaty. 

For example, if a controlled entity receives U.S.-source royalties that are not from 

commercial activities (for example, from a patent purchased for investment purposes) and the 

controlled entity satisfies the other applicable requirements of the 1996 Model treaty language, 

the controlled entity would be entitled to benefits under a treaty similar to the 1996 Model treaty, 

i.e., a zero rate of U.S. income tax withholding under article 12. Under the language of the 2006 

Model treaty, however, it appears that the controlled entity would qualify as a resident of its 

foreign country only if the term “State and any political subdivision or local authority” is 

interpreted by both the United States and the treaty country as including a controlled entity.163 In 

general, where the treaty in question is silent regarding the resident status of a controlled entity, 

the question arising under section 892(a)(3) is whether the domestic tax law of foreign treaty 

partner would recognize for treaty purposes a U.S.-owned controlled entity as a resident of the 

United States. 

Assuming that the controlled entity is tax-exempt in its home country,164 it appears 

unlikely that the controlled entity would be considered a resident of the foreign country for treaty 

purposes as if it were a private corporation organized in that foreign country. The general 

definition of resident of a country under paragraph 1 of article 4 of the 2006 Model treaty and 

 161 The language of the 1996 Model treaty, art. 3, par. 1(i)(ii) (that does not appear in the 2006 

Model treaty) relates to that one type of qualified governmental entity, and closely tracks the language of 

Temp. Treas. Reg. sec. 1.892-2T(a)(3), which defines the term “controlled entity.” 

162 The issue arises only with respect to a controlled entity’s income that, although not within the 

scope of section 892, is of a type that would be eligible for treaty benefits if earned by a resident of the 

treaty country. 

163 This quoted language, where appearing in a limitation-on-benefits article of a particular 

treaty, but not in the residence article, may evidence the treaty partners’ intent to treat the treaty country 

governments as residents of their respective countries. Such a rationale may apply to treaties such as the 

U.S.-Australia treaty. It is less clear, however, how that same rationale might be easily applied to 

controlled entities. 

164 This appears to be a reasonable assumption. In any event, section 892(a)(3) rejects the view 

that residence should turn on home-country taxation of the SWF. The legislative history to section 

892(a)(3) states that “whether a foreign government is liable to pay tax to itself on its income seems to be 

a meaningless question. It does not appear that U.S. tax exemption to a foreign government that is a 

treaty partner should depend, for instance, on its internal sovereign immunity laws.” S. Rep. No. 99-313, 

at 416-17 (1986) (Senate Finance Committee Report on Tax Reform Act of 1986). 
61 

other treaties requires that the person is “liable to tax therein by reason of his domicile, 

residence, citizenship, place of management, place of incorporation, or any other criterion of a 

similar nature.” Moreover, the literal language of paragraph 2 of article 4 of the 2006 Model 

treaty requires that a tax-exempt organization (that is not a pension fund) must be established and 

maintained in that country exclusively for religious, charitable, scientific, artistic, cultural, or 

educational purposes. A controlled entity would not meet any of these purposes. Therefore, 

outside the pension area, a controlled entity may not rely on a treaty’s general tax-exempt 

residency provision. 

Classification of certain treaties relevant to present-day SWFs

A number of foreign countries that have SWFs have entered into income tax treaties with 

the United States.165 Of those U.S. income tax treaties, those with Japan, Canada and France 

provide language in their residence article that is similar to that provided in the 2006 Model 

treaty, i.e., “State, political subdivision, or local authority.” In addition, the U.S.-Canada and 

U.S.-France treaties provides language that expressly includes “any agency or instrumentality” 

of the treaty country, political subdivision, or local authority. That additional language appears 

to encompass controlled entities. At the present time, Japan has a pension fund that is covered 

by the U.S.-Japan treaty and does not have a SWF. Therefore, these present-day foreign 

investment funds appear to qualify as treaty country residents even if they are controlled entities. 

The language of the residence article of the U.S.-Ireland treaty follows that of the 1996 

Model treaty. Therefore, the Irish SWF appears to be a resident of Ireland under the U.S.-Ireland 

treaty. 

The following U.S. income tax treaties, which mostly entered into force prior to 1996, 

include no language regarding the governments’ status as a resident under the respective treaty: 

U.S.-Australia, U.S.-China, U.S.-Kazakhstan, U.S.-Korea, U.S.-Mexico, U.S.-Netherlands, U.S.-

New Zealand, U.S.-Norway, U.S.-Russia, and U.S.-Venezuela. The Chinese SWF, China 

Investment Corporation, the Korean SWF, Korea Investment Corporation, and two Australian 

SWFs, Queensland Investment Corporation and Victorian Funds Management Corporation, are 

denoted as corporations and, therefore, are probably controlled entities.166 The Kazakhstan 

SWF, the National Oil Fund, is reportedly not a legal entity.167 We have not been able to 

determine definitively whether the SWFs in Mexico, the Netherlands, New Zealand, Norway, 

Russia and Venezuela, and the Future Fund in Australia are controlled entities or instead integral 

 165 The information provided in this section relates to countries that have entered into tax treaties 

with the United States and also have SWFs that are listed in JP Morgan Report; Congressional Research 

Service, Sovereign Wealth Funds: Background and Policy Issues for Congress, at 11, RL34336 (Jan. 31, 

2008) (citing as its source the Peterson Institute for International Economics); and Peterson Institute for 

International Economics, A Blueprint for Sovereign Wealth Fund Best Practices (Apr. 2008). 

166 JP Morgan Report at 31 (China), 58 (Korea), 39 (Queensland, Australia), and 49 (Victoria, 

Australia). 

167 JP Morgan Report at 56. 
62 

parts of their respective foreign governments.168 We also have not been able to determine at the 

present time whether any of these foreign countries would treat a SWF of the United States 

Government as a resident of the United States for tax treaty purposes. 

Limitation-on-benefits provisions and treaty shopping

Limitation-on-benefits provisions in treaties are intended to deny treaty benefits in certain 

cases of treaty shopping engaged in by third-country residents. Many, but not all, of the U.S. 

income tax treaties have a limitation-on-benefits article. Generally, under a limitation-onbenefits provision of a treaty, a resident of either treaty country is entitled to the benefits under 

the treaty if the resident is a “qualified person,” that is, a resident that meets one of a list of 

additional requirements that demonstrate a significant nexus with the treaty country. Most tax 

treaties include the treaty country or a political subdivision or local authority thereof as a 

qualified person.169

Treaty shopping is of limited relevance to SWFs. In general, a third-country resident 

may engage in treaty shopping by, for example, organizing in a treaty country a corporation that 

is entitled to the benefits of the treaty. A SWF organized in a nontreaty country could engage in 

treaty shopping in a treaty country to the same extent as a private company organized in that 

nontreaty country.170 Similarly, a SWF organized in a treaty country could engage in treaty 

shopping in a country with a more beneficial tax treaty to the same extent as a private company 

organized in the SWF’s country. For treaty-shopping purposes, therefore, being a SWF conveys 

no advantages over being a foreign corporation.171

 168 Although these funds are generally described as owned by their respective foreign 

governments, the information we have available does not state whether these funds are separate entities. 

JP Morgan Report at 80 (Mexico), 70 (New Zealand), 24 (Norway), 37 (Russia), 60 (Venezuela), and 41 

(Australia Future Fund). 

169 A SWF that is a controlled entity of a foreign government would also generally be treated as a 

qualified person because it meets the “ownership and base erosion test,” that is, it is owned by a qualified 

person and does not pay out more than 50 percent of its gross income to persons other than that sovereign. 

If the ownership and base erosion test is not met in a particular case, the controlled entity would probably 

be granted qualified person status by the U.S competent authority under a standard treaty provision that 

grants the competent authority discretion to allow benefits to a resident of the other country if it 

determines that the establishment, acquisition, or maintenance of such person and the conduct of its 

operations did not have as one of its principal purposes the obtaining of benefits under the treaty. 2006 

Model treaty, art. 22, par. 4; 1996 Model treaty, art. 22, par. 4. 

170 In contrast, a company organized in a country other than that of the foreign sovereign would 

not qualify as a controlled entity under section 892 and Temp. Treas. Reg. sec. 1.892-2T(a)(3). 

171 While it is hypothetically possible that a third-country resident could be permitted to invest in 

a SWF of a treaty country in order to avail itself of the SWF’s treaty benefits, there is no evidence, 

anecdotal or otherwise, that any SWFs have or would permit any foreign investors. 
63 

IV. TECHNIQUES USED BY SWFs TO INVEST IN UNITED STATES 

As described previously, SWFs made a series of five high-profile investments in U.S. 

financial institutions at the end of 2007 and the beginning of 2008. This section describes the 

structures of these investments and their likely tax treatment under present law, including the 

possible relevance of section 892. In addition, this section describes certain other techniques 

commonly employed by SWFs for investing in the United States. 

A. Mandatory Convertible Securities 

ADIA-Citigroup investment

On November 26, 2007, Citigroup Inc. announced that the Abu Dhabi Investment 

Authority had agreed to purchase $7.5 billion of “Upper DECS Equity Units” in Citigroup (the 

“ADIA-Citigroup investment”).172 Each equity unit is a mandatory convertible security 

consisting of a forward contract to purchase Citigroup common stock on four settlement dates173

and an undivided beneficial interest in each of four trust preferred securities. The trust preferred 

securities are pledged as collateral under the forward contract. The forward contract provides a 

maximum purchase price which may be reset in the event that Citigroup issues certain types of 

equity or equity-linked securities in excess of $5 billion before December 3, 2008. Each trust 

preferred security represents an interest in a separate trust sponsored by Citigroup.174 Each trust 

holds a junior subordinated deferrable interest debenture issued by Citigroup. The Series A and 

Series B trusts hold debentures that mature on different dates in 2041 and bear interest at 6.320 

percent and 6.455 percent, respectively. The Series C and Series D trusts hold debentures that 

mature at different dates in 2042 and bear interest at 6.700 percent and 6.935 percent, 

respectively. The trust preferred securities each provide for quarterly payments equal to the 

amount of interest paid on the underlying Citigroup debenture. Citigroup Inc. holds the common 

interests in each trust. 

Each equity unit held by ADIA provides for quarterly payments at an 11 percent fixed 

annual rate. These payments consist of the payments on the trust preferred securities (i.e., the 

passthrough of the interest paid on the underlying Citigroup debentures) and quarterly “contract 

 172 See Citigroup Inc., Current Report on Form 8-K, filed with the Securities Exchange 

Commission on November 27, 2007, available on the internet at 

http://www.sec.gov/Archives/edgar/data/831001/000114420407064349/v095633_ex99-1.htm. The 

acronym “DECS” stands for Debt Exchangeable for Common Stock. 

173 These settlement dates are March 15, 2010 (the “series A stock purchase date”), September 

15, 2010 (the “series B stock purchase date”), March 15, 2011 (the “series C stock purchase date”) and 

September 15, 2011 (the “series D stock purchase date”). Each settlement date is subject to an extension 

of up to one year. 

174 These trusts are the Citigroup Capital XXIX trust (the “Series A trust”), the Citigroup Capital 

XXX trust (the “Series B trust”), the Citigroup Capital XXXI trust (the “Series C trust”), and the 

Citigroup Capital XXXII trust (the “Series D trust”). 
64 

payments” on the forward purchase contract. The contract payments are made at four different 

rates on the portion of the stated amount of the purchase contract that corresponds to each stock 

purchase date. Thus, with respect to the portion of the purchase contract corresponding to the 

series A stock purchase date, the quarterly contract payments are made at a rate of 4.680 percent 

(which, when added to the 6.320 percent payment on the Series A trust preferred security, equals 

11.000 percent). The quarterly contract payments corresponding to the series B, series C and 

series D stock purchase dates are 4.545 percent, 4.300 percent, and 4.065 percent, respectively. 

According to the press release issued by Citigroup on November 26, 2007 announcing the ADIA 

investment, the 11.000 percent rate “reflects market terms based on the conversion premium as 

well as Citi’s current dividend yield.”175 

Approximately three months prior to each stock purchase date, the trust preferred 

securities corresponding to that stock purchase date will be remarketed to new investors on 

market terms (unless ADIA elects not to participate in the remarketing). The proceeds of the 

remarketing will be applied to settlement of the forward purchase contract on the corresponding 

stock purchase date. The equity units also provide, however, that the holder may separate the 

trust preferred securities from the forward purchase contract (thereby creating “Stripped DECS”) 

at any time other than certain limited periods surrounding a remarketing or a payment date. In 

order to separate the trust preferred securities (for example, in order to sell them separately), the 

holder must substitute qualifying Treasury securities with a corresponding principal amount to 

serve as collateral for its obligation under the forward purchase contract. The holder may also 

subsequently recreate “Normal DECS” by replacing the appropriate series of trust preferred 

securities for the Treasury securities. 

Additional terms of the ADIA-Citigroup investment include the following. ADIA may 

not transfer, sell, or hedge the equity units or its exposure to the underlying common stock until 

at least December 3, 2009. After December 3, 2009 and until three years after the final stock 

purchase date, ADIA will be subject to certain manner-of-sale restrictions for its common stock. 

ADIA’s aggregate ownership of Citigroup’s common stock, including shares bought under the 

forward purchase contract, may not exceed 4.9 percent of Citigroup’s total outstanding common 

stock, and ADIA will have no special rights of ownership or control and no role in the 

management or governance of Citigroup. In particular, ADIA will have no right to designate a 

member of the Citigroup board of directors. 

CIC-Morgan Stanley investment

On December 19, 2007, the China Investment Corporation agreed to purchase 

approximately $5.6 billion of equity units called PEPS issued by Morgan Stanley (the “CICMorgan Stanley investment”).176 The PEPS units in the CIC-Morgan Stanley investment are 

 175 “Citi to Sell $7.5 Billion of Equity Units to the Abu Dhabi Investment Authority,” available at 

http://www.citigroup.com/citigroup/press/2007/071126j.htm. 

176 See Morgan Stanley, Current Report on Form 8-K, filed with the Securities Exchange 

Commission on December 27, 2007, available at 

http://www.sec.gov/Archives/edgar/data/895421/000115752307012287/a5568797ex991.htm. The 

acronym “PEPS” stands for Premium Equity Participating Security. 
65 

similar in structure to the Upper DECS equity units in the ADIA-Citigroup investment and, like 

ADIA, CIC is a passive portfolio investor in Morgan Stanley with no special ownership or 

management rights. 

Each PEPS unit is a mandatory convertible security consisting of a forward contract to 

purchase Morgan Stanley common stock on a stock purchase date177 and an undivided beneficial 

interest in a trust preferred security. The trust preferred security is pledged as collateral under 

the forward contract. The trust preferred security represents an interest in a trust sponsored by 

Morgan Stanley178 that holds a junior subordinated debenture issued by Morgan Stanley. The 

junior subordinated debenture matures in 2042 and bears interest at an annual rate of 6.00 

percent. The trust preferred securities each provide for quarterly payments equal to the amount 

of interest paid on the underlying Morgan Stanley debenture. 

Each PEPS unit held by CIC provides for quarterly payments at a 9 percent fixed annual 

rate. These payments consist of the payments on the trust preferred security (i.e., the 

passthrough of the interest paid on the underlying Morgan Stanley debenture) and quarterly 

“contract payments” on the forward purchase contract at an annual rate of 3 percent. The PEPS 

units provide for remarketing of the trust preferred securities shortly prior to the stock purchase 

date in a manner similar to the remarketing of the Citigroup Upper DECS units and for the 

proceeds of the remarketing to be applied to settlement of the forward purchase contract. The 

PEPS units also provide that the holder may separate the trust preferred securities from the 

forward purchase contract by substituting qualifying Treasury securities to serve as collateral for 

its obligation under the forward purchase contract (creating “Treasury Units”). The holder may 

also subsequently recreate “Corporate Units” by replacing the appropriate series of trust 

preferred securities for the Treasury securities. 

Tax treatment

The mandatory convertible securities issued in the ADIA-Citigroup and CIC-Morgan 

Stanley investments provide significant tax and regulatory benefits to the issuers. However, it is 

not clear that the structure of these securities provides ADIA or CIC with a significant tax benefit 

that would not have been available to a nongovernmental foreign investor. 

More specifically, the terms of the securities purchased by ADIA and CIC are 

substantially similar to the terms of the instruments described in IRS Revenue Ruling 2003-97.179 

 177 The stock purchase date is expected to be August 17, 2010, subject to an extension of up to 

one year. 

178 The PEPS were issued in three series, each representing an interest in a trust preferred 

security issued by one of three separate trusts; each of these trusts in turn held one of three series of 

Morgan Stanley debentures with identical terms. 

179 2003-2 C.B. 380. 
66 

Each of these are variants of mandatory convertible securities.180 The instruments described in 

the revenue ruling consist of a note and a forward contract to purchase common stock of the 

issuer (together referred to in the revenue ruling as the “Purchase-Contract/Note unit”). The note 

is pledged as collateral under the forward contract. The notes in the Purchase-Contract/Note 

units provide quarterly payments of amounts denominated as interest at a fixed rate. The notes 

are required to be remarketed before the forward contract’s settlement date, and the proceeds of 

the remarketing are applied to settle the forward contract. A holder of a Purchase-Contract/Note 

unit may separate the note from the forward contract but is not required to do so. If the holder 

does “strip” out the note, the holder must substitute qualifying Treasury securities to serve as 

collateral for its obligation under the forward contract. 

The Upper DECS equity units and PEPS units acquired by ADIA and CIC, respectively, 

are similar to those described in Revenue Ruling 2003-97, except that they include trust 

preferred securities rather than notes. Each trust preferred security represents, however, a 

beneficial interest in an underlying debenture held by the issuing trust. It appears that the issuing 

trusts were structured in such a manner that they are treated as grantor trusts for U.S. federal 

income tax purposes, so that each holder of a trust preferred security (and thus each holder of an 

equity unit) is treated for federal income tax purposes as holding a proportionate interest in the 

underlying debenture.181

In Revenue Ruling 2003-97, the IRS addressed the questions of whether (a) the note in 

the Purchase Contract/Note unit could be treated as a separate debt instrument during the period 

prior to the remarketing (or instead as a prepayment on the forward contract with the actual notes 

being issued only upon a conversion, a settlement for separate cash or a successful remarketing) 

and (b) if so, whether section 163(l) would prevent the issuer from deducting interest on the 

note.182 The IRS concluded that the note in the Purchase-Contract/Note unit could be treated 

separately from the forward contract at all times and, further, that section 163(l) did not apply to 

disallow a deduction for interest accruing on the note. Because the terms of the Upper DECS 

equity units and the PEPS units are substantially similar to the terms of the PurchaseContract/Note unit, it can be expected that Citigroup and Morgan Stanley are relying on the 

revenue ruling to take the position that they are allowed interest deductions for amounts accruing 

on the debentures underlying the trust preferred securities. This interest deduction provides a 

significant tax benefit to the issuers that would have been unavailable if they had instead issued 

 180 Investment banks have developed proprietary versions of these securities. Citigroup’s version 

has the trade name DECS, Morgan Stanley’s product is called PEPS, and Merrill Lynch’s instrument is 

called Feline PRIDES. The acronym PRIDES stands for preferred redeemable increased dividend equity 

securities. 

181 See Internal Revenue Service Technical Advice Memorandum 199910046 (Nov. 16, 1998), 

addressing the treatment of an earlier version of the trust preferred security issued by a foreign limited 

liability company. 

182 Section 163(l) disallows a deduction for any interest paid or accrued on a “disqualified debt 

instrument,” defined as indebtedness of a corporation that is payable in equity of the issuer or a related 

party. 
67 

common or preferred stock directly. According to one commentator, the annual tax values of the 

interest deductions to Citigroup and Morgan Stanley approximate $175 million and $100 million, 

respectively.183

In addition, the choice of mandatory convertible securities appears to have been 

influenced by regulatory considerations. In particular, it was important that the capital raised by 

Citibank and Morgan Stanley be counted toward “Tier 1” capital requirements for bank 

regulatory purposes.184 The equity units acquired by ADIA and CIC qualified as Tier 1 capital, 

whereas the issuance of a debt security alone would not have so qualified. Moreover, at least 

one analyst has argued that the use of mandatory convertible securities allowed ADIA’s and 

CIC’s percentages of ownership in Citigroup and Morgan Stanley to remain below ownership 

and control thresholds that would have subjected the transactions to CFIUS review.185

It is less clear that the U.S. tax treatment of ADIA and CIC (and the availability of 

section 892 in particular) influenced the structure of these investments. Assuming, as seems 

likely, that ADIA and CIC are integral parts or controlled entities of the Abu Dhabi and Chinese 

governments, they generally should qualify under section 892 for exemption from U.S. tax on 

income eligible for the exemption. Income from the ADIA-Citigroup investment and the CICMorgan Stanley investment should be eligible for the exemption, because the investments are in 

“stocks, bonds, or other securities,” and because the commercial activity and controlled 

commercial entity exceptions would seem not to apply. 

A nongovernmental foreign investor would have enjoyed most, but not all, of the U.S. tax 

benefits obtained by ADIA and CIC. In particular, in the hands of a nongovernmental foreign 

investor, the portion of the return attributable to interest paid on the debentures underlying the 

trust preferred securities generally would have been eligible for the portfolio interest exemption 

of section 871(h) or 882(c) from U.S. withholding tax,186 and any capital gains realized on a sale 

 183 David D. Stewart, “Sovereign Wealth Funds Take Advantage of IRS Ruling,” Tax Notes 

International, Mar. 10, 2008, at 830. In the ADIA-Citigroup investment, interest at 6.5 percent (the 

amount treated as interest) on $7.5 billion is $487.5 million, and the resulting tax savings computed at a 

35 percent corporate tax rate is $170.625 million. In the CIC-Morgan Stanley investment, interest at 6 

percent (the amount treated as interest on $5 billion is $300 million, and the resulting tax savings 

computed at a 35 percent corporate tax rate is $105 million. 

184 See, e.g., Liz Moyer, “Abu Dhabi Pumping $7.5B into Citi,” Forbes.com, Nov. 11, 2007, 

available at http://www.forbes.com/markets/2007/11/26/citi-abudhabi-stake-markets-equitycx_lm_1126markets44.html; “Morgan Stanley F4Q07 (Qtr End 11/30/07) Earnings Call Transcript,” 

available at http://seekingalpha.com/article/57886-morgan-stanley-f4q07-qtr-end-11-30-07-earnings-calltranscript?page=-1. 

185 See David D. Stewart, “Sovereign Wealth Funds Take Advantage of IRS Ruling,” Tax Notes 

International, Mar. 10, 2008, at 831 (citing New America Foundation official Douglas Rediker). 

186 The portfolio interest exemption would not be available to a foreign investor that was a 10-

percent (or greater) shareholder of Citigroup or Morgan Stanley, as applicable. Secs. 871(h)(3)(B), 

881(c)(3)(B). The Citigroup Upper DECS acquired by ADIA, and the Morgan Stanley PEPS acquired by 
68 

of the investments or the stock received on maturity of the forward contracts would have been 

exempt under section 871 or section 881. 

The only potential U.S. tax advantage obtained by ADIA and CIC, when compared to a 

nongovernmental foreign investor in identical equity units, relates to the portion of the return 

attributable to the quarterly contract payments. In the case of a nongovernmental foreign 

investor, those payments might be characterized as “fixed and determinable annual or periodic 

income,” in which case the payments would be subject to withholding tax at a 30-percent rate 

unless the investor were eligible for an exemption or reduced rate under an income tax treaty.187 

By contrast, regardless of the proper characterization of such contract payments, ADIA and CIC 

probably would be exempt from taxation on the contract payments by virtue of Section 892. 

A foreign investor eligible for section 892 also obtains a U.S. tax benefit when compared 

to a nongovernmental foreign investor, in respect of dividends received on the stock delivered 

under the forward contract portion of the equity units. For a nongovernmental foreign investor, 

dividends are generally subject to withholding tax at a 30 percent rate, unless reduced by an 

income tax treaty. 

 

CIC, represented less than 10-percent ownership interests in the issuers, taking into account the stock to 

be delivered on maturity. 

187 The proper characterization of contract payments in arrangements similar to that described in 

Revenue Ruling 2003-97 is uncertain, and the revenue ruling does not address that case. One plausible 

interpretation is that those contract payments constitute a miscellaneous fee paid by the issuer to induce 

the investor to make the relevant investment. Another possible interpretation is that the contract 

payments represent net option premium paid by the issuer to the investor on a periodic basis (which in 

turn is not the norm for option premium payments). Other interpretations also could be developed.
69 

B. Common and Convertible Preferred Stock 

On December 24, 2007, Merrill Lynch & Co., Inc. (“Merrill Lynch”) announced that it 

would sell up to $6.2 billion in common stock to Temasek Holdings188 and Davis Selected 

Advisors, L.P. Temasek Holding’s share of the transaction was a $4.4 billion initial stock 

purchase, with an option to purchase an additional $600 million in common stock by March 28, 

2008.189 

On January 15, 2008, Merrill Lynch announced that it would issue $6.6 billion of 

nonvoting mandatory convertible non-cumulative preferred stock to a group of investors that 

included the Kuwait Investment Authority (“KIA”), the Korean Investment Corporation (“KIC”) 

and Mizuho Bank.190 The preferred stock pays a dividend of 9 percent per annum and has a 

maturity of 23⁄4 years, at which point it mandatorily converts into Merrill Lynch common stock. 

On January 23, 2008, Citigroup Inc. sold $12.5 billion in convertible preferred stock to a 

group of investors that included the Singapore Government Investment Corporation Pte Ltd. 

(“GIC”),191 KIA, the New Jersey Investment Division and a number of private investors 

including nongovernmental foreign investors.192 The preferred stock is perpetual and pays a 

dividend of 7 percent per annum. The holder may convert the preferred stock into common 

stock of Citigroup at any time, and Citigroup may convert the stock into common stock at any 

time on or after February 15, 2015. The preferred stock is also redeemable for cash on or after 

February 15, 2015 subject to certain limitations. The preferred stock conveys no governance 

rights, subject to the customary right of preferred stockholders to elect two members to the board 

of directors upon nonpayment of dividends for six dividend periods. 

For the SWF investors in each of these transactions, section 892 would exempt any 

dividend payments on the common or preferred stock. In the case of the two convertible 

preferred stock issuances, however, the stock was sold on the same terms to a group of investors 

that included both SWFs and other nongovernmental foreign investors (who would be subject to 

 188 Temasek Holdings is a Singapore corporation that is wholly owned by the Singapore Ministry 

of Finance. It holds and manages investments for the Government of Singapore. 

189 See Merrill Lynch & Co., Inc., Current Report on Form 8-K, filed with the Securities 

Exchange Commission on December 27, 2007, available at 

http://www.sec.gov/Archives/edgar/data/65100/000095012307017127/y45445exv99w1.htm. This 

transaction settled on December 28, 2007 (60 percent) and January 11, 2008 (40 percent). 

190 See Merrill Lynch & Co., Inc., Current Report on Form 8-K, filed with the Securities 

Exchange Commission on January 15, 2008, available at 

http://www.sec.gov/Archives/edgar/data/65100/000095012308000429/y46693exv99w1.htm. 

191 GIC acquired $6.88 billion of the preferred stock. 

192 See Citigroup Inc., Current Report on Form 8-K, filed with the Securities Exchange 

Commission on January 15, 2008, available on the internet at 

http://www.sec.gov/Archives/edgar/data/831001/000110465908002663/a08-1948_1ex99d1.htm. 
70 

U.S. withholding tax on dividend payments). This suggests that the availability of an exemption 

under section 892 was not a significant consideration in the choice of convertible preferred 

securities. A more significant concern may have been the qualification of the preferred stock as 

Tier 1 capital for bank regulatory purposes. 
71 

C. Other Investment Strategies 

Due to the risk that tax-exempt income may become tainted, a foreign government 

considering investing in a partnership through a controlled entity typically will seek to avoid any 

situation that might result in the attribution of any commercial activity (occurring anywhere in 

the world) to its controlled entity. One method by which a foreign government could minimize 

the risk of tainting its otherwise tax-exempt income under section 892 in this circumstance is by 

having its controlled entity (“Corp A”) create (at least) two subsidiary brother-sister corporations 

(“Sub B” and “Sub C”). Corp A would then function solely as a holding company for Sub B and 

Sub C, making no investments itself. Sub B would make all non-U.S. investments (including 

any investments in non-U.S. partnerships). Sub C would invest solely in the U.S., and would not 

invest directly in any partnership. If Sub C desired to invest in a U.S. partnership, such as a U.S. 

hedge fund or private equity fund, it would do so only by investing in a corporate entity (i.e., a 

blocker company) that it would not control, such as the foreign feeder corporation commonly 

found in many U.S. hedge fund or private equity fund structures.193 With such a structure, it is 

irrelevant whether Sub B engages in, or is treated as engaging in, any commercial activities, as 

all of its investments are outside the United States, and thus not subject to U.S. tax. As brothersister corporations, any Sub B commercial activities would not taint Sub C. Sub C’s income 

would not be tainted because it would not engage in any commercial activities itself and would 

have no commercial activities attributed to it as a result of any investment in a U.S. hedge fund 

or private equity fund because the foreign feeder corporation would block any potential 

attribution. 

In certain cases, a SWF might also invest in an investment fund organized as a 

partnership, not only as a limited partner but also as a member of the general partner managing 

the fund assets (typically itself organized as a passthrough entity, such as a partnership or limited 

liability company). As a member of the general partner, the SWF would share in both fee 

income derived by the general partner and the so-called “carried interest,” generally a partnership 

profits interest under which the general partner has a right to receive a percentage of partnership 

profits but has no obligation to contribute capital and no right to partnership assets on 

liquidation.194 Because the character of a partnership’s income passes through to its partners, the 

general partner’s share of income has the same character as the income has when it is realized by 

the underlying investment fund. Accordingly, under present law income from a carried interest 

may be reported as long-term capital gain to the extent that the income is attributable to gains 

 193 For a description of a common fund structure that employs a foreign feeder corporation, as 

well as an explanation of some of the possible tax advantages of such a structure, see Joint Committee on 

Taxation, Present Law and Analysis Relating to Tax Treatment of Partnership Carried Interests and 

Related Issues, Part II (JCX-63-07), at 2-5, Sept. 4, 2007. 

194 For a comprehensive discussion of partnership carried interests and their tax treatment, see 

Joint Committee on Taxation, Present Law and Analysis Relating to Tax Treatment of Partnership 

Carried Interests and Related Issues, Part I (JCX-62-07) and Part II (JCX-63-07), Sept. 4, 2007. 
72 

realized by the investment fund from capital assets held for more than one year.195 In the case of 

a SWF, the investment management activities of the general partner might be treated as a 

commercial activity that would be attributed to the SWF.196 If so, section 892 would not be 

available with respect to income derived by the SWF through its interest in the general partner. 

However, any portion of the carried interest treated as capital gains would normally be exempt in 

any event under the rules generally applicable to foreign investors; other income, such as 

dividends, would likewise receive the same treatment as in the hands of a private foreign 

investor. Moreover, the use of a special purpose “blocker” company, as described above, could 

prevent the commercial activity attributed to the SWF from tainting other income earned by the 

SWF, including its income earned as a limited partner in the investment fund.197 

 195 Section 1201 of the Tax Reduction and Reform Act of 2007, H.R. 3970, 110th Cong., 

introduced on October 25, 2007, would generally treat income from a carried interest as ordinary income. 

196 Temp. Treas. Reg. sec. 1.892-5T(d)(3). 

197 An alternative, and perhaps simpler, way for a SWF to invest in an investment fund manager 

and share in the carried interest would be to acquire stock in one of the publicly traded fund managers, 

such as The Blackstone Group L.P. or Fortress Investment Group LLC. Both dividends and capital gains 

realized from such an investment presumably would be exempt under section 892. 
73 

V. POLICY CONSIDERATIONS REGARDING THE CURRENT TAX TREATMENT 

OF U.S. INVESTMENT BY FOREIGN GOVERNMENTS 

As discussed above, the U.S. income tax treatment afforded U.S. investments by foreign 

governments is generally similar to, but somewhat better than, the tax treatment afforded similar 

investments by foreign corporations. We have set out below a number of factors that should be 

considered in evaluating the merits of this differential. As a preliminary matter, however, we 

note that it is difficult to conceive of any reasonable justification for modifying the existing rules 

to treat SWFs, or foreign governments more generally, less favorably than foreign corporations. 

A. Economic Policy Considerations 

Economic theory generally argues that unencumbered trade in goods and services and 

cross border investment creates the greatest opportunity for growth both in the United States and 

abroad. Policies that impede cross border investment can lead to inefficient investment decisions 

and potentially reduced aggregate investment. Reduced aggregate investment and an inefficient 

allocation of investment dollars reduces future growth compared to that achievable in the 

absence of restrictions. Reduced growth means that per capita income will be lower in the future 

than it might otherwise be. This analysis would argue that restrictions on investments by SWFs 

cannot improve economic well being in the United States. On the other hand, as documented 

above, investment by SWFs is small relative to aggregate U.S. investment and even smaller 

relative to aggregate worldwide investment. If SWFs are not the marginal investor in the United 

States, that is if investments made by SWFs would be readily substituted by other funds at little 

or no change in the cost of capital, restrictions on the investments of SWFs would have little or 

no effect on future economic growth in the United States. However, restrictions on some foreign 

investors may be interpreted by other potential investors as an indication that the United States is 

inhospitable to foreign investors. Such a perception could make foreign investment funds more 

expensive and reduce aggregate investment. 

B. Tax Policy Considerations 

Sovereign immunity

As discussed in more detail above, the exemption from U.S. income tax afforded foreign 

governments with respect to certain income has a long history that is consistent with the 

development of the concept of sovereign immunity under U.S. law. When first added to the U.S. 

income tax laws in 1917, the predecessor to the exemption now found in section 892 was 

consistent with the then-prevailing absolute theory of sovereign immunity, under which one 

country was absolutely immune from the jurisdiction of the courts of another country. The broad 

exemption from U.S. income tax that Congress provided to foreign countries was a natural 

extension of this immunity from U.S. courts. 

The income tax exemption evolved with the passage of time in such a way as to reflect 

sovereign immunity developments and an increase in the scope of activities engaged in by 

foreign countries. In the 1950s, the United States moved from following an absolute theory of 

immunity to following a restrictive theory of immunity. With the enactment of FSIA in 1976, 

the United States statutorily adopted a restrictive theory of immunity. FSIA broadly provides 
74 

foreign countries immunity from the jurisdiction of U.S. courts, except in certain cases 

involving, inter alia, commercial activities. In 1980, regulations under section 892 were adopted 

that narrowed the scope of the tax exemption by stating that it was not available with respect to 

income derived from commercial activities in the United States. In 1986, section 892 was 

amended to specifically include a commercial activities exception to the exemption. As 

amended and applied, section 892 is generally consistent with FSIA in that it provides exemption 

from the U.S. income tax laws for certain types of investment income, but does not provide 

exemption for income derived from commercial activities. In light of this background, any 

consideration of the proper scope of section 892 should take into account, and reflect the scope 

of, the immunity provided under FSIA. 

Differences in U.S. tax treatment of various investors in the United States

Another consideration is that the difference between the U.S. income tax treatment of 

foreign governments and foreign corporations is limited as a practical matter. That difference is 

described in more detail above. In brief, however, there are three principal differences: portfolio 

dividends, interest income from certain noncontrolled commercial entities, and income from the 

disposition of interests in noncontrolled USRPHCs that are not domestically controlled REITs. 

In each instance, the income is generally exempt under section 892 when received by a foreign 

government but is taxable when received by a foreign corporation. However, the differential 

U.S. income tax treatment with respect to the first two categories of income may be reduced or 

eliminated in cases in which U.S. income tax treaties apply to provide foreign persons relief from 

U.S. income tax on dividends and interest. With respect to the third category, U.S. income tax 

treaties generally preserve the United States ability to impose U.S. income tax on dispositions of 

interests in USRPHCs by foreign persons, so the differential tax treatment will generally 

continue to exist in that case. 

Given these limited differences in the U.S. income tax treatment between foreign 

governments and foreign corporations, achieved through different Code provisions and the 

application of U.S. income tax treaties, one might consider whether the tax exemption in section 

892 provides much meaningful benefit to foreign governments. If one concludes that it does not, 

that conclusion might suggest, on the one hand, that narrowing or eliminating the specific tax 

exemption in section 892 might be of little practical consequence; on the other hand, that 

conclusion might suggest that there is limited justification for altering the specific tax exemption 

in section 892 (particularly in light of the risk that foreign countries might choose to respond to 

any narrowing of section 892 with changes in their own laws that could disadvantage U.S. 

investors). 

A further consideration is that the income tax treatment afforded foreign governments 

(including their political subdivisions) under section 892, although somewhat better than the 

treatment afforded foreign corporations, is significantly less favorable than the U.S. income tax 

treatment afforded nonfederal sovereigns, specifically U.S. States and Indian tribes. As 

discussed above, States are not subject to U.S. income tax on any income that they earn directly, 

even if from commercial activities. Moreover, States are specifically exempt under the Code 

from tax on certain income that they earn indirectly, if the income is derived from a public utility 

or the exercise of an essential governmental function. This exemption may apply to income 

derived from commercial activities. As also discussed above, Indian tribes and wholly owned 
75 

tribal corporations chartered under Federal law are similarly not subject to U.S. income tax, even 

if the income is from commercial activities and even if the activity is conducted off the tribe’s 

reservation. One might suggest that this disparity in the existing treatment between foreign 

sovereigns and nonfederal sovereigns demonstrates that section 892 already provides too narrow 

of an exemption or, conversely, that the exemption provided to nonfederal sovereigns is too 

broad. 

Select section 892 considerations

Section 892 contains a fairly broad definition of foreign government, which includes 

certain controlled entities. One could imagine utilizing a narrower definition for this purpose, 

but any such effort might present difficult line-drawing issues. For example, if one were to 

consider limiting the definition of foreign government to foreign sovereigns and their integral 

parts (i.e., the definition would not include controlled entities), it would be necessary to consider 

whether there is any type of controlled entity that should nevertheless qualify (e.g., a separately 

organized pension trust). One would also need to consider whether investments that are 

currently made through controlled entities might instead be made through integral parts, such as 

bureaus or departments that might be established specifically to make those investments. 

A related issue arises with respect to the different outcome under section 892 if an 

integral part or a controlled entity engages in commercial activity. If an integral part engages in 

commercial activity, the income from that activity does not qualify for the section 892 tax 

exemption, but any other income received by the integral part that would otherwise qualify for 

the exemption continues to qualify for the exemption (i.e., the commercial activity does not taint 

the other income). However, if a controlled entity engages in commercial activity, neither the 

income from that activity nor any other income received by the controlled entity qualifies for the 

section 892 tax exemption (i.e., the commercial activity taints all of the income). In effect, this 

disparity in outcome elevates form over substance, in that in either case the source of the funds 

for the investment that generated the noncommercial income is the same—the funds belong to 

the foreign sovereign—and the only difference is the form the foreign sovereign chooses to 

utilize to make the investment. On the one hand, it is true that the foreign sovereign is generally 

free to choose the form of its investment and, in so doing, accepts the consequences. More 

importantly, however, the disparate impact of commercial activities on integral parts and 

controlled entities creates a potential trap for the unwary—a controlled entity that engages in any 

commercial activity, no matter how minimal, anywhere in the world, taints all of that controlled 

entity’s income. Although structural solutions are available, one might consider whether it is 

appropriate to employ a rule with such consequences in a case in which the Code generally 

provides U.S. income tax exemption. Other approaches, such as a de minimis rule or an 

examination of the activities of the controlled entity as a whole, may be more appropriate. 

An additional issue is the nature of the interaction between the section 892 exemption and 

the look-through rule of section 897(h)(1) for distributions from QIEs, including REITs. This 

issue is discussed in Notice 2007-55, which is described in more detail above. In brief, the 

Notice indicates the IRS’s view that the look-through rule applies to REIT distributions 

(including liquidating distributions) to foreign governments, such that the section 892 exemption 

does not apply to a distribution to the extent it is attributable to gains from the sale or exchange 

by the REIT of interests in real property located in the United States or the Virgin Islands. In 
76 

addition, the Notice states that the Treasury Department and the IRS will clarify the interaction 

of these provisions in regulations. As noted earlier, the issue presented by the Notice is whether 

a foreign government’s exemption under section 892 should shelter gain realized by the REIT. 

In this regard, one might consider whether a foreign government that receives a distribution from 

a REIT should be exempt from U.S. income tax to the extent that the distribution is from the 

REIT’s sale of property that, if sold by the foreign government directly, would be subject to tax. 

On the other hand, section 892 exempts from U.S. income tax a foreign government’s gain from 

the sale of an interest in a noncontrolled USRPHC, including a REIT. This treatment may 

suggest that a foreign government that receives a REIT distribution attributable to gains from the 

sale or exchange by the REIT of interests in U.S. real property should be exempt from U.S. 

income tax under the general rule of section 892 that dividends from noncontrolled commercial 

entities, including REIT distributions, are exempt. 
77 

VI. COMPARISON WITH FOREIGN LAW 

Appendix One hereto contains a report prepared by the Directorate of Legal Research for 

International, Comparative, and Foreign Law of The Law Library of Congress entitled Taxation 

of the Passive Income of Foreign Governments and Sovereign Wealth Funds in Selected Foreign 

Countries. These countries are Australia, Canada, Germany, Japan, Norway, Poland, 

Switzerland and the United Kingdom. For purposes of the analysis in the report, passive income 

is defined as interest, dividends and capital gains. 

As the report illustrates, four of those countries have adopted a general policy that is 

broadly similar to that of the United States in that they exempt foreign governments unilaterally 

from taxation of passive income, based on a principle of sovereign immunity. Each of these 

countries, however, has implemented that policy in a manner different from the United States, 

including with respect to SWFs. The remaining countries either do not exempt foreign 

governments from taxation or do so only bilaterally through income tax treaties (in which case 

SWFs may or may not benefit from the exemption, depending on the treaty). 

Japan and the Commonwealth countries of Australia, Canada and the United Kingdom 

have each adopted a general policy of exemption for foreign governments from taxation on 

passive income. In Australia and Canada, that policy is implemented administratively and on an 

individual government-by-government basis. In both cases, exemptions are granted to SWFs in 

only limited circumstances. Thus, in Australia, a foreign government or its agency may obtain an 

exemption for funds that will remain governmental by applying for a private ruling that usually 

is granted for portfolio investments (with 10 percent or less equity ownership being a guidepost 

for defining a noncommercial activity). A SWF may obtain an exemption only by establishing 

that the passive investment income that will be eligible for the exemption results from the 

performance of a governmental function in Australia. In Canada, the government or a central 

bank of a foreign country may obtain an exemption from withholding taxes for Canadian source 

portfolio investments that serve a truly governmental function, and not a commercial activity, 

provided that there is reciprocity. For this purpose, SWFs appear to have been evaluated based 

on whether their purpose is public/humanitarian, or commercial. 

Japan apparently exempts foreign governments from taxation on interest and dividends 

by administrative practice, while capital gains are exempt by law. SWFs do not benefit, 

however, from the administrative exemption for interest and dividends. Instead, they are taxable 

in the same manner as a foreign corporation, except to the extent that an income tax treaty may 

grant relief for a SWF based in the treaty country. The United Kingdom also exempts foreign 

governments from taxation on passive income by administrative practice; SWFs benefit fully 

from this exemption (assuming the SWFs are integral parts of the governments of their 

respective countries). 

Germany, Norway, Poland, and Switzerland do not apply the doctrine of sovereign 

immunity to exempt foreign governments from taxation. Germany taxes foreign governments, 

including SWFs, in the same manner as foreign corporations, and its income tax treaties also do 

not provide any specific exemption for foreign governments. However, Germany’s tax laws 

provide a general exemption for both interest and non-substantial-participation capital gains 

derived by nonresidents; a 95-percent exemption is also provided for dividends and substantial 
78 

participation capital gains. Thus, all nonresidents, including foreign governments, bear relatively 

little tax on passive income from German sources. 

Norway’s tax laws do not appear to include any special provision for foreign 

governments or SWFs. However, Norway does not tax interest income earned by nonresidents. 

Norway also provides an exemption for dividend income and capital gains attributable to 

ownership of stock in Norwegian companies by corporate shareholders in EEA countries; 

dividends paid to corporate shareholders outside the EEA are subject to a 25-percent withholding 

tax, unless reduced by treaty. Certain of Norway’s income tax treaties also appear to provide for 

reciprocal government exemptions. 

Like Norway, Poland’s tax laws do not provide an exemption for foreign governments or 

SWFs. In fact, Poland’s tax laws do not distinguish between residents and nonresidents; all 

income of corporations originating in Poland is subject to a flat 19 percent corporate tax, 

regardless of the residence of the corporation. Certain income tax treaties entered into by Poland 

do provide reduced dividend withholding rates for nonresidents and, in some cases (such as 

Kuwait) an exemption for the other country’s government. 

Switzerland also does not exempt foreign governments from taxation by law. It does, 

however, provide exemptions on a reciprocal basis through its income tax treaties. 
Directorate of Legal Research for International, Comparative, and Foreign Law 

James Madison Memorial Building; 101 Independence Avenue, S.E.; Room LM 240; Washington, DC 20540-3200 

Reception: (202) 707-5065 – FAX: (202) 315-3654 

www.loc.gov/law/congress

The Law Library of Congress 

REPORT FOR CONGRESS 

May 2008 

Directorate of Legal Research 

LL File No. 2008-00763 

TAXATION OF THE PASSIVE 

INCOME OF FOREIGN 

GOVERNMENTS AND SOVEREIGN 

WEALTH FUNDS IN SELECTED 

FOREIGN COUNTRIES 

Australia, Canada, Germany, Japan, Norway, Poland, Switzerland, and the United Kingdom. 

. 

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APPENDIX ONE:

FOREIGN LAW TAX TREATMENT OF GOVERNMENT INVESTMENT

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2008-00763 

LAW LIBRARY OF CONGRESS 

TAXATION OF THE PASSIVE INCOME OF FOREIGN GOVERNMENTS AND SOVEREIGN 

WEALTH FUNDS IN SELECTED FOREIGN COUNTRIES 

COMPARATIVE SUMMARY 

Executive Summary 

On the basis of the principle of sovereign immunity, Australia, Canada, Japan, 

and the United Kingdom exempt foreign governments and their instrumentalities from 

taxation of their source country passive investments through administrative acts or 

practices, and to a limited extent, sovereign wealth funds may also benefit from these 

regimes. Germany, Norway, Poland, and Switzerland do not apply the doctrine of 

sovereign immunity to grant foreign governments general exemptions from taxation on 

their source country income. However, the Norway-Russia double taxation treaty 

exempts interest earned by the other government and its central bank while the KuwaitPoland treaty exempts source dividends earned by the other county’s governments and 

their funds. Germany appears to have no such exemptions in its double taxation treaties, 

while the Swiss double taxation treaties allow for much discretion and flexibility on the 

basis of informal agreements between the Contracting States. 

In their domestic legislation, Canada, Germany, Norway, and the United 

Kingdom do not tax source country interest of non-residents, whereas Australia, Japan, 

Poland, and Switzerland withhold tax on such interest at varying rates. Source country 

dividends are exempted for non-residents in the United Kingdom, and for corporate nonresidents they are totally exempted in Norway and 95 percent exempted in Germany. 

Australia taxes only the dividends from untaxed corporate profits, whereas Canada, 

Japan, Poland, and Switzerland withhold taxes on source country dividends at varying 

rates. 

I. Scope of the Project 

This report consists of individual reports for Australia, Canada, Germany, Japan, Norway, 

Poland, Switzerland, and the United Kingdom. All these countries are members of the Model Tax 

Convention of the Organization for Economic Co-operation and Development [OECD Model Tax 

Convention]1

 and for each of these countries the report surveys the country’s domestic legislation, policy, 

or practice on the taxation of passive income (interest, dividends, and capital gains) earned by foreign 

governments or their instrumentalities and by foreign sovereign wealth funds. To assess the significance 

of any tax exemptions for foreign governments and their funds, this report also reviews the domestic laws 

on taxing source country income from interest, dividends, and capital gains that is earned by non-resident 

corporations in general. In addition, to provide a sampling of the applicable double taxation treaties, each 

country report examines at least one double taxation treaty with another country that has a prominent 

sovereign wealth fund. 

 

 

1

 Organization for Economic Co-operation and Development, Model Tax Convention on Income and on Capital, Electronic 

Version, Feb. 1, 2005, available by subscription from the official Web-site http://www.oecd.org/document/17/ 

0,3343,es_2649_33747_35035793_1_1_1_1,00.html. 

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Comparative Summary: Taxation – May 2008 The Law Library of Congress - 2 

II. Taxation of Foreign Governments 

 In comparing the domestic laws and policies on the taxation of foreign governments and their 

entities, a difference between Japan and the Commonwealth countries of Australia, Canada, and the 

United Kingdom on the one hand and Continental Europe on the other becomes apparent. Whereas Japan 

and the surveyed Commonwealth countries base their practice of exempting foreign governments and 

their agencies from taxation of their passive source income on the international law concept of sovereign 

immunity, this theory is not used to generally exempt governments from taxation in continental Europe.2

 

In the domestic laws of Germany, Norway, Poland, and Switzerland, foreign governments are deemed to 

be treated like other foreign entities, and if exemptions are made, they are most likely to be found in 

double taxation treaties or the practice resulting from them. 

 Australia and Canada exempt foreign governments from taxation on their passive source income; 

they implement this principle through individual administrative acts. 

• In Australia, a foreign government or its agency may obtain an exemption for funds that will 

remain governmental by applying for a private binding ruling that usually will be granted for 

portfolio investments, with 10 percent equity or less being the guidepost for defining a noncommercial activity. 

• In Canada, the government or a central bank of a foreign country may obtain an exemption from 

withholding taxes for Canadian source portfolio investments that serve a truly governmental 

function and not a commercial activity, provided that there is reciprocity. 

 Japan and the United Kingdom exempt foreign governments from taxation on their passive source 

income through their administrative practice, which in the case of Japan has found expression in the 

exemption of the foreign governments from having to report source income to the authorities, on the 

grounds that it would not be taxed in any event. 

 In addition to these unilateral or reciprocity-based practices, these above described countries may 

allow for further exceptions on the basis of their double taxation treaties. 

 Among the surveyed continental European countries that do not subscribe to the sovereign 

immunity concept for the taxation of foreign government’s passive investments, Germany stands out by 

adhering to the principle of taxing foreign governments like any other foreign company, not only in its 

domestic legislation but also in its treaty practice. The German double taxation treaties follow the spirit 

of article 4, paragraph 1 of the OECD Model Tax Convention by treating the governments of the treaty 

states as residents, and therefore as taxpayers, and by not making exceptions from this principle. 

 Norway and Poland, while adhering to the principle that foreign governments should be 

taxpayers, nevertheless make some treaty exceptions to this principle. The double taxation treaty between 

Norway and Russia, for instance, exempts passive income from taxation at the source if it is beneficially 

owned by the other Contracting State or its subdivisions or instrumentalities, central banks, certain named 

financial institutions for foreign trade, and similar institutions designated by mutual agreement. 

 Poland has double taxation treaties with China, Kuwait, Russia, and Singapore. Of these, the 

only exemption from the taxation of a foreign government is found in the treaty with Kuwait. It provides 

that dividends earned in the source country by the government of the other state are exempt from taxation. 

 2

 All the surveyed countries are members of the Convention on Diplomatic Relations, Apr. 18, 1961, 23 UST 3227; 

TIAS 7502; 500 UNTS 95 and of the Convention on Consular Relations, Apr. 24, 1963, 21 UST 77; 596 UNTS 261, and it can 

be safely assumed that they observe these conventions by exempting diplomatic and consular staff from taxation, as well as 

exempting foreign governments for mission-related purposes. These Conventions are not further discussed in this report. 

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Comparative Summary: Taxation – May 2008 The Law Library of Congress - 3 

 Switzerland has no domestic legislation exempting foreign governments from taxation of their 

passive Swiss-source income. It also appears that the double taxation treaties do not specify such 

exemptions. The actual practice, however, cannot be deduced from a reading of the relevant double 

taxation treaties, because they contain many discretionary clauses that should allow the contracting states 

to make exceptions from the otherwise governing regimes for dividends and interest. This, at least, was 

found in the double taxation treaties with Norway and Kuwait. 

III. Taxation of Sovereign Wealth Funds 

In exempting foreign governments from taxation of their passive source income, Australia, 

Canada, and the United Kingdom may extend this principle to sovereign wealth funds on the basis of 

individual decisions that examine the governmental nature and purpose of the fund. 

• In Australia, a sovereign wealth fund may be exempted from the dividend or interest 

withholding tax, if the fund establishes that the generated passive investment income 

results from the performance of a governmental function within Australia. 

• In Canada, the scrutiny of the sovereign wealth fund appears to focus on the 

public/humanitarian or commercial purpose of the fund: Chinese banks have been denied 

exempt status, whereas the New Zealand Earthquake Relief Fund qualified. 

• In the United Kingdom, a sovereign wealth fund will be exempted from passive 

investment income if it is an integral part of the government of a foreign sovereign state, 

but the exemption will be denied if the fund is an entity that is separate from the 

government, even though the government may own its shares. 

 Germany, Japan, Norway, Poland, and Switzerland have no unilateral or reciprocity-based rules 

on exempting sovereign wealth funds, thus allowing only for treaty provisions to exempt sovereign 

wealth funds from the taxation of their passive source-country income. German treaties appear to contain 

no such provisions, whereas the flexibility found in the Swiss double taxation treaties is not helpful in 

revealing the actual practice. 

 The treaty between Japan and Singapore exempts the taxation of interest earned not only by the 

Contracting State’s governments, their local authorities, and central banks, but also of any institution 

wholly owned by that government. The Canada-Norway double taxation treaty contains a similar 

provision, thus exempting Canadian and Norwegian sovereign wealth funds from taxation of dividend 

and interest income in the other country. The treaty between Poland and Kuwait exempts dividend income 

earned by a company owned by the government of the other country. 

IV. Domestic Tax Rates for Passive Investment Income Earned by Foreign Corporations 

 Interest 

 Canada, Germany, Norway and the United Kingdom exempt interest from taxation to a 

considerable extent, if the interest is earned by a non-resident portfolio investor. In Germany, the only 

types of interest that are taxable for non-residents are mortgage interest and interest derived from certain 

hybrid debt instruments that are similar to shares. Interest from German bank accounts is not taxed if 

earned by a foreign resident. In Canada, interest is exempt if earned by a foreign resident through an 

arm’s length transaction, and in the United Kingdom, interest earned from bank accounts is exempt for 

foreign residents. Norway generally exempts interest earned by non-residents. 

 Australia, Japan, Poland, and Switzerland tax non-residents on source country interest, usually by 

applying the general withholding tax from which relief can only be obtained through an applicable double 

taxation treaty. Australia taxes interest at the general rate of 10 percent; the Japanese tax rate for interest 

earned by passive investments is 15 percent; Poland taxes non-resident corporations on their PolishA-4
Comparative Summary: Taxation – May 2008 The Law Library of Congress - 4 

source interest at the flat corporate rate of 19 percent; and Switzerland generally withholds at the rate of 

35 percent, with certain exceptions applying to affiliated enterprises within the European Union. 

Dividends 

Norway exempts foreign corporations from being taxed on their source country dividends on the 

theory that this avoids inter-corporate taxation. Norway, however, taxes non-resident portfolio dividends 

of non-residents from outside the European Economic Area and also dividends earned by residents of tax 

havens. Such dividends are taxed at the generally applicable rate of 25 percent. 

 The German provisions and their underlying philosophies are similar, yet Germany exempts from 

taxation only 95 percent of the dividends earned by resident and non-resident corporations. The 

remaining 5 percent, as well as dividends earned by individual non-resident shareholders, are taxed at the 

rate of 26.38 percent. The United Kingdom, on the other hand, generally exempts from taxation the 

dividends earned by non-residents. 

 Australia, Canada, Japan, Poland, and Switzerland tax non-residents on their source country 

dividends, usually at the rates that also apply to residents. Australia, however, distinguishes between 

franked and unfranked dividends and imposes the 30 percent tax rate only on dividends from profits for 

which the corporation has not been taxed. 

 Canada generally withholds at the rate of 25 percent, aside from various exceptions; the Japanese 

withholding rate for passive income dividends earned by non-residents is 20 percent; Poland withholds 

dividends earned by non-resident business entities at the flat corporate rate of 19 percent; and Switzerland 

applies the withholding rate of 35 percent to portfolio holdings while granting a participation exemption 

to substantial holdings by Swiss and European investors. 

Capital gains 

 Capital gains from passive investments of non-residents are not taxed in Japan and the United 

Kingdom. Norway exempts capital gains from the sale of stock if earned by a non-resident corporation 

under the principles that are applied to dividend income. In Germany, non-resident corporate entities pay 

capital gains tax at the rate of 26.38 percent on only 5 percent of the gain from on the sale of substantial 

participations ( one percent of shares held during five years). 

Capital gains from passive investments that are earned by non-residents are generally taxed in 

Australia, Canada, Poland, and Switzerland. Australia applies the marginal tax rate, Canada withholds at 

25 percent, Poland applies the 19 percent corporate tax rate to business entities, and Switzerland applies 

the federal income tax rate of 8.5 percent. 

IV. Tax Rates in Sample Double Taxation Treaties 

 In this very limited sampling of double taxation treaties,3

 the bilateral treaties between Norway on 

the one hand and Australia, Canada, Germany, Japan, and Switzerland, on the other, have been reviewed 

because the Norwegian Pension Fund is one of the oldest and most prominent sovereign wealth funds.4

 

 Of these, the treaty with Canada exempts dividends and interest earned by the governments of the 

contracting states. The treaty with Switzerland exempts the Swiss dividends earned by the Norwegian 

Government, Central Bank, and Oil Fund, and no corresponding provision for interest is needed because 

 3

 For a more comprehensive treatment of several double taxation treaties between Australia and countries that have 

sovereign wealth funds, see the country report on Australia. 

4

 For more information, see the country report on Norway. 

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Comparative Summary: Taxation – May 2008 The Law Library of Congress - 5 

it is generally not taxed at the source. The treaty with Poland exempts dividends earned by the Kuwaiti 

government or a company owned by it, but does not provide a corresponding provision for interest? Does 

this last sentence refer to a Norwegian treaty? 

 The treaties with Australia, Germany, and Japan contain no specific exemption of Norway’s 

government or its funds. 

 The treaty with Australia taxes source country interest at a rate of up to 15 percent, portfolio 

dividends at up to 15 percent, and dividends from participations at 0 to 5 percent. The treaty with 

Germany taxes source country interest with a rate of 0 percent, portfolio dividends at up to 15 percent, 

and dividends from participations at up to 5 percent. The treaty with Japan does not tax Japanese interest 

and dividends earned by Norwegian residents. 

Prepared by Edith Palmer 

Senior Foreign Law Specialist 

May 2008 

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2008-00763 

LAW LIBRARY OF CONGRESS 

TAXTION OF THE PASSIVE INCOME EARNED BY FOREIGN GOVERNMENTS AND 

SOVEREIGN WEALTH FUNDS 

AUSTRALIA 

Australia does not grant a complete immunity from Australian taxation to foreign 

sovereigns. Rather Australia distinguishes between commercial and non-commercial 

investments and permits non-commercial passive investments to apply for and be granted 

an exemption from taxation on the basis of sovereign immunity. Australia’s foreign policy 

and domestic legislation permits commercial investments by foreign sovereigns to be 

taxed. 

Australia has signed a number of taxation agreements that may reduce the rate 

of Australian taxation payable by any foreign resident. In some recent taxation 

agreements the term resident is defined to include the governments of the contracting 

parties. 

Introduction 

Within Australia taxation is primarily levied in accordance with the Income Tax Assessment Act 

1936 (Cth) and the Income Tax Assessment Act 1997 (Cth). Rulings and interpretations on application of 

income tax law may be made by the Australian Taxation Office.1

International tax agreements are governed by the text of the relevant treaty and the International 

Tax Agreements Act 1953 (Cth). Direct foreign investment is regulated via the Foreign Acquisitions and 

Takeovers Act 1975 (Cth) and overseen by the Foreign Investment Review Board.2

 

Immunities granted to foreign states are governed by the Foreign States Immunities Act 1985 

(Cth) and the public international law doctrine of sovereign immunity. 

I. Tax Status of Foreign Governments 

General Position 

Generally, a non-resident is liable for Australian taxation on income that is sourced in Australia 

and is not liable for Australian taxation on foreign sourced income.3

 In accordance with the International 

 1

 See the Australian Taxation Office Web site at: http://www.ato.gov.au/default.asp?menu=4244 (last visited May 2, 

2008). Income Tax Assessment Act 19997 (Cth) §§ 6-5(3), 6-10(5), available from the official Web site of the Australian 

government, Attorney-General’s Department, http://www.comlaw.gov.au. 

2

 See the Foreign Investment Review Board’s website at http://www.firb.gov.au/content/default.asp (last visited May 

2, 2008). Legislation available from the official Web site of the Australian government, Attorney-General’s Department, 

http://www.comlaw.gov.au. 

3

 Income Tax Assessment Act 1997 (Cth) §§ 6-5(3), 6-10(5), available from the official Web site of the Australian 

government, Attorney-General’s Department, http://www.comlaw.gov.au. 

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Australia: Taxation – May 2008 The Law Library of Congress - 2 

Tax Agreements Act 1953 (Cth) and taxation treaties, rates of taxation for some situations are agreed and 

recorded within the relevant treaty. These treaties become schedules to the International Tax Agreements 

Act 1953 (Cth). 

Australia’s policy on commercial investments by foreign governments is, as articulated by the 

Foreign Investment Review Board, to require “...commercial investments by foreign governments or their 

agencies to be structured in a manner that enables all normal taxes and charges to be levied, and avoids 

questions of sovereign immunity arising”.4

Further § 20 of the Foreign States Immunities Act 1985 (Cth) provides that: 

A foreign State is not immune in a proceeding in so far as the proceeding concerns an obligation 

imposed on it by or under a provision of a law of Australia with respect to taxation, being a 

provision that is prescribed,5

 or is included in a class of provisions that is prescribed, for the 

purposes of this section. 

Exemption for Foreign Governments 

In general foreign governments (and their agencies) that hold “passive investments” may be 

exempt from withholding tax on interest or dividends provided they meet the following conditions: 

• the investment is made by a foreign government (or agency of a foreign government); 

• the funds invested are and will remain government funds; and 

• the income is derived from a “non-commercial activity.”6

 

An exemption may be obtained by the foreign government seeking a binding private ruling from 

the Australian Taxation Office (ATO). In general a holding of 10 percent or less equity in a company (i.e. 

a portfolio holding) will be considered “non-commercial activity. 7

 

The basis for this exemption is the doctrine of sovereign immunity, and while there is no 

legislation establishing this exemption, it is a long-standing practice and has been detailed in an 

Australian Taxation Office interpretive decision.8

 

On November 4, 2005, the then Australian Treasurer announced that new legislation would be 

introduced to clarify and codify the existing practice,9 however, to date such legislation has not been 

 4

 See also Foreign Investment Review Board, ANNUAL REPORT 2005-2006: CHAPTER 3 OVERVIEW OF THE FOREIGN 

ACQUISITIONS AND TAKEOVERS ACT 1975, available at http://www.firb.gov.au/content/Publications/AnnualReports/2005-

2006/Chapter3.asp. 

5

 By virtue of regulation 3 and the schedule to the Foreign States Immunities Regulations 1987 (Cth), prescribed 

legislation includes the Income Tax Assessment Act 1936 (Cth) and the International Tax Agreements Act 1953 (Cth). All 

legislation available from the official Web site of the Australian government, Attorney-General’s Department, http://www. 

comlaw.gov.au

6

 Australian Taxation Office Interpretative Decision, ATO ID 2002/45, available from the Australian Taxation Office 

Web site, http://law.ato.gov.au/atolaw/view.htm?dbwidetocone=05%3AATO%20Interpretative%20Decisions% 

3ABy%20Year%3A2002%3A1-99%3A%230045%23ATO%20ID%202002%2F45%20-%20Sovereign%20Immunity%3B

(official source, last visited May 2, 2008). 

7

 Id. 

8

 ATO ID 2002/45, id. 

9

 Press Release, Australian Government, 094/2005: Clarifying The Taxation Of Foreign Government Investments 

(Nov. 4, 2005), available at http://www.treasurer.gov.au/DisplayDocs.aspx?doc=pressreleases/2005/094.htm& 

pageID=&min=phc&Year=2005&DocType=0. 

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Australia: Taxation – May 2008 The Law Library of Congress - 3 

introduced. 

II. Tax Status of Sovereign Wealth Funds 

Unless an exemption applies, dividends, interest, and royalties derived by sovereign wealth funds 

are subject to a final withholding tax at the time of payment.10 Currently the general rates of taxation 

are:11 

• unfranked dividends12 – 30 percent; 

• interest – 10 percent; and 

• royalties – 30 percent. 

These rates may be reduced due to the operation of a tax treaty or agreement (also known as 

double taxation avoidance agreements) between foreign governments and Australia.13 For example, an 

agreement between Australia and China prescribes the following rates for tax on income: 15 percent for 

unfranked dividends; 10 percent for interest; and 10 percent for royalties.14

Sovereign wealth funds that are beneficiaries of Australian trusts (including beneficiaries that are 

trustees) are taxed upon distribution.15 Where the sovereign wealth fund is a beneficiary of an Australian 

managed investment trust, the fund is taxed via a non-final withholding tax rate of 30 percent16 (this rate 

may be reduced as the result of a tax treaty). 

Where a sovereign wealth fund has direct ownership of real property, any associated rental 

income will be taxed at the general tax rate, and, the property may be subject to capital gains tax on 

disposal.17 

Similar to a foreign government, where a sovereign wealth fund establishes that income generated 

results from the performance of a governmental function within Australia and that the income is from a 

 10 Income Tax Assessment Act 1936 (Cth) §§ 128B(1), (2) and (2B), available from the official Web site of the 

Australian government, Attorney-General’s Department, http://www.comlaw.gov.au. 

11 Current rates of tax are available from the Australian Taxation Office Web site at http://www.ato.gov.au/. (last 

visited April 10, 2008). 

12 Unfranked dividends are dividends paid from profits on which Australian tax has not been paid. Franked dividends 

do not attract dividend withholding tax. 

13 Australia has entered into tax agreements with over 40 countries. See Australian Taxation Office Web site, PAYG

Withholding From Interest, Dividends And Royalties To Non-Residents, AUSTRALIAN TAX AGREEMENTS, http://www.ato.gov. au 

businesses/content.asp?doc=/Content/50240.htm&page=15&H15 (last visited April 10, 2008). Details of each agreement, and 

the domestic legislation implementing each agreement, are available from the Australian Government, Treasury Web site at 

http://www.treasury.gov.au/documents/625/XLS/Australian_Tax_Treaty_Table_April_2008.xls (last visited April 10, 2008). 

14 Agreement between the Government of Australia and the Government of the People's Republic of China for the 

Avoidance of Double Taxation and the Prevention of Fiscal Evasion [1990] ATS 45, arts. 10-12, [1990] Australian Treaty Series 

(ATS) 45 (official source). A copy of the treaty is available from the AustLII Australian Treaty Series Web site, 

http://www.austlii.edu.au/au/other/dfat/treaties/1990/45.html (unofficial source, last visited May 2, 2008). 

15 The trustee of the Australian trust is assessed on behalf of the Sovereign Wealth Fund. 

16 Taxation Administration Act 1953 (Cth), Schedule 1, Division 12, §§ 12-375 – 12-40, available from the official 

Web site of the Australian government, Attorney-General’s Department, http://www.comlaw.gov.au. Also see Australian 

Taxation Office, WITHHOLDING ARRANGEMENTS FOR MANAGED FUND DISTRIBUTIONS TO FOREIGN RESIDENTS, http://www.ato. 

gov.au/taxprofessionals/content.asp?doc=/content/78088.htm&pc=001/005/054/002/014&mnu=24612&mfp=001&st=&cy=1

(last visited Apr. 10, 2008). The current company tax rate is available from the Australian Taxation Office Web site at: 

http://www.ato.gov.au/businesses/content.asp?doc=/content/44266.htm (last visited Apr. 10, 2008). 

17 Advice from the Australian Embassy, Washington DC, to author, dated April 10, 2008. 

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Australia: Taxation – May 2008 The Law Library of Congress - 4 

“passive investment,” the fund may be exempted from dividend or interest withholding tax.18 

However, where a sovereign wealth fund carries on a business in Australia, either through a 

resident subsidiary or a branch, the fund will be taxed on the same basis as an Australian resident 

company and generally will not be able to claim any sovereign immunity exemption for any subsequent 

passive income through that entity.19

III. Domestic Law 

Section 995-1 of the Income Tax Assessment Act 1997 (Cth) defines a foreign resident as “a 

person who is not a resident of Australia for the purposes of the Income Tax Assessment Act 1936” 

(person is defined to include a company). 

Section 44(1)(b) of the Income Tax Assessment Act 1936 (Cth) provides that the assessable 

income of a foreign resident shareholder in a company (whether the company is resident in Australia or 

not) includes: 

(i) dividends (other than non-share dividends) paid to the shareholder by the company to the extent 

to which they are paid out of profits derived by it from sources in Australia; and 

(ii) non-share dividends paid to the shareholder by the company to the extent to which they are 

derived from sources in Australia; and 

(c) if the shareholder is a non-resident carrying on business in Australia at or through a permanent 

establishment of the shareholder in Australia, and the company is a resident: 

(i) dividends (other than non-share dividends) that are paid to the shareholder by the company and 

are attributable to the permanent establishment, to the extent to which they are paid out of profits 

derived by the company from sources outside Australia; and 

(ii) non-share dividends that are paid to the shareholder by the company and are attributable to the 

permanent establishment, to the extent to which they are derived from sources outside Australia. 

Section 855 of the Income Tax Assessment Act 1997 (Cth) provides that a foreign resident is 

subject to capital gains tax where a capital gains tax event20 occurs in relation to specified assets. 

 18 In accordance with ATO ID 2002/45, supra note 6. 

19 Id. 

20 Section 104-5 of the Income Tax Assessment Act 1997 (Cth) describes a capital gains tax event as: “Disposal of a 

capital gains tax asset; Use and enjoyment before title passes; Loss or destruction of a capital gains tax asset; Cancellation, 

surrender and similar endings; End of option to acquire shares etc; Creating contractual or other rights; Granting an option; 

Granting a right to income from mining; Entering into a conservation covenant; Creating a trust over a capital gains tax asset; 

Transferring a capital gains tax asset to a trust; Converting a trust to a unit trust; Capital payment for trust interest; Beneficiary 

becoming entitled to a trust asset; Disposal to beneficiary to end income right; Disposal to beneficiary to end capital interest; 

Disposal by beneficiary of capital interest; Creating a trust over future property; Granting a lease; Granting a long term lease; 

Lessor pays lessee to get lease changed; Lessee receives payment for changing lease; Lessor receives payment for changing 

lease; Capital payment for shares; Liquidator or administrator declares shares or financial instruments worthless; Forfeiture of a 

deposit; Receipt for event relating to a capital gains tax asset; Individual or company stops being an Australian resident; Trust 

stops being a resident trust; Company stops being member of wholly-owned group after roll-over less that market value; Change 

in relation to replacement asset or improved asset after a roll-over under Subdivision 152-E; Trust fails to cease to exist after a 

roll-over under Subdivision 124-N; Failure to acquire replacement asset and to incur fourth element expenditure after a roll-over 

under Subdivision 152-E; Cost of acquisition of replacement asset or amount of fourth element expenditure, or both, not 

sufficient to cover disregarded capital gain; Bankrupt pays amount in relation to debt; Asset passing to tax-advantaged entity; 

capital gains tax asset starts being trading stock; Special capital loss from collectable that has fallen in market value; Pre- capital 

gains tax shares or trust interest; Balancing adjustment occurs for a depreciating asset that you used for purposes other than 

taxable purposes; Direct value shifts affecting your equity or loan interests in a company or trust; Entitlement to receive payment 

of a carried interest; You make a FOREX realisation gain covered by item 1 of the table in subsection 775-70(1); You make a 

FOREX realisation loss covered by item 1 of the table in subsection 775-75(1); Foreign hybrid loss exposure adjustment section 

705-57 in tax cost setting amount of assets of entity becoming subsidiary member of consolidated group or MEC group; Amount 

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Australia: Taxation – May 2008 The Law Library of Congress - 5 

In relation to capital gains tax events occurring on or after December 12, 2006, the specified 

assets are taxable Australian property (i.e. direct or indirect interests in Australian real property and an 

Australian permanent establishment’s business assets (other than real property)) (§ 855-20).21 

On the basis of Australia law (and in the absence of a relevant double taxation treaty or Sovereign 

exemption from taxation ruling)22 a non-resident corporations is subject to a final withholding tax at the 

time of payment23 and is subject to capital gains tax. 

Currently the general rates of taxation are:24 

 unfranked dividends25 – 30 percent; 

 interest – 10 percent; and 

 royalties – 30 percent. 

Capital gains are taxed at the gain at marginal tax rate26 (capital losses may be carried forward). 

Australia considers Australian real property owned by non-residents (whether owned directly or 

via an entity) as eligible for taxation and that income (or gains) from the alienation of property may also 

 remaining after step 3A etc. of joining allocable cost amount is negative; Tax cost setting amounts for retained cost base assets 

exceed joining allocable cost amount; No reset cost base assets against which to apply excess of net allocable cost amount on 

joining; Amount remaining after step 4 of leaving allocable cost amount is negative; Error in calculation of tax cost setting 

amount for joining entity’s assets; Discharged amount of liability differs from amount for allocable cost amount purposes; and 

Reduction in tax cost setting amount for reset cost base assets on joining cannot be allocated.” Available from the official Web 

site of the Australian government, Attorney-General’s Department, http://www.comlaw.gov.au. 

21 AUSTRALIAN MASTER TAX GUIDE, 2007 ¶ 13-720 (41st ed, CCH, Sydney, 2007). There are three methods that may 

be used to establish the capital gains tax payable. See: The Australian Tax Office, CALCULATORS – CAPITAL GAINS – THREE 

METHODS OF CALCULATING CAPITAL GAINS, Sept. 2007, available at http://www.ato.gov.au/businesses/content. 

asp?doc=/content/33748.htm&pc=001/003/019/002/007&mnu=601&mfp=001/003&st=&cy=1. 

22 Details of reduce taxation rates resulting from taxation agreements may be viewed on the Australian Taxation Office 

website at http://www.ato.gov.au/businesses/content.asp?doc=/Content/50240.htm&page=15&H15 (last visited May 2, 2008). 

23 Income Tax Assessment Act 1936 (Cth) §§ 128B(1), (2) and (2B), available from the official Web site of the 

Australian government, Attorney-General’s Department, http://www.comlaw.gov.au. 

24 Current rates of tax are available from the Australian Taxation Office Web site at http://www.ato.gov.au/ (last 

visited Apr. 10, 2008). 

25 Unfranked dividends are dividends paid from profits on which Australian tax has not been paid. Franked dividends 

do not attract dividend withholding tax. 

26 Non-resident individual tax rates for 2007-2008 are: 

Taxable income Tax on this income 

$0 – $30,000 29c for each $1 

$30,001 – $75,000 $8,700 plus 30c for each $1 over $30,000 

$75,001 – $150,000 $22,200 plus 40c for each $1 over $75,000 

$150,001 and over $52,200 plus 45c for each $1 over $150,000 

Non-resident companies are taxed at the same marginal rate as Australian companies. The current income tax rate for 

companies is 30% (with some superannuation and non-profit companies being eligible for a 15% tax rate). See Australian Tax 

Office, COMPANY TAX RATES, TAX RATES 2006-2007, Jan. 2008, available at http://www.ato.gov.au/businesses/ 

content.asp?doc=/content/44266.htm&pc=001/003/019/001/006&mnu=601&mfp=001/003&st=&cy=1. 

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Australia: Taxation – May 2008 The Law Library of Congress - 6 

be taxed.27 

IV. Treaties on Double Taxation 

Australia has double taxation agreements with several nations that have significant Sovereign 

wealth funds, including China; Norway, Russia, and Singapore. The taxation rates set in those 

agreements are: 

Withholding taxes (% rate limits)28

Country 

Dividends Interest Royalties Application dates 

China29 15 10 10 July 1, 1991 

Norway30

(1983 and 2006 

Convention) 

0/5/15 0/15 5/10 July 1, 1983 and January 

1, 2008 (respectively) 

Russia31 5/15/30 10 10/30 July 1, 2003 

Singapore32 0/15 10 10 July 1, 1969 

 27 AUSTRALIA MASTER TAX GUIDE, supra note 21, at 1204. 

28 See Australian Government, Treasury Web site, http://www.treasury.gov.au/documents/625/XLS/Australian_ 

Tax_Treaty_Table_April_2008.xls (last visited May 2, 2008) and PAYG Withholding From Interest, Dividends And Royalties To 

Non-Residents, supra note 13. 

29 Agreement between the Government of Australia and the Government of the People's Republic of China for the 

Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, 1990 ATS 45 (official 

source). A copy of the treaty is available from the AustLII Australian Treaty Series Web site, http://www.austlii.edu. 

au/au/other/dfat/treaties/1990/45.html (unofficial source, last visited May 6, 2008). 

30 Convention with the Kingdom of Norway for the Avoidance of Double Taxation with Respect to Taxes on Income 

and the Prevention of Fiscal Evasion, 2007 ATS 32 (official source); Convention between Australia and the Kingdom of Norway 

for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital, and 

Protocol, 1983 ATS 19 (official source). Copies of the treaties are available from the AustLII Australian Treaty Series Web site, 

http://www.austlii.edu.au/au/other/dfat/treaties/2007/32.html & http://www.austlii.edu.au/ au/other/dfat/treaties/1983/19.html, 

respectively (unofficial source, last visited May 6, 2008). 

31 These rates do not apply where the “dividend, royalty or interest income is preferentially taxed and information 

related to that dividend, royalty or interest income is given confidential treatment,” see PAYG Withholding From Interest, 

Dividends And Royalties To Non-Residents, supra note 13. Thus the effect of Article 23 of the treaty (Limitation of Benefits) is 

to deny treaty benefits for highly mobile income where the income is preferentially taxed and information concerning that income 

is not readily exchanged between the two countries, meaning that dividends, interest, and royalties falling into this category are 

subject to withholding tax at the Australian domestic law rates. For this reason there are three possible withholding tax rates for 

Russian-bound dividends (5%, 15% and 30%) and two royalty withholding tax rates (10% and 30%). 

32 Agreement between the Government of the Commonwealth of Australia and the Government of the Republic of 

Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, 1969 

ATS 14 (official source); Protocol amending the Agreement with the Government of the Republic of Singapore for the 

Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, 1990 ATS 3 (official 

source). Copies of the treaty and protocol are available from the AustLII Australian Treaty Series Web site, http://www. 

austlii.edu.au/au/other/dfat/ treaties/1969/14.html and http://www.austlii.edu.au/au/other/dfat/treaties/1990/3.html, respectively 

(unofficial source, last visited May 6, 2008). 

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Australia: Taxation – May 2008 The Law Library of Congress - 7 

Capital Gains Tax Provisions 

Australia introduced a capital gains tax regime in 1985 and has several “pre-capital gains tax” 

treaties, some of which have been amended by subsequent protocols or re-negotiations to include 

provisions dealing comprehensively with capital gains (eg. Malaysia (1999),33 New Zealand (1995), 34 

and Singapore (1989)35). 

However, it should be noted that Australia’s Commissioner of Taxation has released a public 

ruling that “Australia's right to tax gains taxable in Australia exclusively under the capital gains tax 

regime ... is not limited by pre-CGT treaties.. because: (a) from Australia's perspective these treaties do 

not distribute taxing rights over capital gains; and (b) ...Australia's tax on capital gains is not a tax to 

which pre-CGT treaties apply.”36

Australia’s treaty provisions in relation to pre and post introduction of capital gains tax may be 

represented as:37

Pre-Capital Gains Tax Post-Capital Gains Tax 

Heading Alienation of Property Alienation of Property 

Activities No article in pre-OECD treaties 

(ie. negotiated before Australia’s 

membership of the OECD) and 

later pre-capital gains tax treaties 

did not deal with alienation of 

property comprehensively, thus 

often only real property alienations 

is addressed. 

Comprehensively deals with 

capital gains. 

 33 Agreement between the Government of Australia and the Government of Malaysia for the Avoidance of Double 

Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (Canberra, 20 August 1980) [1981] ATS 15 

(official source), amended by Protocol Amending the Agreement between the Government of Australia and the Government of 

Malaysia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income of 20 

August 1980 (Sydney, 2 August 1999), [2000] ATS 25 (official source) & by Second Protocol And Exchange Of Letters, 

Amending The Agreement Between The Government Of Australia And The Government Of Malaysia For The Avoidance Of 

Double Taxation And The Prevention Of Fiscal Evasion With Respect To Taxes On Income Of 20 August 1980, a amended by 

the First Protocol of 2 August 1999, (Genting Highlands, 28 July 2002), [2004] ATS 1 (official source). 

34 Agreement between the Government of Australia and the Government of New Zealand for the Avoidance of Double 

Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (Melbourne, 27 January 1995) [1997] ATS 23 

(official source), amended by Protocol Amending the Agreement between the Government of Australia and the Government of 

New Zealand for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, 

Melbourne, 15 November 2005, [2007] ATS 5 (official source). 

35 Agreement between the Government of the Commonwealth of Australia and the Government of the Republic of 

Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income 

(Canberra, 11 February 1969) [1969] ATS 14 (official source), amended by Protocol amending the Agreement between the 

Government of the Commonwealth of Australia and the Government of the Republic of Singapore for the Avoidance of Double 

Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income of 11 February 1969 (Canberra, 16 October 

1989) [1990] ATS 3 (official source). 

36 Australian Tax Office, TAXATION RULING TR 2001/12 available at the ATO Web site, http://law.ato.gov. 

au/atolaw/print.htm?DocNum=0000540667&Life=20011219000001-99991231235959&DB=full&printTitle= 

Rulings~Taxation~TR%202001%2F12~Income%20tax%20and%20capital%20gains%20tax%3A%20capital%20gains%20in%2

0pre-CGT%20tax%20treaties%20-%20Overview%20(As%20at%2019%20December%202001) (official source, last visited Apr. 

30, 2008). 

37 Table abbreviated version of that found in Australian Tax Office, id. 

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Australia: Taxation – May 2008 The Law Library of Congress - 8 

Pre-Capital Gains Tax Post-Capital Gains Tax 

Characterization Generally expressed to deal only 

with income from alienation of 

property. 

Income, profits, and gains. 

Source Rules Income Income, profits, and gains. 

Entry into force 

provisions in 

treaties address 

Income Income, profits, and gains. 

Force of law 

provisions 

Give treaty force of law in relation 

to 'income' 

General formula introduced: 

provisions of the treaty have force 

of law 'according to their tenor' 

(i.e., dealing with income, profits, 

or gains). 

Capital gains tax provisions are addressed in the treaties between Australia and China, Norway, 

Russia and Singapore and in recent agreements between Australia and Canada38 and Australia and 

Finland.39 The intention of the Australian government is to more closely align the treaty provisions 

addressing capital gains tax to those in the model OECD treaty.40

Status of Contracting States’ Governments 

The 2006 Convention with Norway41 specifically includes the government of the contracting 

states within the resident provision (art. 4, para. 1): “The Government of a Contracting State or a political 

subdivision or local authority of that State is also a resident of that State for the purposes of the 

Convention.” 

 

Agreements with China, Singapore and Russia do not include this provision; however, it is 

included in the agreements with the United Kingdom,42 Japan (not yet in force),43 and South Africa (not 

 38 Protocol Amending the Convention between Australia and Canada for the Avoidance of Double Taxation and the 

Prevention of Fiscal Evasion with Respect to Taxes on Income, Canberra, 23 January 2002, [2002] ATS 26 (official source). 

Available from the Australian Treaty Database on Austlii, http://www.austlii.edu.au/cgi-bin/sinodisp/au/other/dfat/ 

treaties/2002/26.html?&nocontext=1 (unofficial source, last visited May 1, 2008). 

39 Agreement between the Government of Australia and the Government of Finland for the Avoidance of Double 

Taxation with Respect to Taxes on Income and the Prevention of Fiscal Evasion, Melbourne, 20 November 2006, [2007] ATS 36 

(official source). Available from the Australian Treaty Database on Austlii, http://www.austlii.edu.au/cgibin/sinodisp/au/other/dfat/treaties/2007/36.html?&nocontext=1 (unofficial source, last visited May 1, 2008). 

40 See Hon. Peter Costello, Press Release, New Australia-Finland Taxation Treaty Signed, No. 126 (Nov. 2006), 

available at http://www.treasurer.gov.au/DisplayDocs.aspx?pageID=&doc=pressreleases/2006/126.htm&min=phc. 

41 Convention Between Australia and the Kingdom of Norway for the Avoidance of Double Taxation with Respect to 

Taxes on Income and the Prevention of Fiscal Evasion, Canberra, 8 August 2006, [2007] ATS 32 (official source). Available 

form the Australian Treaty Database on Austlii, http://www.austlii.edu.au/cgi-bin/sinodisp/au/other/dfat/treaties/ 

2007/32.html?&nocontext=1 (unofficial source, last visited May 1, 2008). 

42 Convention between the Government of Australia and the Government of the United Kingdom of Great Britain and 

Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income 

and on Capital Gains, Canberra, 21 August 2003, 2003 ATS 22 (in force) (official source). Available from the Australian Treaty 

Database on Austlii, http://www.austlii.edu.au/cgi-bin/sinodisp/au/other/dfat/treaties/2003/22. html?&nocontext=1 (unofficial 

source, last visited May 1, 2008). 

43 Convention between Australia and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal 

Evasion with Respect to Taxes on Income, Protocol, and Exchange of Notes,Tokyo, January 31, 2008, [2008] AUSTRALIAN 

TREATIES NOT IN FORCE, (ATNIF) 1 (not yet in force) (official source). Available from the Australian Treaty Database on 

Austlii, http://www.austlii.edu.au/au/other/dfat/treaties/notinforce/2008/1.html (unofficial source, last visited May 6, 2008). 

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Australia: Taxation – May 2008 The Law Library of Congress - 9 

yet in force).44

Sample text from some of Australia’s taxation treaties addressing the definition of resident and 

the implementation of capital gains tax is detailed in Annex A. 

V. Foreign Investment Approval 

All direct investments by foreign governments (or their agencies) are subject to the Foreign 

Acquisitions and Takeovers Act 1975 (Cth)45 and the Australian Government’s foreign investment 

policy; as such, direct investments require prior notification to, and prior approval from, the Australian 

government. 

Direct investment includes investments made via an entity that is 15 percent or more owned by a 

foreign government.46 However, these are distinguished from non-controlling investments where the 

investing party is not in a position to determine the policy of the business.47 In accordance with the 

Foreign Acquisitions and Takeovers Act 1975 (Cth) and the Government’s foreign investment policy, the 

Australian government may block proposals (subject to the Act) where it determines that the proposal is 

contrary to Australia’s national interest.48

In determining “national interest,” the Australian Government will have regard to the six issues49

including “whether the investment may impact on Australian Government revenue or other policies.” 

Thus “investments by foreign government entities must be taxed on the same basis as operations by other 

commercial entities.”50

VI. Australia’s Sovereign Funds 

Australia has two sovereign wealth funds. The Australian Future Fund (derived from 

privatization of national government assets (eg. Telstra), budget contributions and taxation revenue) is 

intended to fund public sector superannuation payments.51 The Australian Future Fund is established 

 44 Protocol Amending the Agreement between the Government of Australia and the Government of the Republic of 

South Africa for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income of 

1999, Pretoria, 31 March 2008 [2008] ATNIF 2 (not yet in force) (official soruce). Available from the Australian Treaty 

Database on Austlii, http://www.austlii.edu.au/cgi-bin/sinodisp/au/other/dfat/treaties/notinforce/2008/2.html?&nocontext=1

(unofficial source, last visited May 1, 2008). 

45 Foreign Acquisitions and Takeovers Act 1975 (Cth), available from the official Web site of the Australian 

government, Attorney-General’s Department, http://www.comlaw.gov.au.

46 Id., § 17F. 

47 Id., § 19(7), id. 

48 Id., § 17F. Also see Australian government, the Treasury, Summary of Australia’s Foreign Investment Policy, Mar. 

2008, available at http://www.firb.gov.au/content/_downloads/General_Policy_Summary%20march%202008%20-

%20including%20guidelines%20and%20electronic%20lodgement.rtf. 

49 The other five issues are: 1. Whether an investor’s operations are independent from the relevant foreign government. 

2. Whether an investor is subject to and adheres to the law and observes common standards of business behavior. 3. Whether an 

investment may hinder competition or lead to undue concentration or control in the industry or sectors concerned. 4. Whether an

investment may impact on Australia’s national security. 5. Whether an investment may impact on the operations and directions of

an Australian business, as well as its contribution to the Australian economy and broader community. 

50 See Attachment A: The Treasury, Summary of Australia’s Foreign Investment Policy, supra note 48. 

51 Australian Government Future Fund Web site, http://www.futurefund.gov.au/ (last visited April 9, 2008). 

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Australia: Taxation – May 2008 The Law Library of Congress - 10 

under the Future Fund Act 2006 (Cth)52 and operates separately and independently from the Australian 

government. 

The Higher Education Endowment Fund (established via the Higher Education Endowment Fund 

Act 2007 (Cth))53 is managed by the Future Fund Board of Guardians under a specific investment 

mandate. The Higher Education Endowment Fund provides funding for education sector capital works 

and research projects (as decided by the Minister for Education, Employment and Workplace Relations 

and the Minister for Industry, Innovation, Science and Research).54

Prepared by Lisa White 

Foreign Law Specialist 

May 2008 

 52 Available from the official Web site of the Australian government, Attorney-General’s Department, 

http://www.comlaw.gov.au. 

53 Id. 

54 For further information on the Higher Education Endowment Fund, see Australian government, Department 

Education, Employment and Workplace Relations’ website at: http://www.heef.dest.gov.au/default.htm (last visited May 6, 

2008). 

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Australia: Taxation – May 2008 The Law Library of Congress - 11 

I. Annex A 

Country55 Capital Gains Tax 

China 

Agreement between 

the Government of 

Australia and the 

Government of the 

People's Republic of 

China for the 

Avoidance of Double 

Taxation and the 

Prevention of Fiscal 

Evasion with respect 

to Taxes on Income 

1990 ATS 45 

Article 4 

Resident 

1. For the purpose of this Agreement, the term "resident", in relation to a 

Contracting State, means a person who is fully liable to tax therein by reason 

of being a resident of that State under the tax law of that State. 

2. A person is not a resident of a Contracting State for the purposes of this 

Agreement if the person is liable to tax in that State in respect only of income 

from sources in that State. 

3. Where by reason of the preceding provisions of this Article a person, being 

an individual, is a resident of both Contracting States, then the status of the 

person shall be determined in accordance with the following rules: 

(a) the person shall be deemed to be a resident solely of the Contracting State 

in which a permanent home is available to the person; 

(b) if a permanent home is available to the person in both Contracting States, 

or in neither of them, the person shall be deemed to be a resident solely of the 

Contracting State with which the person's economic and personal relations are 

the closer. 

4. Where by reason of the provisions of paragraph (1) a person other than an 

individual is a resident of both Contracting States, then it shall be deemed to be 

a resident solely of the Contracting State in which its place of effective 

management or head office is situated. However, where such a person has its 

place of effective management in a Contracting State and its head office in the 

other Contracting State, the person shall be deemed to be a resident solely of 

that other State. 

5. If a company has become a resident of a Contracting State for the principal 

purpose of enjoying benefits under this Agreement, that company shall not be 

entitled to any of the benefits of Articles 10, 11 and 12. 

 55 See Australian government, Treasury Web site at, http://www.treasury.gov.au/documents/625/XLS/Australian_ 

Tax_Treaty_Table_April_2008.xls (last visited Apr. 30, 2008) for links to the Australian Treaty Database on Austlii. A copy of 

the treaty is available from the Austlii Australian Treaty Serie, http://www.austlii.edu.au/cgi-bin/sinodisp/au/other/ 

dfat/treaties/2007/36.html?&nocontext=1(last visited May 1, 2008). 

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Australia: Taxation – May 2008 The Law Library of Congress - 12 

Country55 Capital Gains Tax 

6. Where by reason of the provisions of paragraph (1) a company is a resident 

of Australia and, under a tax agreement between China and a third country, is 

also a resident of that third country, the company shall not be considered to be 

a resident of Australia for the purposes of enjoying benefits under this 

Agreement. 

Article 13 

Alienation of property 

1. Income or gains derived by a resident of a Contracting State from the 

alienation of real property referred to in Article 6 and, as provided in that 

Article, situated in the other Contracting State may be taxed in that other State. 

2. Income or gains from the alienation of property, other than real property 

referred to in Article 6, that forms part of the business property of a permanent 

establishment which an enterprise of a Contracting State has in the other 

Contracting State or pertains to a fixed base available to a resident of the firstmentioned State in that other State for the purpose of performing independent 

personal services, including income or gains from the alienation of such a 

permanent establishment (alone or with the whole enterprise) or of such a 

fixed base, may be taxed in that other State. 

3. Income or gains from the alienation of ships or aircraft operated in 

international traffic, or of property other than real property referred to in 

Article 6 pertaining to the operation of those ships or aircraft, shall be taxable 

only in the Contracting State of which the enterprise which operated those 

ships or aircraft is a resident. 

4. Income or gains derived by a resident of a Contracting State from the 

alienation of shares or comparable interests in a company, the assets of which 

consist wholly or principally of real property in the other Contracting State of a 

kind referred to in Article 6, may be taxed in that other State. 

5. Nothing in this Agreement affects the application of a law of a Contracting 

State relating to the taxation of gains of a capital nature derived from the 

alienation of property other than that to which any of paragraphs (1), (2), (3) 

and (4) apply. 

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Australia: Taxation – May 2008 The Law Library of Congress - 13 

Country55 Capital Gains Tax 

Singapore 

Protocol amending 

the Agreement with 

the Government of 

the Republic of 

Singapore for the 

Avoidance of Double 

Taxation and the 

Prevention of Fiscal 

Evasion with Respect 

to Taxes on Income 

1990 ATS 3. 

Article 10A 

(1) Income or gains derived by a resident of one of the Contracting States from 

the alienation of real property referred to in Article 4A and, as provided in that 

Article, situated in the other Contracting State may be taxed in that other State. 

(2) Income or gains from the alienation of property, other than real property 

referred to in Article 4A, that forms part of the business property of a 

permanent establishment which an enterprise of one of the Contracting States 

has in the other Contracting State or pertains to a fixed base available to a 

resident of the first-mentioned State in that other State for the purpose of 

performing independent personal services, including income or gains from the 

alienation of such a permanent establishment (alone or with the whole 

enterprise) or of such a fixed base, may be taxed in that other State. 

(3) Income or gains from the alienation of ships or aircraft operated in 

international traffic, or of property (other than real property referred to in 

Article 4A) pertaining to the operation of those ships or aircraft, shall be 

taxable only in the Contracting State of which the enterprise which operated 

those ships or aircraft is a resident. 

(4) Income or gains derived by a resident of one of the Contracting States from 

the alienation of shares or comparable interests in a company, the assets of 

which consist wholly or principally of real property in the other Contracting 

State of a kind referred to in Article 4A and, as provided in that Article, 

situated in that other State, may be taxed in that other State. 

(5) Nothing in this Agreement affects the application of a law of a Contracting 

State relating to the taxation of gains of a capital nature derived from the 

alienation of property other than that to which any of paragraphs (1), (2), (3) 

and (4) apply.". 

Russia 

Agreement between 

the Government of 

Australia and the 

Government of the 

Russian Federation 

for the avoidance of 

Double Taxation and 

Article 4 

Residence 

1 For the purposes of this Agreement, a person is a resident of a Contracting 

State if the person is a resident of that State under the law of that State relating 

to its tax. 

2 A person is not a resident of a Contracting State for the purposes of this 

Agreement if the person is liable to tax in that State in respect only of income 

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Australia: Taxation – May 2008 The Law Library of Congress - 14 

Country55 Capital Gains Tax 

the prevention of 

Fiscal Evasion with 

respect to Taxes on 

income, and Protocol 

2003 ATS 23 

from sources in that State. 

3 Where by reason of the preceding provisions of this Article a person, being 

an individual, is a resident of both Contracting States, then the person shall be 

deemed to be a resident solely of the Contracting State in which a permanent 

home is available to the person, or if a permanent home is available to the 

person in both Contracting States, or in neither of them, the person shall be 

deemed to be a resident solely of the Contracting State with which the person's 

personal and economic relations are closer. For the purpose of this paragraph, 

an individual's citizenship of one of the Contracting States shall be a factor in 

determining the degree of the individual's personal and economic relations 

with that Contracting State. 

4 Where by reason of the provisions of paragraph 1 a person other than an 

individual is a resident of both Contracting States, then it shall be deemed to be 

a resident solely of the State in which its place of effective management is 

situated. 

Article 13 

Income from alienation of property 

1 Income or profits derived by a resident of a Contracting State from the 

alienation of real property situated in the other Contracting State may be taxed 

in that other State. The meaning of the term "real property", and its situation, 

shall be determined in accordance with Article 6. 

2 Income or profits from the alienation of property, other than real property, 

that forms part of the business property of a permanent establishment which an 

enterprise of a Contracting State has in the other Contracting State or pertains 

to a fixed base available in that other State to a resident of the first mentioned 

State for the purpose of performing independent personal services, including 

income or profits from the alienation of that permanent establishment (alone or 

with the whole enterprise) or of that fixed base, may be taxed in that other 

State. 

3 Income or profits from the alienation of ships or aircraft operated by an 

enterprise of a Contracting State in international traffic, or of property (other 

than real property) pertaining to the operation of those ships or aircraft, shall 

be taxable only in that State. 

4 Income or profits derived by a resident of a Contracting State from the 

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Australia: Taxation – May 2008 The Law Library of Congress - 15 

Country55 Capital Gains Tax 

alienation of any shares or other interests in a company, or of an interest of any 

kind in a partnership, trust or other entity, where the value of the assets of such 

entity, whether they are held directly or indirectly (including through one or 

more interposed entities, such as, for example, through a chain of companies), 

is principally attributable to real property, situated in the other Contracting 

State, may be taxed in that other State. 

5 Nothing in this Agreement affects the application of a law of a Contracting 

State relating to the taxation of capital gains derived from the alienation of any 

property other than that to which any of the preceding paragraphs of this 

Article apply. 

Norway 

Convention 

Between Australia 

and the Kingdom of 

Norway for the 

Avoidance of 

Double Taxation 

with Respect to 

Taxes on Income 

and the Prevention 

of Fiscal Evasion 

2007 ATS 32 

(2006 Convention) 

Article 4 

Residence 

1 For the purposes of this Convention, the term "resident of a Contracting State 

" means: 

(a) in the case of Australia , a person who is a resident of Australia for the 

purposes of Australian tax; and 

(b) in the case of Norway, a person who is liable to tax therein by reason of 

domicile, residence, place of management or any other criterion of a similar 

nature. 

The Government of a Contracting State or a political subdivision or local 

authority of that State is also a resident of that State for the purposes of the 

Convention. 

2 A person is not a resident of a Contracting State for the purposes of this 

Convention if the person is liable to tax in that State in respect only of income 

from sources in that State. 

3 Where by reason of the preceding provisions of this Article a person, being 

an individual, is a resident of both Contracting States, then the person's status 

shall be determined as follows: 

(a) the individual shall be deemed to be a resident only of the State in which a 

permanent home is available to that individual; but if a permanent home is 

available in both States, or in neither of them, that individual shall be deemed 

to be a resident only of the State with which the individual's personal and 

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Australia: Taxation – May 2008 The Law Library of Congress - 16 

Country55 Capital Gains Tax 

economic relations are closer (centre of vital interests); 

(b) if the State in which the centre of vital interests is situated cannot be 

determined, the individual shall be deemed to be a resident only of the State of 

which that individual is a national; 

(c) if the individual is a national of both States or of neither of them, the 

competent authorities of the Contracting States shall endeavour to resolve the 

question by mutual agreement. 

4 Where by reason of the provisions of paragraph 1 a person other than an 

individual is a resident of both Contracting States, then it shall be deemed to be 

a resident only of the State in which its place of effective management is 

situated. 

5 Where under this Convention any income, profits or gains are relieved from 

tax in a Contracting State and, under the law in force in the other Contracting 

State, an individual in respect of that income or those profits or gains is exempt 

from tax by virtue of being a temporary resident of the other State within the 

meaning of the applicable tax laws of that other State, then the relief to be 

allowed under this Convention in the first-mentioned State shall not apply to 

the extent that that income or those profits or gains are exempt from tax in the 

other State. 

Article 13 

Alienation of Property 

1 Income, profits or gains derived by a resident of a Contracting State from the 

alienation of real property referred to in Article 6 and situated in the other 

Contracting State may be taxed in that other State. 

2 Income, profits or gains from the alienation of property, other than real 

property, that forms part of the business property of a permanent establishment 

which an enterprise of a Contracting State has in the other Contracting State, 

including income, profits or gains from the alienation of that permanent 

establishment (alone or with the whole enterprise), may be taxed in that other 

State. 

3 Income, profits or gains of an enterprise of a Contracting State from the 

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Australia: Taxation – May 2008 The Law Library of Congress - 17 

Country55 Capital Gains Tax 

alienation of ships or aircraft operated by that enterprise in international traffic, 

or of property (other than real property) pertaining to the operation of those 

ships or aircraft, shall be taxable only in that State. 

4 Income, profits or gains derived by a resident of a Contracting State from the 

alienation of any shares or comparable interests deriving more than 50 per cent 

of their value directly or indirectly from real property situated in the other 

Contracting State, may be taxed in that other State. 

5 Gains of a capital nature from the alienation of any property, other than that 

referred to in the preceding paragraphs shall be taxable only in the Contracting 

State of which the alienator is a resident. 

Norway 

Convention 

between Australia 

and the Kingdom of 

Norway for the 

Avoidance of 

Double Taxation 

and the Prevention 

of Fiscal Evasion 

with respect to 

Taxes on Income 

and on Capital, and 

Protocol 

1983 ATS 19 

(1983 Convention) 

Article 4 

Residence 

(1) For the purposes of this Convention, a person is a resident of one of the 

Contracting States- 

(a) in the case of Australia, subject to the provisions of paragraph (2), if the 

person is a resident of Australia for the purposes of Australia tax; and 

(b) in the case of Norway, if the person is liable to tax therein by reason of his 

domicile, residence, place of incorporation or any other criterion of a similar 

nature but not if he is liable to tax in Norway in respect only of income from 

sources therein. 

(2) In relation to income from sources in Norway, a person who is subject to 

Australian tax on income which is from sources in Australia shall not be 

treated as a resident of Australia unless the income from sources in Norway is 

subject to Australian tax or, if that income is exempt from Australian tax, it is 

so exempt solely because it is subject to Norwegian tax. 

(3) Where by reason of the preceding provisions of this Article an individual is 

a resident of both Contracting States, then his status shall be determined in 

accordance with the following rules: 

(a) he shall be deemed to be a resident solely of the Contracting State in which 

he has a permanent home available to him; 

(b) if he has a permanent home available to him in both Contracting States, or 

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Australia: Taxation – May 2008 The Law Library of Congress - 18 

Country55 Capital Gains Tax 

if he does not have a permanent home available to him in either of them, he 

shall be deemed to be a resident solely of the Contracting State with which his 

personal and economic relations are the closer. 

(4) For the purposes of the last preceding paragraph, an individual's citizenship 

or nationality of a Contracting State as well as his habitual abode shall be 

factors in determining the degree of his personal and economic relations with 

that Contracting State. 

(5) Where by reason of the provisions of paragraph (1), a person other than an 

individual is a resident of both Contracting States, then it shall be deemed to be 

a resident solely of the Contracting State in which its place of effective 

management is situated. 

Article 13 

Alienation of property 

(1) Income or gains from the alienation of real property or of an interest in or 

over land or of a right to exploit, or to explore for, a natural resource may be 

taxed in the Contracting State in which the real property, the land or the natural 

resource is situated. 

(2) For the purposes of this Article, shares or comparable interests in a 

company, the assets of which consist wholly or principally of real property or 

of interests in or over land in one of the Contracting States or of rights to 

exploit, or to explore for, natural resources in one of the Contracting States, 

shall be deemed to be real property situated in the Contracting State in which 

the land or the natural resources are situated or in which the exploration may 

take place. 

(3) Subject to the provisions of paragraph (1), income from the alienation of 

capital assets of an enterprise of one of the Contracting States or of capital 

assets available to a resident of one of the Contracting States for the purpose of 

performing professional services or other independent activities shall be 

taxable only in that State, but, where those assets form part of the business 

property of a permanent establishment or fixed based situated in the other 

Contracting State, such income may be taxed in that other State. 

(4) Gains from the alienation of shares in a company the capital of which is 

wholly or partly divided into shares and which is a resident of Norway for the 

purposes of Norwegian tax, derived by an individual who is a resident of 

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Australia: Taxation – May 2008 The Law Library of Congress - 19 

Country55 Capital Gains Tax 

Australia, may be taxed in Norway. 

(5) Gains from the alienation of ships or aircraft operated in international 

traffic, or movable property pertaining to the operation of such ships or aircraft 

shall be taxable only in the Contracting State of which the alienator is a 

resident. 

A-25
2008-00763 

LAW LIBRARY OF CONGRESS 

TAXATION OF PASSIVE INCOME EARNED BY FOREIGN GOVERNMENTS AND 

SOVEREIGN WEALTH FUNDS 

CANADA 

Executive Summary 

Canada does not have a specific law on the subject, but it does have a written 

departmental policy of granting qualified sovereign immunity to the passive income 

earned by foreign governments or their agencies through non-commercial activities. 

Applications for exemptions are filed with the Revenue Canada Agency. Canada also has 

provisions exempting certain types of income earned by foreign governments in its many 

tax treaties. These provisions vary from country to country. 

I. Tax Status of Foreign Governments 

Are they exempt from taxation on their passive income (interest, dividends, capital gains) on the 

basis of legislation? 

 

Canada’s Income Tax Act1

 and its supporting regulations do not contain a provision specifically 

exempting passive income earned by foreign governments or their agencies from taxation. 

Is there a practice of exempting them? 

Canada recognizes a qualified principle of sovereign immunity to exempt most income earned by 

foreign governments and their agencies from Canadian income tax. The Revenue Canada agency has 

published an Information Circular in which it outlines this principle in the following terms: 

Sovereign Immunity 

50. Under the Doctrine of Sovereign Immunity, the Government of Canada may grant exemption 

from tax on certain Canadian-source investment income paid or credited to the government or 

central bank of a foreign country. Written authorization not to withhold tax is given to the 

Canadian resident payer upon request after substantiation that such investment income (other than 

that already exempt under the Act and Regulations) is the property of the government or central 

bank of a foreign country. The written authorization will have an expiry date at which time the 

Canadian payer would be required to re-apply for further authorization not to withhold. A request 

for authorization not to withhold should be forwarded to: Revenue Canada, Taxation 875 Heron 

Road Ottawa, Ontario K1A 0L8 Attention: Provincial and International Relations Division 

Investment income of a foreign government or its agency is exempt only if (a) the other country 

would provide a reciprocal exemption to the Canadian Government or its agencies; (b) the income 

is derived by the foreign government or agency in the course of exercising a function of a 

governmental nature and is not income arising in the course of an industrial or commercial activity 

carried on by the foreign authority; and (c) it is interest on an arm's length debt or portfolio 

dividends on listed company shares. Income such as rentals, royalties or direct dividends from a 

 1

 R.S.C. c. 1 (5th Supp. 1989), as amended, (official source), also available at http://lois.justice.gc.ca/ en/showtdm/cs/I3.3?noCookie (unofficial source, last visited May 2, 2008). 

A-26
Canada: Taxation – May 2008 The Law Library of Congress - 2 

company in which the foreign government has a substantial or controlling equity interest does not 

qualify for exemption.2

The above paragraph does not specifically mention capital gains. However, it appears that 

Revenue Canada would apply the same basic rules in deciding whether the capital gain was taxable as a 

commercial activity or would be exempt under the principle of sovereign immunity.3

Is that practice based on the country’s understanding of international customary law? 

 Revenue Canada officials believe that the principle of sovereign immunity has been recognized 

for many years and may well be based upon Canada’s understanding of international customary law. 

However, there are no legislative provisions in which sovereign immunity is specifically recognized, even 

though observation of it has long been the practice of Canadian tax authorities. Therefore, there is no 

supporting legislative history or commentary.4

If there is no legislation or practice, does that mean that they are taxed as ordinary foreign 

taxpayers? 

 

Canada does recognize sovereign immunity and has included relevant and supporting provisions 

in most of its tax treaties. It should be noted that foreign governments are non-residents and thus the 

immunity they generally enjoy is from withholding taxes, rather than from the income taxes paid by 

Canadian residents. The general rate of withholding tax on dividends and capital gains is 25 percent, but 

this is usually reduced or eliminated by tax treaties. Canada has recently exempted interest income 

earned at arm’s length by non-residents from withholding tax.5

Is their tax treatment brought about by treaties? 

 

Canada has over eighty tax treaties. Many of these treaties contain provisions exempting interest 

income earned by foreign governments. Such a provision is contained in article 11(3) of the CanadaUnited States Income Tax Convention of 1980.6

 There are no comparable provisions for dividends or 

capital gains in the treaty with the United States, but as has already been pointed out, applications for the 

exemption of these types of passive income may be filed with the Revenue Canada Agency. 

II. Tax Status of Sovereign Wealth Funds 

 Revenue Canada authorities indicate that Canada does not have any special rules for sovereign 

wealth funds. Interest earned by these funds would generally be exempt from Canadian withholding tax 

under the Income Tax Act and under Canada’s tax treaties. Applications for sovereign immunity for 

dividends and capital gains would have to be filed with Revenue Canada. Passive income from 

commercial activities would normally be taxable. Revenue Canada authorities cited Chinese banks as an 

example of government-owned enterprises that had been denied sovereign immunity. Investments by 

New Zealand’s Earthquake Commission were cited as an example of a foreign government agency that 

 2

 Revenue Canada Agency, IC77-16R4, s. 50, http://www.cra-arc.gc.ca/E/pub/tp/ic77-16r4/ic77-16r4-e.html (last 

visited May 3, 2008). 

3

 Id. 

4

 Information obtained by telephone from the Revenue Canada Agency on May 2, 2008. 

5

 2007 S.C. c. 35, § 59 (official source). 

6

 1984 S.C. c. 20, Part I (official source), also available at http://www.lexum.umontreal.ca/ca_us/cgibin/disp.pl/en/cts.1984.15.1.en.html?query=%22tax%22&langue=en&selection=&database=en&method=all&retour=/ca_us/cgibin/srch.pl?numhits=25~~language=en~~method=all~~query=tax~~database=en (unofficial source). 

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Canada: Taxation – May 2008 The Law Library of Congress - 3 

had been granted sovereign immunity and is not taxed on its Canadian earnings.7 

 

III. Domestic Law 

 Non-resident interest paid at arm’s length is currently not taxable in Canada. Interest that is not 

paid at arm’s length is taxed at the 25 percent withholding rate. Dividends and capital gains are also 

generally subject to the 25 percent withholding rate, although there are a number of complicated 

exceptions.8

 

IV. Treaties on Double Taxation 

 Canada has a tax treaty with the Kingdom of Norway. Like the Canada-United States Tax Treaty, 

this treaty exempts interest income earned in one country and paid to the government or a political 

subdivision of the other from tax in the country in which it is earned. However, unlike the Canada-United 

States Tax Treaty, the Canada-Norway treaty contains a virtually identical provision respecting dividends. 

Thus, dividends earned by Norway’s SWF or the Province of Alberta’s Heritage Fund are not taxable in 

the country in which they are earned. This means that Norway’s SWF does not have to apply for 

sovereign immunity, as a SWF founded in a country that does not have a similar provision in its tax treaty 

with Canada would. 

Under the Canada-Norway tax treaty, dividends may be taxed in the country in which they are 

earned at the rate of 5 percent, if the recipient holds at least 10 percent of the voting power of the payer, 

and 15 percent in other cases. The treaty also provides that capital gains from transactions involving real 

property are subject to withholding tax.9

 

 

Prepared by Stephen F. Clarke 

Senior Foreign Law Specialist 

May 2008 

 7

 Information obtained by telephone from the Revenue Canada Agency on May 6, 2008. 

8

 C.C.H. Canada, CANADIAN TAX REPORTER, para. 26,105 (2008). 

9

 Canada-Norway Income Tax Convention 2002, 2002 S.C. c. 24. (official source), also available at C.C.H. Canada, 

id., para 31,903. 

A-28
2008-00763 

LAW LIBRARY OF CONGRESS 

 TAXATION OF PASSIVE INCOME EARNED BY FOREIGN GOVERNMENTS AND 

SOVEREIGN WEALTH FUNDS 

GERMANY 

 

Executive Summary 

Germany taxes foreign governments and sovereign wealth funds on their passive 

investments in the same manner as any other foreign corporate entity. There is no 

exemption on the basis of statutory law or deemed customary international law or 

practice, nor do German double taxation treaties exempt foreign governments or their 

entities. 

Nevertheless, the tax burden of foreign governmental entities on their passive 

income from German sources is light, because domestic law generally exempts from 

taxation most German-source interest that is earned by foreign residents, and it also 

exempts from taxation 95 percent of the dividends from German corporations that are 

earned by foreign corporate entities. Capital gains are not taxed at all, unless they 

amount to a participation, in which case they also enjoy the 95 percent corporate 

exemption. 

I. Tax Status of Foreign Governments 

 Germany does not exempt foreign governments from taxation on their passive German-source 

income.1

 Instead, foreign governments are deemed to be foreign corporate entities that are taxed on their 

passive German source income.2

 Although section 5 of the German Corporation Tax Code3 exempts 

certain specifically named German governmental units from taxation, there are no corresponding 

provisions for foreign governments, and consequently, the general provision of section 2 of the 

Corporation Tax Code applies to them. It provides that foreign entities are subjected to limited tax 

liability, which means that they are taxed on their German-source income as provided by law.4

 German authorities are not under the impression that foreign governments should be exempted 

from taxation by virtue of international customary law.5

 Instead, exemptions of governmental institutions 

are provided only on the basis of bilateral and multilateral treaties, for the specific purposes listed in these 

treaties,6

 and these treaties do not include any general immunity of foreign governments, central banks, or 

 1

 This information has been obtained from officials of the German Federal Ministry of Finance. 

2

 D. Gosch, Körperschaftsteuergesetz 111 (München, 2005). 

3

 Körperschaftsteuergesetz [KStG], repromulgated Oct. 15, 2002, BUNDESGESETZBLATT [BGBl, official law gazette of 

the Federal Republic of Germany] I at 4210, as amended. 

4

 KStG, § 2 subjects foreign entities to “limited tax liability”; Einkommensteuergesetz [EStG], repromulgated Oct. 19, 

2002, BGBl I at 4210, as amended; § 49 lists the taxes that are imposed on limited taxpayers. 

5

 Information obtained from officials of the German Federal Ministry of Finance. 

6

 The Ministry of Finance periodically publishes a list of tax-exempting treaties for the benefit of the decentralized tax 

authorities. The latest of this list is Bundesministerium der Finanzen, Vorschrift VV DEU BMF 2007-08-20 IV B 3 –S 

1311/07/0039, Aug. 20, 2007, available at the official Web-site http://www.bundesfinanzministerium.de/nn_58004/ 

DE/BMF__Startseite/Aktuelles/BMF__Schreiben/Veroffentlichungen__zu__Steuerarten/einkommensteuer/055.html. The 

listings contained therein are limited to multilateral treaties such as the Vienna Conventions and very specific bilateral treaties 

exempting specifically named governmental institutions in the host country, such as, for instance, cultural institutions. 

A-29
Germany: Taxation – May 2008 The Law Library of Congress - 2 

sovereign wealth funds. Moreover, the German philosophy is strongly influenced by article 4, paragraph 

1 of the OECD Model Treaty,7

 according to which a foreign government and its subdivisions are 

residents (and therefore taxpayers) in the other treaty country. 

 

 Despite this seemingly categorical approach to taxing foreign governments, the tax burden 

imposed on their passive investments in Germany is light due to a tax policy that aims to attract foreign 

investments (see below, section III).8

II. Tax Status of Sovereign Wealth Funds 

 Germany taxes sovereign wealth funds like any other foreign corporate taxpayer.9

 Since, as 

explained above, Germany does not exempt foreign governments from taxation on their passive income, 

there is no occasion in German law to distinguish between types of sovereign wealth funds according to 

their degree of governmental management or purpose. Yet, as is explained below (section III), the tax 

burden on these funds is light. 

 

III. Domestic Law on the Taxation of Passive Income Earned by Foreign Residents 

 Interest 

 Aside from a few exceptions, Germany does not tax foreign taxpayers on their German interest 

earnings. This is provided in section 49 of the Income Tax Code.10 This provision contains a complete 

listing of the circumstances under which foreign individuals or corporations are taxed on their German 

source income.11 The only types of interest that are listed in this section as taxable to non-residents are 

interest derived from loans secured by mortgages and interest derived from convertible bonds, non-voting 

preferred stock, and profit-sharing bonds. For a non-resident, the interest on these specified types of debt 

instruments is withheld at the rate of 25 percent. 12

Dividends 

 Ninety-five percent of the dividends from German corporate entities are exempted from taxation 

if they are earned by a corporate shareholder. This is provided in section 8b, paragraph 1 of the 

Corporation Tax Act, and this rule applies to domestic corporations and foreign corporations alike.13 This 

exemption of corporate dividend income became applicable in 2003 and is the result of a reform of the 

German corporation tax that was designed to avoid inter-corporate double taxation. Under this system, 

the domestic dividend-distributing corporation is taxed at a 25 percent tax rate on its earned income 

(whether distributed or not), and ultimately the domestic private shareholder is taxed on his dividend 

7

 Organization for Economic Co-operation and Development, Model Tax Convention on Income and on Capital, 

version of January 2003, promulgated in German translation in the official administrative gazette BUNDESSTEUERBLATT 2007 I at 

656. 

8

 GERMAN TAX AND BUSINESS LAW GUIDE ¶ 131,000 (Sweet & Maxwell, London, 2002- ). 

9

 This information has been obtained from officials of the German Federal Finance Ministry. 

10 EStG, supra note 3. 

11 W. Bächle & T. Rupp, Internationales Steuerrecht 461 (Stuttgart, 2002). 

12 EStG § 43 20 1 and EStG § 43 a ¶ 1. Added to this withholding is a 5.5% surcharge [Solidaritätszuschlaggesetz, 

repromulgated Oct. 15, 2002, BGBl I at 4130, as amended], thus amounting to 26.38%. 

13 Gosch, supra note 2, at 802. 

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Germany: Taxation – May 2008 The Law Library of Congress - 3 

income.14 In between these two stages, dividends are generally not taxed. Foreign corporations are 

included in this exemption from taxation, in order to grant them equal treatment.15

 There are some exceptions from this principle that make dividends taxable if the shares are 

owned by banks, life insurers, or pension funds. These exceptions, however, only affect corporate 

shareholders who reside in Germany, in the member states of the European Union (EU), or in 

Switzerland16 and do not apply to residents of other countries.17

 The actual exemption of only 95 percent of dividend income results from section 8 b, paragraph 

5, which provides for the taxation of 5 percent of the dividend income on the grounds that this percentage 

is deemed to be attributed to expenses related to this income that the corporation may be able to deduct in 

its general income computation. The result of this complex rule is a definitive limitation of the tax 

exemption of dividends to 95 percent.18

 Capital Gains 

 Capital gains realized by a non-resident corporate entity from the sale of shares in German 

companies are taxed only if they amount to the sale of a participation,19 which is defined as the ownership 

of at least 1 percent of the shares of the company over the five years preceding the sale.20 Capital gains 

of such substantial participations are taxed according to the same principles as dividends from foreign 

companies:21 section 8 b, paragraphs 2 and 3 of the Corporation Tax Act exempt 95 percent of the capital 

gains from a participation in a German corporation if the gains are realized by a foreign or domestic 

corporation. The remaining 5 percent of the gains are taxed.22

IV. Treaties on Double Taxation 

 In General 

 German double taxation treaties are to a large extent irrelevant for the taxation of passive 

German-source income earned by foreign residents because, aside from certain exceptions, the exemption 

of 95 percent of corporate dividends and of capital gains from participations also applies to foreign 

corporations residing in countries that have a double taxation treaty with Germany.23 In addition, it 

appears that the non-taxability of German-source interest for foreign residents also should override any 

less favorable treaty provisions, because there is no tax liability generated for such income to which a 

 14 Individual taxpayers, both foreign and domestic, who have portfolio holdings of shares in German companies are 

subject to a withholding tax of 25%, [EStG § 20 ¶ 1, in conjunction with EStG § 43, 43 a, and § 49 ¶ 5 (a)], plus a 5.5% 

surcharge [Solidaritätszuschlaggesetz, repromulgated Oct. 15, 2002, BGBl I at 4130, as amended], thus amounting to 26.38%. 

15 Gosch, supra note 2, at 791. 

16 KStG, § 8b ¶ 7 & 8. 

17 Gosch, supra note 2, at 894 

18 Id., at 874. 

19 Gains derived from the sale of substantial participations, German permanent establishment, and ships or real 

property are the only types of gains that are listed in ESTG § 49 as creating a tax liability for taxpayers with a limited tax 

liability. 

20 As defined by EStG § 17. 

21 Bächle, supra note 11 at 469; C. Bourseaux, Germany in TAXATION OF COMPANIES IN EUROPE at 8.4.2.3 

(Amsterdam, 2004). 

22 KStG § 2 no. 1, in conjunction with EStG § 49 ¶ 1 no. 2 (e). 

23 Gosch supra note 2, at 790 & 823. 

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Germany: Taxation – May 2008 The Law Library of Congress - 4 

treaty could apply. These features of German law may also reduce scope of application of the EU ParentSubsidiary Directive24 and the EU Savings Directive.25

 Generally, the newer German double taxation treaties follow the Model Tax Convention of the 

Organization for Economic cooperation and Development [OECD]26 by considering the governments of 

the treaty states as residents and therefore taxpayers. 

 The OECD Model Convention’s philosophy of limiting the source country taxation of interest, 

dividends, and capital gains from passive investment is also observed in these treaties.27 It is often stated 

that the focus on taxing passive source income less at the source and more in the country of residence of 

the transnational taxpayer favors the European countries when they export capital.28 On the other hand, 

this distribution of the taxes on passive income may benefit the European member states of the OECD by 

allowing them to compete for investments through lower source-country tax rates.29

 Kuwait 

 

 The double taxation treaty between Germany and Kuwait30 defines the governments of the treaty 

states and their governmental institutions as residents, which appears to imply that they are deemed to be 

taxpayers. 

 Interest is not taxed in the source country, and portfolio dividends may be taxed in the source 

country with a rate of up to 15 percent while dividends of substantial holdings (at least 10 percent of the 

share capital) may be taxed in the source country with a rate of up to 5 percent. Capital gains from 

passive investments are not taxed at all in the source country. 

 Norway 

The double taxation treaty between Germany and Norway31 contains no provisions on the 

taxation of each other’s governments or their agencies or funds, other than the confirmation of diplomatic 

immunities as provided by treaty or customary international law. 

 According to this agreement, source country interest earned by residents of the other country is 

not taxed in the source country; source country dividends earned from portfolio investments of a resident 

of the other country may be taxed by the source country with a rate of up to 15 percent, while dividends 

earned from a substantial participation (of at least 25 percent of the shares) in a source country 

corporation may not be taxed at all by the source country. Capital gains from the sale of shares or 

 24 Council Directive 90/435/EEC of 23 July 1990, on the common system of taxation applicable in the case of parent 

companies and subsidiaries of different member states, 1990 OFFICIAL JOURNAL OF THE EUROPEAN COMMUNITIES [O. J., official 

source] (L225) 6. 

25 Council Directive 2003/48/ECof 3 June 2003, on taxation of savings income in the form of interest payments, 2003 

O. J. (L 157) 38. 

26 Model Tax Convention on Income and on Capital, supra note 7, at 656. 

27 K. VOGEL, DOPPELBESTEUERUNGSABKOMMEN 772, 962, & 1087 (München, 1986). 

28 OBERSON & H. Hull, Switzerland in International Tax Law 77 (Amsterdam, 2006). 

29 W. SCHÖN, TAX COMPETITION IN EUROPE 3 (Amsterdam, 2003). 

30 Abkommen zwischen der Bundesrepublik Deutschland und dem Staat Kuwait zur Vermeidung der 

Doppelbesteuerung auf dem Gebiet der Steuern vom Einkommen und vom Vermögen und zur Belebung der writschaftlichen 

Beziehung, May 18, 1999, BGBl 2000 II at 390. 

31 Abkommen zwischen der Bundesrepublik Deutschland und dem Königreich Norwegen zur Vermeidung der 

Doppelbesteuerung und über gegenseitige Amtshilfe auf dem Gebiet der Steuern vom Einkommen und vom Vermögen, Oct. 4, 

1991, BGBl 1993 II at 969. 

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Germany: Taxation – May 2008 The Law Library of Congress - 5 

participations in a source country company are not taxable in the source country, if the seller of the shares 

or participations is a corporation that resides in the other country. 

Prepared by Edith Palmer 

Senior Foreign Law Specialist 

May 2008 

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2008-00763 

LAW LIBRARY OF CONGRESS 

JAPAN 

TAXATION OF PASSIVE INCOME EARNED BY FOREIGN GOVERNMENTS AND 

SOVEREIGN WEALTH FUNDS 

Executive Summary 

Though there is no explicit provision to exempt foreign governments from tax on passive 

income, they are, in fact, exempted from tax on interests on deposits and dividends. 

There is no provision for taxation on sovereign wealth funds either. They are taxed the 

same way as other funds. The Japan-Singapore Tax Treaty and the Japan-Norway Tax 

Convention have provisions to exempt the Singapore government and Singapore’s 

sovereign wealth fund from taxation on interest. 

I. Tax Status of Foreign Governments 

Though the Corporation Tax Law and the Income Tax Law do not have provisions to exempt the 

foreign government from taxation, passive income earned in Japan by foreign governments are exempted 

from taxation. 

 By reading the Corporation Tax Law,1

 it appears that foreign governments are liable to pay tax on 

domestic source income. Under the definitions of the Corporation Tax Law, a foreign government is 

classified as a foreign corporation. A foreign corporation must pay corporation tax if it has domestic 

source income unless it is a public corporation. A foreign government is not a public corporation because 

foreign governments are not listed as public corporations in the Schedule No. 1 of the Corporation Tax 

Law. In comparison, local governments are listed in the Schedule though they are domestic corporations. 

Article 2 

(iii) Domestic corporation: a corporation maintaining its head office or main 

office within the country. 

(iv) Foreign corporation: a corporation other than domestic corporations. 

(v) Public corporation: the corporations listed in Schedule No. 1.2

Article 4 

(2) Foreign corporations shall be liable to pay corporation tax pursuant to this 

Act in cases where they have domestic source income defined in Article 138 

(Domestic source income) (with respect to public interest corporations, etc. or 

non-juridical organizations, etc. that are foreign corporations, they are liable to 

 

1

 Hōjinzei hō [Corporation Tax Law], Law No. 34 of 1965, as amended by Law No. 100 of 2007, available at

http://law.e-gov.go.jp/htmldata/S40/S40HO034.html (a government Web site, unofficial source). 

2

 Translation from YUJI GOMI and TASUKU HONJO, WA-EI TAIYAKU HŌJINZEI HŌ [CORPORATION TAX ACT OF JAPAN], 2 

(2007) (unofficial translation). 

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pay corporation tax only if they have such domestic source income derived from 

profit-making activities), where they undertake a corporate taxation trust, or 

where they carry out operations for retirement fund, etc. defined in Article 145-3 

(Computation of amount of retirement pension fund as to foreign corporations). 

(3) Notwithstanding the preceding two paragraphs, public corporations shall not 

be liable to pay corporation tax.3

Domestic source income includes interests on national government bonds or municipal bonds or 

certain credits issued by domestic corporations and interest on deposits and savings in Japan.4

 Also 

included in domestic source income are: dividends of surplus or profits, distribution of surplus or funds 

from a domestic corporation, or distribution of profits of investment trusts (excluding bond investment 

trusts and investment trusts on employment of publicly issued bonds) or specified beneficiary certificate 

issuance trusts that have been entrusted to business places in Japan.5

 In addition to the Corporation Tax Law, the Income Tax Law states that foreign corporations are 

obligated to pay income tax when they receive payment that is classified as “foreign corporation taxable 

income” or that derives from certain trustee activities.6

 “Foreign corporation taxable income” includes 

interests and dividends. 7

 Based on these provisions, it looks foreign governments must pay tax on interests on bonds and 

savings, and dividends of profit. However, interests accrued in bank deposits in Japan for a foreign 

government are not taxed in Japan.8

 It is explained that such treatment is an international custom based 

on international law of sovereign immunity.9

 This treatment is not based on explicit provisions of laws in 

Japan. For tax on dividends, it appears foreign governments are also exempted from them though 

documents that directly so state were not located. Corporations have to submit notices before they 

receive interests or dividends to the payer of those under article 224 of the Income Tax Law.10 Foreign 

 

3

 Id. at 51. 

4

 Corporation Tax Law, Law No. 34 of 1965, as amended by Law No. 100 of 2007, art. 138, item 4. 

5

 Id. art. 138, item 5. 

6

 Income Tax Law, Law No. 33 of 1965, as amended by Law No. 100 of 2007, art. 5, para. 4, available at http://law.egov.go.jp/htmldata/S40/S40HO033.html (a government Web site, unofficial source). 

7

 “Foreign corporation taxable income” means incomes prescribed in article 161, item 1-2 through item 7 and item 9 

through item 12 of the Income Tax Law. Id. art. 5, para. 2. Article 61, items 4 and 5 of the Income Tax Law lists interests and 

dividends. 

8

 Yasunori Chikaishi , Gaikoku seifu · gaikoku taishikan tō no gensen chōshū gimu oyobi nōzei gimu [Obligation of 

foreign governments and foreign embassies to withhold and pay tax], ZEIDAI RONSHU 45, 79, 104-5 (2004), available at

http://www.nta.go.jp/ntc/kenkyu/ronsou/45/chikaishi/ronsou.pdf; and KONOSUKE KIMURA, KOKUSAI ZEIHŌ [INTERNATIONAL TAX 

LAW], 151 (2000). 

9

 Chikaishi, supra note 8 at 104-105; and KIMURA, supra note 8, at 151. 

10 Article 224 of the Income Tax Law, Law No. 30 of 1965, as amended by Law No. 100 of 2007. 

A person (excluding corporations mentioned in the Attached List No. 1 (Table of public 

corporations) of the Corporation Tax Law and others prescribed by Cabinet Order; ...) who in this 

country receives payment of interest, etc. or dividend, etc. (excluding interest of ordinary deposits 

and others prescribed by Cabinet Order; ...) provided for in Article 23 paragraph 1 (Interest 

Income) or Article 24 paragraph 1 (Dividend income) shall, as prescribed by Cabinet Order, not 

later than the date such payment becomes definite, give notice of his name or title and address (...) 

to a person (...) who makes payment of that interest, etc. or dividend, etc. .... (translated by 

author.) 

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Japan: Taxation – May 2008 The Law Library of Congress - 3

governments, however, are exempted from this notice requirement. It is explained that there is little 

reason to get notices from corporations that do not have to pay these tax.11 Therefore, it is assumed that 

foreign governments are not paying tax on dividends. Presumably, this exemption was also based on 

sovereign immunity though no documents stated so. 

 Capital gains on stocks are not listed as taxable income of foreign corporations in the Corporation 

Tax Law and the Income Tax Law. 

II. Tax Status of Sovereign Wealth Funds 

Sovereign Wealth Funds are not treated differently from other funds. 12 They are taxed in 

accordance with Japanese tax law and tax treaties. 

 In a case of Singapore’s fund, a Sovereign Wealth Fund is exempted from tax in Japan based on 

the Agreement between the Government of the Republic of Singapore and the Government of Japan for 

the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on 

Income.13 Article 11, paragraph 3 of the Agreement reads: 

3. Notwithstanding the provisions of paragraph 2, interest arising in a Contracting State 

and derived by the Government of the other Contracting State, a local authority there of, 

the central bank of that other Contracting State or any institution wholly owned by that 

Government, or by any resident of the other Contracting State with respect to debt-claims 

guaranteed, insured or indirectly financed by the Government of that other Contracting 

State, a local authority thereof, the central bank of that other Contracting State or any 

institution wholly owned by that Government shall be exempt from tax in the firstmentioned Contracting State. 

The Japan-Norway Tax Convention also has a similar provision.14 

III. Domestic Law 

Tax rates for foreign corporations on domestic source interests and dividends depend on their 

size, business, or other factors. Also, temporary treatment to reduce such tax would be applied. There 

may be exceptions to the general rule on specific items. The following are the general rules. The general 

tax rate for a foreign corporation is thirty percent of income as of 2008.15 

 

Article 355, paragraph 2 of the Income Tax Law Enforcement Order lists foreign governments and foreign local 

governments as “others” who are excluded from the notice requirement of the Income Tax Law Article 224, paragraph 1. 

11 Masasuke Takeda, DHC konmentaru shotokuzei hō [DHC Income Tax Law Commentary], 8895 (1983), cited by

Chikaishi, supra note 8, at 150. 

12 Confirmed by an e-mail from a National Tax Agency official, to Sayuri Umeda, Senior Foreign Law Specialist, Law 

Library of Congress (Apr. 3, 2008) (on file with the author). 

13 Agreement between the Government of the Republic of Singapore and the Government of Japan for the Avoidance 

of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, Treaty No. 8 of 1995, available at

http://www.iras.gov.sg/ESVPortal/resources/singaporejapandta.pdf (unofficial source). 

14 Convention between Japan and The Kingdom of Norway for the Avoidance of Double Taxation and the Prevention 

of Fiscal Evasion with Respect to Taxes on Income, Treaty No. 8 of 1992, art. 11, para. 3. Ministry of Foreign Affairs, 

Nikokukan jōyaku shū [Treaties between two countries] 1992, 1857 (1994) (unofficial source). 

15 Corporation Tax Law, Law No. 34 of 1965, as amended by Law No. 100 of 2007, art. 143, para. 1. 

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Interest 

In general, fifteen percent of interest is withheld at the source.16 If a foreign corporation has a 

permanent establishment in Japan, interest income should be included in taxable income when it pays tax 

by self assessment.17 The amount of tax withheld is credited to the corporation tax to be paid. 

Dividends 

In general, twenty percent of dividend is withheld at the source.18 If a foreign corporation has a 

permanent establishment in Japan, dividend income should be included in taxable income when it pays 

tax by self assessment.19 The amount of tax withheld is credited to the corporation tax to be paid. 

Capital Gain from Shares 

As stated in section I, a foreign company’s capital gain from shares is generally not taxed in 

Japan. 

IV. Treaties on Double Taxation 

 Japan has treaties on double taxation with fifty-five countries, including China, Singapore, and 

Sweden, but not Kuwait.20 In the Japan–Singapore Tax Agreement,21 there is no provision on whether 

governments and their subdivisions are considered taxpayers or not. Though there are more details, the 

general rules of taxation and rates on interest, dividends, and capital gains in Japan for a Singapore 

resident are as follows. 

 Interest 

 It is not taxed (taxed in Singapore).22 The beneficial owner of the interest is taxed up to ten 

percent of the gross amount of interest.23

 Dividends 

 They are not taxed (taxed in Singapore).24 The beneficial owner of the dividends is taxed fifteen 

percent of the gross amount of the interest.25 The tax rate is five percent if the beneficial owner is a 

 

16 Income Tax Law, Law No. 33 of 1965, as amended by Law No. 100 of 2007, art. 179, item 3 and art. 212, para. 1. 

17 Corporation Tax Law, Law No. 34 of 1965, as amended by Law No. 100 of 2007, art. 141, item 1. 

18 Income Tax Law, Law No. 33 of 1965, as amended by Law No. 100 of 2007, art. 179, item 1 and art. 212, para. 1. 

19 Corporation Tax Law, Law No. 34 of 1965, as amended by Law No. 100 of 2007, art. 141, item 1. 

20 KAZUO KINOSHITA AND HIROSHI KANEKO EDS., KOKUSAI KAZEI NO RIRON TO KADAI [THEORIES AND TASKS OF 

INTERNATIONAL TAXATION], 36-7 (2005). 

21 Agreement between the Government of the Republic of Singapore and the Government of Japan for the Avoidance 

of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, Treaty No. 8 of 1995. 

22 Id. art. 11, para. 1. 

23 Id. art. 11, para. 2. 

24 Id. art. 10, para. 1. 

25 Id. art. 10, para. 2 (b). 

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company which owns twenty five percent or more of the voting shares of the company in Japan for six 

months.26 

 Capital Gains 

 A nonresident’s capital gains from shares are basically not taxed in Japan. They may be taxed in 

the following cases: 

(a) gains from the alienation of shares of a company not traded regularly at a recognized 

stock exchange, or of an interest in a partnership, a trust or an estate, the property of 

which consists principally of immovable property situated in a Contracting State, may be 

taxed in that Contracting State. 

(b) gains derived by a resident of a Contracting State from the alienation of shares of a 

company being a resident of the other Contracting State may be taxed in that other 

Contracting State, if: 

(i) shares held or owned by the alienator (together with such shares held or owned by 

any other related persons as may be aggregated therewith) amount to at least 25 per cent 

of the entire share capital of such company at any time during the taxable year or the 

basis period for the year of assessment; and 

(ii) the total of the shares alienated by the alienator and such related persons during that 

taxable year or the basis period for that year of assessment amounts to at least 5 per cent 

of the entire share capital of such company.27 

 In the Japan-Norway Tax Convention, there are almost identical provisions concerning interest 

and dividends.28 There is, however, no provision similar to the above paragraph in the Convention.29 

Nonresident’s capital gains from shares are basically not taxed in Japan. 

Prepared by Sayuri Umeda 

Senior Foreign Law Specialist 

April 2008 

 

26 Id. art. 10, para. 2 (a). More specifically, six months period should be “immediately before the end of the 

accounting period for which the distribution of profits takes place.” 

27 Id. art 13, paragraph 4. 

28 Convention between Japan and The Kingdom of Norway for the Avoidance of Double Taxation and the Prevention 

of Fiscal Evasion with Respect to Taxes on Income, Treaty No. 8 of 1992, arts. 10 and 11. 

29 Id. art. 13. 

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2008-00763 

LAW LIBRARY OF CONGRESS 

TAXATION OF PASSIVE INCOME EARNED BY FOREIGN GOVERNMENTS AND 

SOVEREIGN WEALTH FUNDS 

NORWAY 

Executive Summary 

Norway has ratified the Vienna Convention on Diplomatic Relations and the 

Vienna Convention on Consular Relations, which govern the status of foreign 

government personnel in Norway. Norway applies a tax exemption on companies’ 

income from shares. This exemption applies to both private and state-owned companies, 

as well as to foreign companies within the European Economic Area. No provisions 

specifically concerning the taxation of sovereign wealth funds in Norway were located. 

Norway has a large sovereign wealth fund called the Government Pension Fund which 

manages Norway’s substantial petroleum revenues to meet the needs of the increasing 

public pension expenditures. 

I. Tax Status of Foreign Governments 

 Chapter 2 of the Norwegian Tax Act contains provisions regarding limitations on taxation and tax 

exemptions for certain persons and organizations.1

 According to the Tax Act, the Norwegian state is 

exempt from paying taxes, which includes government institutions, government establishments, and 

government funds.2

 No similar provisions have been found for foreign states. 

The status of foreign government agencies and personnel, consular officers, and representatives 

of international organizations in Norway is governed by the provisions of the Vienna Convention on 

Diplomatic Relations (1961),3

 and the Vienna Convention on Consular Relations (1963).4 Foreign 

government personnel are exempt from municipal wealth and income taxes.5

II. Tax Status of Sovereign Wealth Funds 

 No information was found with regards to the taxation of foreign sovereign wealth funds in 

Norway during the preparation of this report. As discussed under section III below, Norway applies a tax 

exemption on companies’ incomes from shares. The tax exemption also applies to state-owned foreign 

companies within the European Economic Area (EEA), but not to companies outside the EEA (which are 

still taxed at a rate of 25 percent). 

 1

 Skatteloven (Act No. 14, Mar.28, 1999) [in Norwegian], available at http://www.lovdata.no/all/hl-19990326-

014.html (official source). 

2

 Id., ch. 2 § 30. 

3

 Vienna Convention on Diplomatic Relations, Apr.18, 1961, 500 UNITED NATIONS TREATY SERIES (UNTS, official 

source) 95, available at http://untreaty.un.org/ilc/texts/instruments/english/ conventions/9_1_1961.pdf.

4

 Vienna Convention on Consular Relations, Apr. 24, 1963, 596 UNTS 261, available at http://untreaty.un.org/ 

ilc/texts/instruments/english/conventions/9_2_1963.pdf. 

5

 Ministry of Foreign Affairs, Diplomat in Norway, June 21, 2006, available at http://www.regjeringen.no/ 

en/dep/ud/Documents/veiledninger/2006/Diplomat-in-Norway.html?id=419528 (offficial Web site of the Norwegian Ministry of 

Foreign Affairs). 

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Norway: Taxation – May 2008 The Law Library of Congress - 2 

III. Domestic Law 

Interest 

Interest earned directly by non-residents from Norwegian sources is not taxable in Norway.6

 Capital Gains 

In the information available from the Norwegian government, share income constitutes both 

dividends and capital gains. Please see text below under “Dividends.”7

Dividends 

Since 2004, Norway has granted a tax exemption on companies’ income from shares. The tax 

exemption model was adopted to avoid chain taxation when shares are owned by companies in multi-tier 

corporate structures. The tax exemption applies to Norwegian private and public limited companies and 

other companies of the same standing for tax purposes. It also applies to associations, institutions, 

Norwegian stock investment funds, estates in bankruptcy, and municipal and state-owned companies. 

The tax exemption model also applies to foreign companies and entities within the EEA that correspond 

to the Norwegian companies.8

 According to the Ministry of Finance, the tax exemption generally applies 

to domestic and cross-border income on shares.9

 In order to prevent tax avoidance, the tax exemption is 

not applicable to investments in foreign countries outside the EEA with low corporate taxation or to 

portfolio investments outside the EEA.10

The withholding tax regime on dividends from Norwegian companies to corporate shareholders 

outside the EEA has not changed. These corporate shareholders are still subject to a withholding tax of 

25 percent or a reduced rate if there is an applicable double tax convention.11

IV. Treaties on Double Taxation 

 On the Norwegian Government’s official Web site, a list of the countries with which Norway has 

double-taxation treaties, with links to the relevant treaties, is available.12 As an example, Norway and 

Russia entered into a double taxation treaty in 1996, which came into force in 2002. The treaty applies to 

persons who are residents in either Norway or Russia, or both.13 The term “persons” means individuals, 

 6

 Norway, THE TAXATION OF PATENT ROYALTIES, DIVIDENDS, INTEREST IN EUROPE 11 (IBFD Amsterdam, 2002-). 

7

 Ministry of Finance, The Corporate Tax System and Taxation of Capital Income, http://www.regjeringen.no/ 

nb/dep/fin/tema/Norsk_okonomi/topics/The-corporate-tax-system-and-taxation-of-capital-income.html?id=418058 (official Web 

site of the Norwegian Ministry of Finance, last visited May 5, 2008). 

8 Id. 

9

 Id.. 

10 Id., & Elisabeth A. Landmark, Kildeskatt på Aksjeutbytte til Utenlandske Aksjonærer – Fritaksmetoden,

SKATTEDIREKTORATET, Mar. 2, 2005, available at http://www.nordea.no/sitemod/upload/root/www_nordea_no/ 

Text/Corporate/issuer_services_05-05457_informasjon_kildeskatt-fritaksmetodenb-020305-el.pdf. 

11 Landmark, id.

12 Ministry of Finance, General Tax Conventions between Norway and Other States, Oct. 9, 2007, available at

http://www.regjeringen.no/en/dep/fin/Selected-topics/Taxes-and-Duties/skatteavtaler/tax-treaties-between-norway-and-other-st2.html?id=450647. 

13 Convention between The Kingdom of Norway and The Russian Federation for the avoidance of Double Taxation 

and the Prevention of Fiscal Evasion with Respect to Taxes and Income on Capital, art. 1, Ministry of Finance Web site, May 17,

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Norway: Taxation – May 2008 The Law Library of Congress - 3 

companies, or other bodies of persons.14 According to article 4 of the OECD model tax convention, the 

term “resident” includes States, political subdivisions, and local authorities thereof.15 Article 4 of the tax 

treaty between Norway and Russia, which also defines the term “resident,” does not include States. The 

first paragraph of this article states: 

For the purposes of this Convention, the term "resident of a Contracting State" means any person 

who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place 

of registration, place of management or any other criterion of a similar nature. But this term does 

not include any person who is liable to tax in that State in respect only of income from sources in 

that State or capital situated therein. 

With regard to dividends, article 10, first paragraph, of the tax treaty between Norway and Russia 

follows the OECD model convention, stating: “Dividends paid by a company which is a resident of a 

Contracting State to a resident of the other Contracting State may be taxed in that other State.” 16

The second paragraph differs from the OECD Model Convention and states that dividends may 

also be taxed in the Contracting State where the company paying the dividends is a resident, according to 

the laws of that State, but if the recipient is the beneficial owner of the dividends, the tax shall not exceed 

10 percent of the gross amount of the dividends.17

Interest arising in a Contracting State that is paid to a resident of the other State may be taxed in 

that other State.18 This is the same rule as in the OECD Model Convention. The second paragraph of 

article 11 differs, and in the Norway-Russia tax treaty it states: 

However, such interest may also be taxed in the Contracting State in which it arises and according 

to the laws of that State, but if the recipient is the beneficial owner of the interest the tax so 

charged shall not exceed 10 per cent of the gross amount of the interest. 

The third paragraph of article 11 contains a provision which exempts interest from tax in cases 

where the interest is beneficially owned by the Norwegian or Russian state, a regional or local authority 

thereof, or by an instrumentality of Norway or Russia which is not subject to tax within the state. The 

paragraph states: 

Notwithstanding the provisions of paragraph 2, interest shall be exempt from tax in the 

Contracting State in which it arises if: 

a) the interest is beneficially owned by a Contracting State, a regional or local authority thereof or 

by an instrumentality of that State which is not subject to tax therein; 

b) the interest is beneficially owned by: the Central Bank of Norway, the Norwegian Guarantee 

Institute for Export Credits, A/S Eksportfinans; the Central Bank of Russia, Foreign Trade Bank 

of Russia; or any other institution similar to the above-mentioned institutions, as may be agreed 

from time to time between the competent authorities of the Contracting States; 

 2001, available at http://www.regjeringen.no/en/dep/fin/Selected-topics/Taxes-and-Duties/skatteavtaler/Skatteatale-NorgeRussland-vedlegg2.html?id=107028. 

14 Id., art. 3, point d. 

15 Articles of the Model Convention with Respect to Taxes on Income and on Captial, OECD, July 15, 2005, available 

at http://www.oecd.org/dataoecd/50/49/35363840.pdf. 

16 Convention between The Kingdom of Norway and The Russian Federation for the Avoidance of Double Taxation 

and the Prevention of Fiscal Evasion with Respect to Taxes and Income on Capital, art. 10, Ministry of Finance Web site, May 

17, 2001, available at http://www.regjeringen.no/en/dep/fin/Selected-topics/Taxes-and-Duties/skatteavtaler/Skatteatale-NorgeRussland-vedlegg2.html?id=107028. 

17 Id.

18 Id., art. 11. 

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Norway: Taxation – May 2008 The Law Library of Congress - 4 

c) the interest is paid by a purchaser to a seller in connection with a commercial credit resulting 

from deferred payments for goods, merchandise, equipment or services. 19

The general rule for capital gains is the same in the tax treaty between Norway and Russia as in 

the OECD model convention and states that “gains derived by a resident of a Contracting State from the 

alienation of immovable property referred to in Article 6 and situated in the other Contracting State may 

be taxed in that other State.”20 Paragraph 5 of article 13 of the tax treaty between Norway and Russia 

differs from the OECD Model Convention and regulates gains derived from the alienation of shares and 

other corporate rights. It states: 

Gains derived by an individual of a Contracting State from the alienation of shares or the other 

corporate rights in an entity which is a resident of the other Contracting State, and gains from the 

alienation of any other security which are subjected in that other State to the same taxation 

treatment as gains from the alienation of such shares or other rights may be taxed in that other 

Contracting State, but only if: 

a) the alienator has been a resident of that other Contracting State at any time during the five years 

immediately preceding the alienation of the shares, rights or security; and 

b) the alienator was the beneficial owner of the abovementioned shares or rights while a resident 

of that other State.21

V. Other Information 

Norway is unique among the Nordic countries because of its substantial oil revenues. The 

Government Pension Fund was established in 2006 and consists of two funds: the “Government Pension 

Fund – Global,” which was formerly called the Government Petroleum Fund, and the “Government 

Pension Fund – Norway,” which was formerly the National Insurance Scheme Fund.22 

The Government Petroleum Fund was established in 1990 as a fiscal tool to manage national 

petroleum revenues. The Fund was renamed in 2006 as part of a broader national pension reform, 

designed to facilitate government savings to meet the rapidly raising needs of public pension 

expenditure.23 In 2007, the size of the Government Pension Fund – Global was about US$373 billion.24 

The Norwegian Ministry of Finance is responsible for the management of the Government Pension Fund. 

It is the Norwegian Central Bank, Norges Bank, that invests the Government Pension Fund – Global’s 

capital abroad in bonds and equities, in accordance with guidelines issued by the Norwegian Ministry of 

Finance.25

Prepared by Linda Forslund 

Contract Foreign Law Specialist 

May 2008 

 19 Id. 

20 Id., art. 13. 

21 Id.

22 Ministry of Finance, The Government Pension Fund, http://www.regjeringen.no/en/dep/fin/TheMinistry/Underliggende-etater/The-Government-Pension-Fund-.html?id=270410 (last visited May 5, 2008). For information on 

the Government Pension Fund, please visit the Norwegian Ministry of Finance official Web site at http://www.regjeringen. 

no/en/dep/fin/Selected-topics/The-Government-Pension-Fund.html?id=1441. 

23 Ministry of Finance, The Government Pension Fund –Global, Fact Sheet, Apr. 2008, available at

http://www.regjeringen.no/upload/FIN/Statens%20pensjonsfond/summary-apr08.pdf (official Web site of the Ministry of 

Finance). 

24 Id.

25 The Government Pension Fund, supra note 22. 

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2008–00763 

LAW LIBRARY OF CONGRESS 

POLAND 

TAXATION OF PASSIVE INCOME EARNED BY FOREIGN GOVERNMENTS AND 

SOVEREIGN WEALTH FUNDS 

Executive Summary 

Polish tax legislation is based on principles of limited and unlimited tax liability 

and does not exempt entities established and/or owned by foreign governments from 

taxation. There is no special tax regime for foreign direct investments either. All income 

originated in Poland is subject to a flat-rate 19 percent corporate income tax. Taxation 

of dividends may vary depending on provisions of a bilateral tax treaty.

I. Tax Status of Foreign Governments 

Legislation of Poland does not provide for a special tax regime in regard to foreign direct 

investments, including those conducted by a foreign government. Mechanisms of investment, the status 

of investors, and guarantees provided to investors by the Government of Poland are established by a 

number of legislative acts, including the Law on Investment Funds1

 and the Law on Securities.2 These 

documents emphasize the equality of all forms of investment in Poland and expand the domestic regime 

to all foreign investors, including foreign governments. No special permits are required to conduct 

investment activities in Poland, except in a few special sectors. Rules on minimum capital contributions 

by foreign investors and minimum share requirements, which were previously in force, were abolished by 

present legislation. The repatriation or reinvestment of dividends received from investment activities in 

Poland can be conducted without restrictions regardless of the source of the company’s revenue or its 

origin, and is subject to regular taxation. There is no controlled foreign corporation legislation in Poland 

as well as other laws that would address foreign government investment entities. Dividends received by 

foreign governments can be taxed under domestic law, and according to the provisions established by 

bilateral treaties. Depending on the terms of a treaty, Polish law expands the definition of foreign 

government institutions to Central banks, public state organizations, municipal authorities, certain 

government agencies, pension funds, and investment funds. 

II. Tax Status of Sovereign Wealth Funds

Basic principles of the taxation legislation are determined by the Tax Ordinance Act, 

which entered into force on July 1, 2007.3

 Provisions of the Act regarding the equal status of all 

taxpayers in the country (art.3) and principles of limited and unlimited tax liability were 

confirmed and explained by the Minister of Finance in his letter of April 12, 2005.4

 The letter 

established that all companies with their seats or management on the territory of Poland are 

liable for tax on the whole of their income regardless of the location of its sources. Taxpayers 

with no seat or management in the territory of Poland are liable for tax on income earned only in 

the territory of Poland. There is no special tax regime regarding Sovereign Wealth Funds, and 

therefore there is no provision in Polish tax legislation that would grant tax exemption to them. 

The existing legislation exempts from taxation foreign investment companies, which operate in 

 

1

 DZIENNIK USTAW RZECZYPOSPOLITEJ POLSKIEJ (Journal of Laws of the Republic of Poland (official gazette), hereinafter DZ. U.) 

2004, No. 146, Item 1546. 

2

 Dz.U.2002, No. 41, Item 363. 3

 Dz.U.2005, No. 8, Item 60. 4

 Dz.U.2005, No. 36, Item 1521. 

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Poland: Taxation – May 2008 The Law Library of Congress - 2

special economic zones, and this exemption applies to all types of investment funds. The Income 

Tax Treaty concluded between the United States and Poland on October 8, 1974,5

 is also based on the 

principle that a resident of one state may be taxed by another state on any income from sources within this 

state. It appears that the only exemptions provided are for foreign shareholders from the European Union 

Member States in regard to taxation of dividends paid by Polish companies. 

III. Domestic law

The Polish law provides for a flat-rate 19 percent corporate income tax, which is applicable to all 

resident and non-resident business income except exempt income or where different tax rates apply. 

Capital gains, interest, royalties, and other forms of income are included in the taxable income base. 

Dividends are subject to withholding 19 percent tax, which may be reduced by relevant provisions of a 

tax treaty if the recipient is a non-resident.

IV. Treaties on Double Taxation 

Within the scope of this request, Poland has concluded treaties on avoidance of double taxation 

with China, Kuwait, Russia, and Singapore. All of them establish special rates for taxing dividends paid 

to a foreign company by a Polish resident company. In regard to the withholding tax rates that are 

applicable to dividends paid to non-residents under the tax treaties, these rates are 10 percent for China, 

Russia, and Singapore, and 5 percent for non-government Kuwaiti companies. Kuwait is the only country 

in this group whose government is exempt from withholding tax on dividends. The Treaty, which entered 

into force in 1996 states (art.8) that no tax shall be paid if a dividend is paid to a company that belongs to 

the government of the other state or a company in which at least 25 percent of the capital is owned by the 

government. 

Prepared by Peter Roudik 

Senior Foreign Law Specialist 

May 2008 

 

5

 IBFD Tax Treaty Database at http://ip-online.ibfd.org/treaty/. 

A-44
2008-00763 

LAW LIBRARY OF CONGRESS 

 TAXATION OF PASSIVE INCOME EARNED BY FOREIGN GOVERNMENTS AND 

SOVEREIGN WEALTH FUNDS 

SWITZERLAND 

Executive Summary 

 Swiss domestic law does not exempt foreign governments or foreign sovereign wealth 

funds from taxation on passive income earned from Swiss sources. 

 Such exemptions may occur as the result of tax treaties or of the practice arising from 

these. The Swiss-Norwegian treaty on double taxation specifically exempts Norway’s government, 

central bank, and oil fund from taxation on dividends earned from Swiss companies, and this 

treaty exempts all Norwegian taxpayers from taxation on interest earned from Swiss sources. 

 Swiss domestic law imposes a 35 percent withholding tax on Swiss source interest and 

dividends, but substantial shareholders enjoy participation exemptions on their dividend income. 

Swiss domestic law imposes a federal gains tax of 8.5 percent on capital gains of portfolio 

shareholders while exempting substantial shareholders. 

 

I. Tax Status of Foreign Governments 

 Swiss domestic law does not exempt foreign governments from taxation on their passive income 

earned in Switzerland.1

 Therefore, it appears Swiss domestic law should operate to the effect that foreign 

governments and their entities are, as a rule, taxed by Switzerland on their Swiss source income from 

interest, dividends, and capital gains like other foreign corporate taxpayers. There is only one statutory 

exemption, and it provides that foreign governments are not taxed on their real estate that is used for 

diplomatic and consular purposes.2

 

 In the absence of statutory unilateral exceptions, foreign governments may nevertheless be 

exempted from taxation of their passive Swiss-source income by treaty or by the practice resulting from a 

treaty. Whereas the Vienna Conventions on Diplomatic Relations3

 and Consular Relations4 exempt 

foreign governments from taxation only for the narrow, mission-related purposes stated therein,5

 bilateral 

double taxation treaties may exempt governmental entities from taxation on various categories of passive 

income.6

 There is, however, much variance in the respective treaty provisions, as is explained below (see

section on Double Taxation Treaties). 

 1

 Information obtained from Mr. Dieter Leutwyler, Press Speaker of the Swiss Federal Finance Ministry. 

2

 Bundesgesetz über die direkte Bundessteuer [DBG], Dec. 14, 1990, as amended, SYSTEMATISCHE SAMMLUNG DES 

BUNDESRECHTS [SR] no. 642.11, art. 56 (i) (official source).

3

 Convention on Diplomatic Relations, Apr. 18, 1961, 23 UST 3227; TIAS 7502; 500 UNTS 95 (official source). 

4

 Convention on Consular Relations, Apr. 24, 1963, 21 UST 77; 596 UNTS 261 (official source). 

5

 One Swiss authority views these conventions as replacing former international customary law on governmental 

immunity from taxation. See E. BLUMENSTEIN & P. LOCHER, SYSTEM DES SCHWEIZERISCHEN STEUERRECHTS 69 (Zürich, 2002). 

6

 Id.

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Switzerland: Taxation – May 2008 The Law Library of Congress - 2 

II. Tax Status of Sovereign Wealth Funds 

 There is no domestic statutory rule exempting foreign sovereign wealth funds from taxation on 

their passive income in Switzerland. It appears, therefore, that in the absence of a tax treaty providing 

otherwise, these funds should be taxed in Switzerland. If a treaty exempts certain governmental entities 

from taxation, sovereign wealth funds may qualify for an exemption to the extent that they live up to the 

treaty criteria in terms of the nature of the fund and its relationship to government by virtue of ownership, 

management, purpose, and control.7

 

III. Domestic Law 

 In General 

Switzerland has a high level of cantonal taxation and a great degree of variance among the 

cantonal taxes.8

 Switzerland also has federal taxes, and of these, the federal withholding tax9 is the most 

relevant for passive income. It is imposed on dividend and interest income, and the revenue is shared 

with the cantons. The federal income tax,10 on the other hand, is imposed on certain capital gains. There 

are many cantonal income taxes, some of which may also tax capital gains, but these are not discussed in 

this report. 

Interest 

Non-resident taxpayers are subjected to a withholding tax of thirty-five percent on interest 

received from Swiss obligations or customer accounts of Swiss banks.11 The withholding may be 

adjusted accordingly if interest is taxed at a lower rate under an applicable double taxation treaty (see 

below, section on Double Taxation Treaties). Corporate taxpayers from member countries of the 

European Union (EU) are not taxed by Switzerland on interest earned from an affiliated Swiss company. 

This is provided in the Swiss–EU agreement adopting the EU Savings Directive.12

Dividends 

 Non-resident taxpayers are subjected to a thirty-five percent withholding tax on dividends 

received from a resident Swiss corporation.13 There are, however, the following exceptions from this tax 

rate or liability: 

• Double taxation treaties usually provide lower rates for portfolio dividends and even lesser rates 

or total exemptions for substantial holdings.14

 7

 Information obtained from Mr. Dieter Leutwyler, Press Speaker of the Swiss Federal Finance Ministry. 

8

 X. OBERSON & H. HULL, SWITZERLAND IN INTERNATIONAL TAX LAW (Amsterdam, 2006). 

9

 Bundesgesetz über die Verrechnungssteuer [VStG], Oct. 13, 1965, as amended, SR no. 642.21, available at the 

official Web site http://www.admin.ch/ch/d/sr/c642_21.html. 

10 DBG. 

11 VStG, art. 4 par. 1 & art. 13. 

12 Agreement between the European Community and the Swiss Confederation providing for measures equivalent to 

those laid down in Council Directive 2003/48/ECof 3 June 2003, on taxation of savings income in the form of interest payments, 

Oct. 26, 2004, effective July 1, 2005, SR 0641.926.81, art. 15; Oberson, supra note 8, at 303. 

13 VStG, art. 4. 

14 R. Wüthrich, Switzerland, in International Bureau of Fiscal Documentation, 2 THE TAXATION OF COMPANIES IN 

EUROPE 8.5.2. 1 (Amsterdam, 2007- ). 

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Switzerland: Taxation – May 2008 The Law Library of Congress - 3 

• According to the EU Parent-Subsidiary Directive,15 foreign corporations from European Union 

countries who own at least twenty-five percent of the stock of a Swiss company are not taxed on 

their dividend income. 

• The Swiss participation relief applies to holdings of at least twenty percent of the Swiss stockdistributing company.16 Technically, this privilege is not an exemption, but it has the same effect 

as an exemption.17 

Capital gains

 Foreign entities must pay federal gains tax on their capital gains realized from shares in Swiss 

corporations.18 The rate of the federal gains tax is 8.5 percent of the net profit,19 yet the participation 

exemption applies to substantial holdings.20 The taxable gain of all profits realized in Switzerland is 

determined according to Swiss principles of income taxation.21 

IV. Treaties on Double Taxation 

 In general 

 

 Switzerland has bilateral double taxation treaties for income with more than eighty countries,22 so 

that, in effect, the treaties are more indicative of the actual practice than the unilateral provision of Swiss 

domestic law. Although many of the newer treaties follow the OECD model treaty,23 they nevertheless 

vary significantly on the treatment of foreign governments and their entities and on the taxation of 

interest, dividends, and capital gains received by foreign creditor or shareholders from Swiss sources. 

Moreover, the wording of the treaties cannot always be regarded as conclusive for determining the actual 

practice, because the contracting states may interpret the treaty according to their mutual intentions.24

Norway 

 The double taxation treaty with Norway exempts each other’s governments from the taxation of 

source country dividends and extends that privilege also to the Swiss Central Bank, the Norwegian 

Central Bank, the Norwegian Oil Fund, and any other governmentally owned entity that is designated by 

 15 Council Directive 90/435/EEC of 23 July 1990 on the common system of taxation applicable in the case of parent 

companies and subsidiaries of different member states, 1990 OFFICIAL JOURNAL OF THE EUROPEAN COMMUNITIES (L225) 6, 

applicable between Switzerland and the EU member states on the basis of Agreement between the European Community and the 

Swiss Confederation providing for measures equivalent to those laid down in Council Directive 2003/48/ECof 3 June 2003 on 

taxation of savings income in the form of interest payments, Oct. 26, 2004, effective July 1, 2005, SR no. 0641.926.81, art. 15. 

16 DBG, art. 69. 

17 Wüthrich, supra note 14, at 7.1.3.1. 

18 DBG, art. 51, in conjunction with DBG, art. 49, par. 3; Wüthrich, supra note 14, at 4; 8.4.2.3 and 7.1.6. 

19 DBG, art. 68. 

20 DBG, art. 69. 

21 DBG, arts. 58 – 67. 

22 Wüthrich, supra note 14, at 8.5.2. 

23 Organization for Economic Co-operation and Development, Model Tax Convention on Income and on Capital 

(electronic version), Feb. 1, 2005, available by subscription from the official Web-site http://www.oecd.org/document/ 

17/0,3343,es_2649_33747_35035793_1_1_1_1,00.html;Oberson, supra note 8, at 77. 

24 Oberson, supra note 8, at 89. 

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Switzerland: Taxation – May 2008 The Law Library of Congress - 4 

agreement of the authorities of in both countries. 25 No corresponding provision exists for exempting 

interest earned by the other government and its entities, because article 11 of the treaty provides that 

interest is not taxed by the source country. 

 The general rate of the taxation of dividends in the source country is up to fifteen percent, but 

substantial holdings in a source country company are exempt from dividend taxation. The only capital 

gains from dividends that are taxed in the source country are substantial holdings owned by individual 

taxpayers. 

Kuwait 

 The double taxation treaty with Kuwait26 specifies in its article 4, paragraph 2 that the 

government of a treaty state and its subdivisions qualify as residents of the respective treaty country and 

that the same status applies to governmental institutions that have been created by a government to 

exercise public functions and that are recognized as such by mutual agreement of the competent 

authorities. The Protocol to the treaty specifies several Kuwaiti entities as falling within the scope of 

article 4, paragraph 2. Listed are: 

• the Central Bank of Kuwait; 

• Public Institution for Social Security; 

• governmental corporations; 

• government offices; 

• government agencies; 

• foundations; and 

• the Development Fund. 

According to article 11 of the treaty, the source country may tax interest of a creditor who resides 

in the other treaty country with a maximum rate of ten percent, and creditors who are foreign 

governments, their subdivisions, and agencies are tax residents within the meaning of this provision. 

Nevertheless, the actual treaty practice cannot be deduced from the treaty itself, due to discretionary 

clauses contained therein that allow for mutual understandings by the treaty countries. 

Source country dividends are taxable with a maximum of fifteen percent, but substantial holdings 

enjoy the participation exemption. Due to discretionary clauses that allow for mutually agreeable 

interpretations, the actual practice of dividend taxation cannot be cannot be ascertained from the treaty 

provisions. 

According to article 13 of the treaty, capital gains from the sale of stock are not taxed in the 

source country. 

Prepared by Edith Palmer 

Senior Foreign Law Specialist 

May 2008 

 25 Abkommen zwischen der schweizerischen Eidgenossenschaft und dem Königreich Norwegen zur Vermeidung der 

Doppelbesteuerung auf dem Gebiet der Steuern vom Einkommen und vom Vermögen, as amended, SR no. 0.672.959.811, art. 10 

(official source). 

26 Abkommen zwischen der schweizerischen Eidgenossenschaft und dem Staat Kuwait zur Vermeidung der 

Doppelbesteuerung auf dem Gebiet der Steuern vom Einkommen und vom Vermögen, Feb. 16, 1999, with Protocol, SR no. 

0.672.947.61 (official source). 

A-48
2008–00763 

LAW LIBRARY OF CONGRESS 

TAXATION OF PASSIVE INCOME EARNED BY FOREIGN GOVERNMENTS AND 

SOVEREIGN WEALTH FUNDS 

UNITED KINGDOM 

Foreign governments are not typically taxed in the UK, based upon the principle 

of sovereign immunity. The UK government has specifically noted that sovereign wealth 

funds are excluded from taxation on the basis of this principle. 

I. Tax Status of Foreign Governments 

 Foreign states are typically exempt from taxation in the UK under the longstanding principle of 

sovereign immunity, provided for by customary international law. The UK has a practice of exempting 

foreign governments from taxation on passive income based on the above principle of customary 

international law.1

 

II. Tax Status of Sovereign Wealth Funds 

 Investment in the United Kingdom through sovereign wealth funds has been actively encouraged, 

and UK Trade and Investment notes that the high profile recently garnered by these funds generates 

opportunities for inward investment.2

 

The investments of foreign states recognized by the United Kingdom are typically exempt from 

tax under the longstanding principle of sovereign immunity provided for by customary international law. 

Her Majesty’s Revenue and Customs has stated that “Income and gains arising to, and in the sole direct 

beneficial ownership of: the Head (for example a reigning Monarch or a President) of a foreign Sovereign 

independent State; the Spouse of such a Head of State; a foreign independent Sovereign Government, are 

... normally immune from taxation.”3

 This immunity only extends to income and gains that are 

beneficially owned by the foreign state and not to entities that are separate from the government, even 

though these may be wholly owned through shares by the government.4

 The government has recently 

stated in Parliament that: 

Where a sovereign wealth fund is an integral part of the government of a foreign sovereign state it 

will benefit from immunity from UK tax. As a result of this immunity no taxation will have been 

received from sovereign wealth funds. The United Kingdom recognises the principle of 

international law known as sovereign immunity whereby one sovereign state does not seek to 

apply its domestic laws to another sovereign state. In accordance with this principle, current UK 

practice is to regard as immune from direct taxes all income and gains which are beneficially 

owned by the head of state and the government of a foreign sovereign state recognised by the 5 UK.

 1

 UK Trade and Investment, UK to Attract Sovereign Wealth Funds, Apr. 11, 2008, available at http://www. 

ukinvest.gov.uk/OurWorld/4019411/en-GB.html

2

 Id. 

3

 HM Revenue and Customs, INTM155010 - Sovereign and Crown Immunity, http://www.hmrc.gov.uk/manuals/ 

intmanual/INTM155010.htm (last visited Apr. 17, 2008). 

4

 Id. 

5

 28 Apr. PARL. DEB., H.C. (6th ser.) (2008) 144W. 

A-49
UK: Taxation – May 2008 The Law Library of Congress - 2 

III. Domestic Law 

nterest 

from bank 

deposits may be paid without this tax if a declaration of non-residence is filed with the bank.7

 

ividends 

here is no tax on dividends that are paid in the UK to a non-resident.8

 

apital Gains 

te tax on any capital gains that are attributable to 

 UK permanent establishment, notably those that arise 

he business in the UK increases or the assets are 

removed from the UK (s. 25(3) The CGA).11 

 

The current rate was reduced from thirty percent to twenty-eight percent in April 2008.12

 Treaties 

aties on this subject.13 The UK currently uses the OECD Model 

onvention for its tax treaties.14 

 

I

The domestic rate of taxation on the payment of interest to non-residents is the savings income 

tax rate of twenty per cent, unless these are quoted Eurobonds or short interest.6

 Interest 

D

T

C

Non-resident companies are liable to UK corpora

a

on the disposal of assets situated in the United Kingdom while the UK trade is being carried on 

and use or acquired for use in the trade carried on through the permanent establishment (s. 

11(2)(b) ICTA9

 and s 10(3) TCGA;10 [and] any unrealized capital gains on assets situated in the 

UK and used for the purpose of the trade if t

IV. Double Tax

 

The UK has concluded over 100 tax treaties on the avoidance of double taxation, and claims to 

have the largest network of tre

C

An example of the tax treatment of foreign governments is present in the double taxation treaty of 

the UK and Singapore.15 In this treaty, the government exempts interest arising in each of its states from 

6

 II THE TAXATION OF COMPANIES IN EUROPE, ¶ 8.5.1.2 (1972-). 

7

 Id. 

8

 THE TAXATION OF COMPANIES IN EUROPE, supra note 6, at II, ¶ 8.5.1.1.; HM Revenue and Customs, IR20 - Residents 

and Non-Residents: Liability to Tax in the United Kingdom, 1999, available at http://www.hmrc.gov.uk/pdfs/ ir20.htm. 

9

 Income and Corporation Taxes Act 1988, c. 1, available at http://www.opsi.gov.uk/acts/acts1988/Ukpga_1988 

0001_en_1 (official source). 

10 Taxation of Chargeable Gains Act 1992 c. 12, available at http://www.opsi.gov.uk/acts/acts1992/Ukpga_1992 

0012_en_1 (official source). 

11 THE TAXATION OF COMPANIES IN EUROPE, supra note 6, at ¶ 8.4.2.1. 

12 Finance Act 2007, c. 11, § 2, available at http://www.opsi.gov.uk/acts/acts2007/pdf/ukpga_20070011_en.pdf

(official source). 

13 UK Trade and Investment, Tax in the UK, Dec. 2007, available at http://www.ukinvest.gov.uk/UnitedKingdom/4016067/en-GB.html. 

14 THE TAXATION OF COMPANIES IN EUROPE, supra note 6, at II, ¶ 8.6.1. 

15 Agreement Between the Government of the United Kingdom of Great Britain and Northern Ireland and the 

Government of the Republic of Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with 

Respect to Taxes on Income and Capital Gains, Feb. 12, 1997, Gr. Brit.-Singapore, Gr. Brit. T.S. No. 41 (2000), (Cm. 4683), 

available at http://www.hmrc.gov.uk/international/singapore-dtc.pdf (unofficial source). 

A-50
UK: Taxation – May 2008 The Law Library of Congress - 3 

tax. The term “government” in this treaty is extended, in the case of Singapore, by the government of 

Singapo

tory body; and any institution 

wholly or mainly owned by the Government of Singapore as may be agreed from time to time 

or the UK, the term “government” in the treaty covers the Government of the United Kingdom 

of Grea

on; and any institution wholly or mainly owned by the 

overnment of the United Kingdom as may be agreed from time to time between the competent 

Under the terms of this Treaty, non-residents may be charged up to fifteen percent in taxes for 

e source country. 

 Clare Feikert 

Foreign Law Specialist 

May 2008 

 

re, to include: 

the Monetary Authority of Singapore and the Board of Commissioners of Currency; the 

Government of Singapore Investment Corporation Pte Ltd; a statu

between the competent authorities of the Contracting States.16 

F

t Britain and Northern Ireland and includes: 

the Bank of England; the United Kingdom Export Credits Guarantee Department; the 

Commonwealth Development Corporati

G

authorities of the Contracting States.17

dividends and interest in th

Prepared by

16 Id., art. 11(4). 

17 Id. 

A-51