ATO ID 2005/355: Withholding Tax: Exemption from interest withholding tax for a German bank undertaking central bank activities
Date of decision: 3 November 2005
Year of income: Year ended 30 June 2003
Business line: Public Groups and International

Issue
Is the taxpayer, a State owned bank in Germany, exempt from interest withholding tax for interest derived in Australia due to the application of paragraph 9 of the Protocol to the tax treaty between Australia and Germany (German Protocol)?

Decision
No. The taxpayer, a State owned bank in Germany, is not exempt from interest withholding tax for interest derived in Australia due to the application of paragraph 9 of the German Protocol.

Facts
The taxpayer, a State owned bank in Germany, intends to invest in interest bearing investments in Australia. The investments will be of an ordinary commercial nature. The bank's funds are not limited to state funds but also include funds from corporate and private clients. The bank is not the central bank of Germany but does perform some central banking activities. The remaining activities undertaken are standard commercial banking activities.

Reasons for decision
Summary: Paragraph 9 of the German Protocol provides exemptions from interest derived by the Government of Germany, another body exercising governmental functions, and by a bank performing central banking functions. Further, the interest is only exempt where it is derived by a body exercising governmental functions or by a bank performing central banking functions. 'Governmental functions' is not defined in the German Protocol but, as the context of this paragraph is to provide an exemption for sovereign immunity, the term 'governmental functions' must be interpreted to reflect this intention. In interpreting what activities are entitled to this immunity, there is general acceptance that a state is not entitled to claim immunity with respect to trading or commercial activities ( Reid v. Republic of Nauru [1993] 1 VR 251). Consequently, an activity will not be considered to be a governmental function where it is of a commercial nature. Notwithstanding that the bank may undertake other governmental functions, where the activity that generates the interest is a commercial activity, the exemption under the German Protocol will not be available. When determining whether a particular activity constitutes the exercise of governmental functions, it is necessary to examine the nature of the activity conducted by the foreign government or its instrumentality. Whether an operation or activity is commercial in nature will depend on the facts of each particular case. The taxpayer is engaged in commercial activities and interest derived from those commercial activities would not be considered to be derived in exercising government functions. The term, 'central banking functions', is also not defined within the German Protocol. The context of this term is explained in the Explanatory Memorandum. It states that the purpose of the exemption is to exempt interest received by its central bank. As the State bank is not the central bank of Germany the interest is not exempt. Therefore, the taxpayer is not exempt from interest withholding tax for interest derived in Australia due to the application of paragraph 9 of the German Protocol.

Legislative references: International Tax Agreements Act 1953 Schedule 9 paragraph 9
Case references: Reid v. Rebublic of Nauru [1993] 1 VR 251
Related ATO interpretative decisions: ATO ID 2002/45
Subject references: Germany International tax Non resident interest withholding tax Tax Treaties