Private ruling: Sovereign immunity
Published: June 2012
Ruling period: 1 July 2011 to 30 June 2014

Ruling: Q1: Is the Fund exempt from Australian income and withholding taxes under the international law doctrine of sovereign immunity on its interest and/or dividend income derived in Australia from passive non-commercial investments? | A1: Yes

Relevant facts and circumstances: The control of the Fund The Fund was established by a decree of the President of the Republic. The decree states that the purpose of the Fund is the accumulation and efficient management of the currency and other revenues generated from the Republic's share of the sale of natural resources as a result of the joint development of those resources with foreign companies. The revenues are to be applied for the best interests of the citizens and future generations of the Republic. The Fund is an extra-budgetary state agency that is accountable to the President of the Republic. The Fund's operations are guided by the Constitution and laws of the Republic, Presidential Decrees, Resolutions and Statutes. A Supervisory Board (Board) has general control of the accumulation and spending of the Fund's assets. The Board, which is chaired by the Prime Minister of the Republic, is composed of government ministers and representatives of public bodies, as well as other persons. Board members must by approved by the President of the Republic. The operational management of the Fund is carried out by an Executive Director who is appointed and may be dismissed by the President of the Republic. Source of the Fund's revenues The decree establishing the Fund directed it to accumulate resources generated from the following sources: · the sale of the Republic's share of natural resources; · bonus payments; · acreage fees' · rental fees for the use of state property under contracts signed with foreign companies; and · revenues generated from the activities of the Fund. Investments by the Fund The published investment policy for the Fund for the 2012 year, which was approved by the President of the Republic, is the maximisation of returns while minimising the probability of substantial losses. The current currency composition of the Fund's investment portfolio is: · 50% invested in assets denominated in X; · 40% invested in assets denominated in Y; · 5% invested in assets denominated in Z; and · 5% invested in assets denominated in other approved currencies. The investment portfolio is to be composed of the following classes of assets: · debt obligations and money market instruments - at least 85% of the portfolio; · equity - up to 5% of the portfolio; · real estate - up to 5% of the portfolio; and · gold - up to 5% of the portfolio. The Fund only undertakes portfolio investments without taking a lasting interest or management control in the invested entity. It employs a buy and hold strategy in purchasing securities with the intention of holding them to maturity or for the long term. The main source of the Fund's income is interest from fixed income securities as indicated by the proportions of the assets making up its investment portfolio set out above. When investing in equities, the Fund aims to replicate the market using the stock market index as its benchmark. It does so by purchasing equities in the same proportion as the index. Investments in Australia The Fund has already invested in Australia. These investments consist only of cash bonds issued by Australian banks and are denominated in X dollars and Y's. The Fund intends to invest also in commercial paper with a six month to one year maturity issued by several state government treasuries. If the Fund makes equity investments, these will also be passive portfolio investments. It will use investment brokers to make its investments in Australia but will not engage in any trade in securities with the intention of making speculative profits.

Relevant legislative provisions: Income Tax Assessment Act 1997 995-1(1)

Reasons for decision: Summary: Australian taxation legislation does not provide a specific exemption from income and withholding taxes for foreign governments and their agencies. However, Australia recognises the international law doctrine of sovereign immunity and will treat as exempt certain income derived by foreign governments and their agencies in Australia. That doctrine provides that any income derived in Australia by a foreign government in the performance of governmental functions is exempt from Australian tax. An activity or operation undertaken by a foreign government agency will generally be accepted as the performance of government functions where the agency is owned and controlled by the foreign government and does not engage in activities that are commercial. This is consistent with the decision in the British House of Lords in I Congreso del Partido [1981] 2 All ER 1064 where it was held that activities of a trading, commercial or other private law character were not government functions. This decision is followed in ATO Interpretative Decision ATO ID 2002/45 where the conditions that must the satisfied for the doctrine of sovereign immunity to apply to exempt interest and dividend income from Australian income and withholding taxes are set out. There are three conditions which are: · that the person making the investment (and therefore deriving the income) is a foreign government or an agency of a foreign government; · that the moneys being invested are and will remain government moneys; and · that the income is being derived from a non-commercial activity. First condition: that the person making the investment (and therefore deriving the income) is a foreign government or an agency of a foreign government The Fund itself is not a foreign government. Therefore, it is necessary to consider whether the Fund is 'an agency of a foreign government'. Subsection 995-1(1) of the Income Tax Assessment Act 1997 provides the following definition of ' foreign government agency': (a) the government of a foreign country or of part of a foreign country; or (b) an authority of the government of a foreign country; or (c) an authority of the government of part of a foreign country. For the purposes of the doctrine of sovereign immunity, an entity that is wholly owned by a foreign government is 'an authority of the government of a foreign country' where that entity is performing functions for the public advantage of the foreign country and is not a private body established for the purpose of profit making. The Fund is an extra-budgetary state agency of the Republic established by a decree of the President of the Republic and accountable to the President. Its operations are subject to presidential decrees and it is controlled by a Supervisory Board that is chaired by the Prime Minister of the Republic and whose members are subject to approval by the President. Its purpose is to generate revenues to be applied for the best interests of the citizens and future generations of the Republic. This is a function of government rather than of private profit making. Therefore, the Fund is an authority of the Republic and is considered to be 'an agency of a foreign government' within the meaning of the first condition in ATO ID 2002/45. Second condition: that the moneys being invested are and will remain government moneys The source of the funds used by the Fund in its investments is the Republic's share of the revenues generated from the exploitation of the Republic's natural resources. These funds are and will continue to be government moneys. These funds are invested to provide revenues which are to be applied to the funding and support of the functions of the government of the Republic, specifically, for the benefit of current and future citizens of the Republic. Therefore, as the funds invested by the Fund and the returns received from those investments are and remain government moneys, the second condition of ATO ID 2002/45 is satisfied. | Detailed Reasoning - Third condition: that the income is being derived from a non-commercial activity: ATO ID 2002/45 states that in determining whether an operation or activity is commercial in nature will depend on the facts of each case. By way of illustration, it states that an activity is commercial where it is concerned with the trading of goods or services, such buying, selling, bartering and transportation and also includes the carrying on of a business. It further states that income derived by a foreign government or by any body exercising governmental functions from interest bearing investments or investments in equities is generally not considered to be income from a commercial operation or activity and therefore, would be exempt from Australian tax under the doctrine of sovereign immunity. An exception to this general rule applies to investments in equities. The extent of the holding may lead to the view that the holding constitutes the carrying on of a business rather than a passive investment. The extent of the holding may lead to a conclusion that it confers some degree of managerial control or influence over the company. As a benchmark, a shareholding of 10% or less in the company would be considered to be a portfolio holding and therefore a passive investment, rather than a commercial activity. Any dividends received from such a holding would be exempt from tax. The Fund has invested and proposes to invest in Australian debt instruments and equities in accordance with its published investment policy. The Fund has already invested in cash bonds issued by Australian banks. It proposes to invest in commercial paper issued by Australian state government treasuries. It has a buy and hold strategy and will not engage in any speculative profit making trading in these securities. These are passive non-commercial investments. The Fund may also invest in Australian equities. Such investments will be made in accordance with its investment policy of making equity investments and will be passive portfolio investments. It will not engage in any speculative profit making trading in these equities. These are also passive non-commercial investments. | Detailed Reasoning - Conclusion: The three conditions set out in ATO ID 2002/45 are satisfied by the Fund. Therefore, the interest and dividend income derived by the Fund from its passive investments in Australian debt instruments and equities will be treated as exempt from Australian income and withholding taxes under the international law doctrine of sovereign immunity.

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