Private ruling: Sovereign immunity
Date of advice: 12 October 2018
Published: December 2018
Ruling period: Year ending 30 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Is Entity B immune from income tax and withholding tax under the common law doctrine of sovereign immunity on any income and capital gains derived from its AUD$X investment in less than 10% of the units on issue in Trust A? | A1: Yes

Relevant facts and circumstances: 1. Entity A is a wholly owned subsidiary of a foreign government department. The foreign government department’s objective is to outline financial policy for the State, and to manage financial affairs to achieve State social and economic development plans. 2. The foreign government department receives the revenues and funds of the State and disperses these funds to other government departments of the State as well as investing surplus funds for the benefit of the people of the State. 3. Entity A is wholly capitalised and funded by the foreign government department. The funds used for capitalisation and ongoing financing are from the general pool of government finances which are managed by the foreign government department. 4. Entity A’s management is elected by the foreign government department. 5. Entity A has a wholly owned subsidiary, Entity B. Entity B’s management is elected by Entity A. Entity B is wholly capitalised and funded by Entity A from funds allocated to Entity A by the foreign government department. 6. Entity A and B were incorporated to be corporate investment vehicles of the foreign government department to invest surplus government funds. The investment – Trust A 7. The foreign government department, through Entity B, is acquiring less than 10% of the units in Trust A, an unlisted single asset Fund. 8. Entity B expects to receive MIT fund payments and capital gains from their investment in Trust A. 9. Trust A’s Constitution states that the initial term of Trust A is X years, which can be extended by an ordinary resolution of the unitholders for a further X years. An ordinary resolution must be passed by unitholders holding at least 50% of the units on issue. The term of the Trust can be further extended by unanimous resolution. Where a unanimous resolution is not passed, the trustee may decide, in its discretion, to provide those unitholders that voted against the resolution an opportunity to exit the investment, and for the trust to continue for a further X year term. 10. Trust A’s Constitution gives unitholders holding at least 5% of the units the right to demand a poll at a unitholder meeting. 11. Unitholders can remove the trustee of Trust A if a resolution is supported by unitholders together holding 35% of all units on issue, and the resolution to remove the trustee is supported by at least 50% of all units where the right to vote was exercised. A replacement trustee must be approved by unitholders holding at least 50% of the total units on issue. 12. Trust A’s Constitution can be amended by a special resolution passed by unitholders holding at least 75% of the units on issue. 13. A Clause in Trust A’s Constitution states that the Trustee has all the powers in respect of the Trust. The Trustee has full discretion over the over the day to day management, and broader business direction and operation of Trust A. Unitholders have no right or entitlement to interfere with any rights, powers, authorities or discretions of the trustee, interfere, encumber, or force the transfer of any Trust A assets, or otherwise interfere with the trustee’s determination of any matter with respect to Trust A’s business. 14. Neither Entity B or any associates of Entity B will be represented on the board of directors of the trustee or the responsible entity of Trust A.


Reasons for decision: Summary: For Australian income tax and withholding tax purposes, it is accepted that the doctrine of sovereign immunity applies to a foreign government or an agency of a foreign government that engages in governmental functions. This approach is consistent with the British House of Lords decision in the case I Congreso del Partido [1981] 2 All ER 1064 which held that activities of a trading, commercial or other private law character were not governmental functions. When determining whether the doctrine of sovereign immunity applies to exempt Australian sourced income and gains from Australian income tax and/or withholding tax, it is necessary to establish the following: ● 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 invested are and will remain government moneys, and ● that the income or gain is being derived from a non-commercial activity. If these three conditions are satisfied, then the income or gains will not be subject to Australian income tax and/or withholding tax. | Detailed Reasoning - Condition 1 – that the person making the investment (and therefore deriving the income) is a foreign government or an agency of a foreign government: An investment undertaken by a foreign government or agency of a foreign government will generally be accepted as the performance of governmental functions provided that it is within the functions of government. The foreign government department’s objective is managing the financial affairs of the State to achieve State social and economic development plans. As part of this objective, the foreign government department manages and invests surplus funds of the State. To achieve these objectives, the foreign government department incorporates wholly owned subsidiaries including Entity A and Entity B for the purpose of investing the surplus funds of the State. The foreign government department elects the management of these entities. In view of Entity B being a wholly owned subsidiary of the foreign government department, the department’s influence over the management of Entity B, and Entity B’s purpose as a corporate investment vehicle for the department, it is considered that Entity B meets the condition that the person making the investment (and therefore deriving the income) is a foreign government or an agency of a foreign government. | Detailed Reasoning - Condition 2 – Moneys are and will remain government moneys: In line with the principle that sovereign immunity applies to foreign states performing only governmental functions, an entity claiming sovereign immunity must establish that the moneys being invested in the scheme are and will remain government moneys. Entity B was established to make and acquire investments for the foreign government department. Entity B is wholly owned, capitalised and funded by Entity A, which in turn is beneficially wholly owned, capitalised and funded by the foreign government department. The foreign government department receives the revenues and funds of the State and disperses these funds to other government departments as well as investing surplus funds for the benefit of the people of the State using its investment vehicles, including Entity A and Entity B. The moneys used for the transaction are therefore government moneys. Entity B is wholly owned by Entity A, which in turn is beneficially wholly owned by the foreign government department, which is part of the Government of the State. As such, the foreign government is the beneficial owner of all the capital invested, and all income derived from that capital by Entity B. The moneys therefore will remain government moneys. It is therefore considered that the moneys being invested by Entity B in the scheme are and will remain moneys of the foreign government. | Detailed Reasoning - Condition 3 – The income is being derived from a non-commercial transaction: When determining whether the doctrine of sovereign immunity applies to provide immunity for Australian sourced income and gains from Australian income tax and/or withholding tax, it is necessary to establish that the income or gain is being derived from a non-commercial activity. As noted in ATO Interpretive Decision ATO ID 2002/45 Withholding Tax: Sovereign Immunity (ATO ID 2002/45) whether an operation or activity is a commercial transaction will depend on the facts of each case. As a guide, a commercial transaction is generally considered to be an activity concerned with the trading of goods and services, such as buying, selling, bartering, transportation, and includes the carrying on of a business. On the other hand, income derived by a foreign government or by any other body exercising governmental functions from interest bearing investments or investments in equities is generally not considered to be income derived from a commercial operation or activity. In all circumstances, consideration will be given to factors relating to the influence or control potentially able to be exercised by the investor (or a related party/associate of the investor) in relation to the investment. This includes (but is not limited to) any potential influence or control in relation to day to day management and key business, strategy and financial decisions. The acquisition by Entity B of units in Trust A is not a commercial activity for the following reasons: ● Entity B’s unit holding in Trust A represents less than 10% of the units on issue in Trust A, and therefore less than 10% of the voting rights ● Entity B has the right to demand a poll at a unitholding. However, unitholders can only demand a poll in relation to the administrative operations of Trust A such as Constitutional changes and trustee removal, and such polls must be resolved and passed by a majority. The calling of a poll is a right of a unitholder that does not allow it to exert any additional influence over the business of the investment. It is merely a request for unitholders to consider and vote on a resolution. A resolution must be passed by 50% of unitholders. ● Entity B is not represented on the board of directors of the trustee and/or the responsible entity of Trust A ● Entity B will not be able to exert actual or potential influence over the day to day management, or broader business direction or operation of Trust A as the trustee of Trust A has full discretion over the day to day operations, business, and strategic direction of Trust A, and ● Entity B will be limited to participating in Trust A unitholder resolutions. These resolutions relate only to the appointment/removal of a trustee, the term of the investment, and changes to Trust A’s Constitution. These changes go to the very nature of the investment, and the thresholds for passing or vetoing those resolutions are set such that Entity B in exercising its voting rights cannot be said to be able to influence or potentially influence the business of Trust A. In light of the above, it is considered that the Entity B’s investment in less than 10% of the units in Trust A is non-commercial in nature. | Detailed Reasoning - Conclusion: The three conditions present in the common law doctrine of sovereign immunity have been satisfied. Entity B is immune from income and withholding tax on all income and gains derived from its investment in Trust A.