Private ruling: Sovereign Immunity
Published: November 2013
Ruling period: Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018
Date scheme commenced: 1 July 2013

Ruling: Q1: Is the non-resident entity subject to interest withholding tax under subsection 128B(2) of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of interest income derived in Australia? | A1: No.

Relevant facts and circumstances: 1. The non-resident entity is a separate entity of a foreign state. 2. A government department holds 100% of the beneficial interest in the non-resident entity as well as being the ultimate parent entity of the non-resident entity. 3. The non-resident entity was incorporated to facilitate and exercise the governmental functions of the government department. 4. The non-resident entity will invest in a portion of the debt in an Australian property development company. 5. The non-resident entity will subscribe for Notes directly issued by the issuer. 6. The non-resident entity will not be subscribing for any equity in the investment and only expects to derive interest income from the investment. 7. The government department is not to take a controlling interest in companies nor does the government department work with non-government entities as partners in business. 8. The existing portfolio of the government department currently lies with non-controlling interests in the banking, industrial oil and gas, and transportation sectors. 9. The non-resident entity has been wholly capitalised and funded by the government department. The funds used for capitalisation and ongoing financing are from the general pool of government finances which are managed by the government department. 10. The government department receives the revenues and funds of the government and disperses these funds to other governmental departments as well as investing surplus funds for the benefit of the people of the foreign state.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 128B(2)

Reasons for decision: Detailed Reasoning - Liability to interest withholding tax: A non-resident that derives interest income from a resident of Australia is liable to withholding tax under subsection 128B(2) of ITAA 1936 unless an exclusion applies. However, if the non-resident is a foreign state or a separate entity of a foreign state, then consideration needs to be given to the common law doctrine of sovereign immunity. | Detailed Reasoning - Sovereign immunity background: The Foreign States Immunities Act 1985 (Immunities Act) is an Australian Commonwealth Act which reflects a more restrictive view of the common law doctrine of sovereign immunity. It has been long-standing practice for the Australian Taxation Office (ATO) to follow the principles delineated in the Immunities Act to apply the more restrictive view of the doctrine of sovereign immunity when considering taxation matters. Pursuant to this approach, an entity claiming sovereign immunity must satisfy three conditions: 1. the entity must be a foreign state, or a separate entity of a foreign state 2. the scheme to which the claim applies must not be a commercial transaction, and 3. the monies being invested in the scheme are and will remain government monies. If these three conditions are satisfied, it has been the long-standing practice of the ATO to not impose the entity's liability to withholding tax in respect of dividend and interest income on the basis that the entity has satisfied the common law doctrine of sovereign immunity. | Detailed Reasoning - Condition 1: a 'foreign state' or 'separate entity' of a foreign state: A claim for sovereign immunity may only be made by a 'foreign state' (section 9 of the Immunities Act). A foreign state is defined in section 3 of the Immunities Act to be a country outside of Australia that is either: · an independent sovereign state, or · a separate territory (whether or not it is self-governing) that is not part of an independent sovereign state. Sovereign immunity also extends to a 'separate entity' of a foreign state pursuant to section 22 of the Immunities Act. A separate entity of a foreign state is defined in section 3 of the Immunities Act to be a natural person, body corporate or corporation sole that: · is an agency or instrumentality of the foreign state, and · is not a department or organ of the executive government of the foreign state. The Full Federal Court Decision in PT Garuda Indonesia Ltd v. Australian Competition and Consumer Commission [2011] FCAFC 52 considered when an entity may be an agency or instrumentality of the foreign state. The court decided (at paragraph 128), that the correct approach is to consider, on the whole of the evidence, whether the person is acting for, or being used by, the foreign state as its means to achieve some purpose or end of that state in the relevant circumstances. | Detailed Reasoning - Is the non-resident entity a 'foreign state' or 'separate entity' of a foreign state?: In carrying out its duties, the non-resident entity is considered to be an agency or instrumentality of a foreign state and consequently a separate entity of a foreign state. | Detailed Reasoning - Condition 2: commercial transaction: Under section 11 of the Immunities Act, a foreign state does not enjoy sovereign immunity in so far as the proceeding concerns a commercial transaction. As suggested by the High Court in the PT Garuda Case at paragraph 5, the necessity for sovereign immunity to be excluded from commercial transactions came about as a result of governments increasingly becoming engaged in various commercial activities and that immunity of governments involved in commercial activities was inconsistent with international law and it was undesirable. As a result, Australia accepts that foreign states performing only governmental functions, rather than undertaking commercial transactions, may claim sovereign immunity. This approach is consistent with the decision of 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 governmental functions. Whether an operation or activity is a commercial transaction will depend on the facts of each particular case. As a guide, a commercial transaction is generally an activity concerned with the trading of goods and services, such as buying, selling, bartering and transportation, and includes the carrying on of a business. | Detailed Reasoning - Is the non-resident entity's investment a commercial transaction?: The non-resident entity's investment is not an investment made to take a controlling interest in the Australian company or to subscribe to any equity in the company. This illustrates the passive nature of the investment. Therefore, the scheme to which the non-resident entity's claim for sovereign immunity applies is not a commercial transaction. | Detailed Reasoning - Condition 3: monies are and will remain government monies: 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 monies being invested in the scheme are and will remain government monies. The monies that are invested by the non-resident entity are and will remain government monies. | Detailed Reasoning - Conclusion: Since the three conditions are satisfied, the non-resident entity's claim for sovereign immunity on its Australian investment has been established. In line with long-standing practice, the ATO will not impose liability to withholding tax in respect of the interest income received from the non-resident entity's Australian investment.

Question 1: Is the non-resident entity subject to interest withholding tax under subsection 128B(2) of the ITAA 1936 in respect of interest income derived in Australia?