6 December 2019
On 4 December 2019 the ATO released LCR 2019/D4, its draft ruling on the significant changes to sovereign immunity and the withholding tax exemption for superannuation funds for foreign residents, which were introduced together with the stapled structure integrity rules earlier this year.
The key change is that neither sovereign immunity nor the foreign pension fund exemption is now available where the relevant entity (or the relevant government):
- has a 10% or greater stake in; or
- has certain influence / control rights in respect of,
the entity paying the relevant distribution. Our 30 July 2018 Tax Brief explains the changes in more detail.
The draft ruling addresses two main topics: the influence / control test common to both exemptions and qualifying as a ‘covered sovereign entity’, the latter being a threshold requirement for a sovereign entity to be entitled to sovereign immunity. It does not address the complex transitional rules.
Influence / control test
The influence / control test is failed if:
- the relevant entity (foreign pension fund or sovereign entity group) can (directly, indirectly or in concert with others) determine the identity of at least one of the persons who make the decisions that comprise control and direction of the test entity’s operations; or
- at least one of those persons is accustomed or obliged, or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the relevant entity.
The ATO acknowledges that it will generally be the Board of a company that makes decisions comprising control and direction of a company’s operations, so the test is primarily focussed on director appointment rights. However, the draft ruling also includes a number of examples in which the influence / control test is failed because a relevant entity can appoint a member of an Investor Advisory Committee (IAC).
The examples assume that either IAC approval is required for ‘control and direction’ matters, or that the Board has habitually followed IAC recommendations in respect of such matters. These assumptions do not hold true for many (and perhaps most) IACs which serve a limited function aimed mostly at investor protection. It will be interesting to see whether in practice the ATO considers the functions of IACs on a case-by-case basis, or whether IAC representation rights will be seen as a bar to accessing these exemptions.
Unfortunately, the draft ruling does not address which matters go to the ‘control and direction’ of a company other than by stating that it “is the making of high-level decisions that set the company’s general policies, and determine the direction of its operations and the type of transactions it will enter” and providing that “this could include setting the investment or operational policy appointing key management personnel, matters of finance or entering into of key business contracts”. This may make it difficult to determine when having IAC representation may preclude relief in any event.
In relation to the ‘acting in concert’ element of the test, the draft ruling states that ‘there must be some form of arrangement or understanding, whether explicit or otherwise, under which [parties] are acting (or have agreed to act) in pursuing a common objective’ for the parties to be acting in concert. This should mean that two unrelated investors who have appointed the same manager under individual mandates should not be acting in concert merely because the common manager manages investments of a sufficient size to give it director / IAC appointment rights, but Example 2 in the draft ruling shows that care will be needed in these scenarios. Indeed, Example 2 states that aggregation for the purposes of the influence test will apply where the same manager has entered into agreements with both entities which govern how the manager will appoint the IAC member.
Usefully, the draft ruling states that “the relevant entity will not be able to determine (the identity of a decision maker), as a matter of fact, where it has irrevocably and unconditionally waived its rights by way of a legally enforceable agreement”.
Covered sovereign entity
A key legislative requirement to qualify as a covered sovereign entity is that the entity must be funded solely by public monies. The draft ruling states that public monies means monies of a foreign government held for a public purpose and accounted for in a manner consistent with Australia’s Consolidated Revenue Fund – this means that foreign government pension funds, including defined benefit pension funds – cannot qualify for sovereign immunity on the ATO view.
More controversially, the draft ruling provides that a sovereign entity will not be funded solely by public monies (and therefore cannot qualify for sovereign immunity) if it obtains any third party debt funding. It is somewhat difficult to reconcile this position with the fact that many governments (Australia included) have substantial (or at least some) debt balances.