Addressing foreign influence – Draft ATO ruling on the limited tax exemptions for foreign pension funds and sovereign entities

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This article was written by Kai-Chen Lamb, Sylvester Urban and Jeremy Tan

On 4 December 2019, the Commissioner of Taxation (Commissioner) released a draft law companion ruling, LCR 2019/D4 (Draft Ruling), which clarifies his view on the "influence" test under the new limitations that have been imposed on the tax exemptions for foreign pension funds and sovereign entities. 

These exemptions form part of the suite of reforms that were passed by Parliament in April 2019, under the somewhat descriptively named Treasury Laws Amendment (Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Act 2019 (Cth) (Act).

Perhaps unsurprisingly, the Commissioner proposes to take a very broad view of what constitutes the influence which would prevent these exemptions from being available.  For example, based on the views expressed by the Commissioner in the Draft Ruling, the Commissioner considers that the requisite degree of influence may exist where the relevant foreign investor is:

  • merely provided with information rights or has non-binding advisory arrangements with the relevant Australian investment vehicle; or
  • part of an investor group which is managed by the same investment manager who is given a degree of influence over the investment vehicle on behalf of the group of investors it represents (some of which may not include foreign pension or sovereign funds). 

On that basis, the Draft Ruling is relevant not only to the foreign pension and sovereign wealth funds to which it directly applies, but also to any other Australian or foreign investors who may be investing alongside such funds.  These investors should be aware of the breadth of the ATO's interpretation of this influence based test, as these considerations are likely to factor into the particular structures which foreign sovereign or pension funds will be seeking to implement.

The Commissioner's formulation of the second sub-test for influence applies, to a significant extent, the principles outlined by the Full Federal Court in Commissioner of Taxation v BHP Billiton Limited [2019] FCAFC 4 (BHP), which concerned a different statutory context, being the meaning of "sufficiently influenced" in the context of the definition of an "associate" for tax purposes.  In this context, the timing of the Commissioner's Draft Ruling is interesting given that these issues are currently the subject of further consideration in the forthcoming decision in the High Court appeal.

The Draft Ruling also provides specific guidance relating to certain aspects of the sovereign entity exemption.


Schedules 3 and 4 to the Act:

  • introduce limitations to the withholding tax exemption for superannuation funds for foreign residents (SFFR); and
  • codify and restrict the previous administrative practice on sovereign immunity from Australian tax. 

A key requirement under both exemptions is that the SFFR or sovereign entity must not, at the time the income was derived, have "influence" of a particular kind in relation to the Australian entity it invests in.

The influence test: Capacity to determine the identity of decision makers

An SFFR or a sovereign entity will fail the influence test if it is able to determine the identity of one or more persons who, individually or together with others, make (or might reasonably be expected to make) the decisions that comprise the control of and direction of the test entity's operations.

The test is a question of fact and the ruling makes clear that the Commissioner has taken a broad view of this test.  In particular, based on the Commissioner's views:

  • the test is not limited to situations where the entity has already determined, or intends to determine, the identity of one of the relevant decision makers;
  • indirect capacity to determine the identity of one of the relevant decision makers can exist where the entity wholly owns another entity that has direct capacity to do so; and
  • the decision makers can include a member of an advisory or investment committee which approves decisions in relation to the control and direction of the company (drawing on the principles relevant to the central management and control test dealt with in Taxation Ruling 2018/5).

However, the Commissioner accepts in the Draft Ruling that the requisite influence will not exist if the foreign entity has irrevocably and unconditionally waived any relevant rights by way of a legally enforceable agreement.

The influence test: Capacity to influence decision makers

The influence test will also be failed if at least one of the relevant decision makers is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of the relevant entity.  This is known as the second sub-test of the influence test.

In the Commissioner's view, this is not a composite test, but it gives rise to three independent tests based on the words "accustomed", "obliged" and "might reasonably be expected":

  • accustomed: requires analysis of the past facts and examining any discernible pattern of the person following the directions, instructions or wishes given by the relevant entity.
  • obliged: depends upon a formal or informal obligation existing at the relevant time.  The inclusion of informal arrangements is interesting, as it is not expressly set out in the legislation (cf the test of "sufficient influence" under review in the BHP case), and has the capacity to make the test very broad.
  • might reasonably be expected: requires a prediction as to future events and a consideration as to the objective likelihood of those future events occurring.  All facts and circumstances impacting upon the relationship between the two parties will be relevant.  This aspect makes it very important that entities relying on the exemption have regard to all of their dealings with the relevant Australian entity, and their dealings with co-investors (through a common investment manager or otherwise), with whom the entity may act "in concert".  Special rights to receive information and provide advice or directions to the Australian investing entity, either directly or indirectly, and whether binding or not could also indicate that the requisite influence exists.

The Commissioner does not view the test as requiring "control".

More generally, in the Draft Ruling, the Commissioner is of the view that it is not necessary that the directions, instructions or wishes of the relevant foreign sovereign or pension fund caused the Australian investment vehicle to act in the relevant way.  Based on the Commissioner's views, it is sufficient if it is likely that the Australian investment vehicle would act in a way that is consistent with those directions, instructions or wishes.

That said, it is unclear from the Commissioner's views in the ruling what level of influence or causation is required.  For example, while the Commissioner states in the Draft Ruling that it requires more than mere coincidence, but does not require control, the Commissioner does not state what degree of influence is actually required.

Impact of the High Court appeal from BHP

Interestingly, the Draft Ruling touches upon the interpretation of certain concepts that are also the subject of the BHP appeal before the High Court of Australia (which is awaiting judgment).  The Full Federal Court (Court) had considered one of the tests of "associate" under the tax legislation.  That required consideration of whether an entity was "sufficiently influenced" by another entity.  The definition of "sufficiently influenced" broadly includes similar concepts as contained in the second sub-test of influence.

In finding that "sufficient influence" existed, the Court held that the test was satisfied where there is something less than legal control and that the test did not require some form of subservience.

Many of the principles contained in the Draft Ruling reflect the majority's view of the "sufficient influence" test.  In particular, Thawley J's views on the phrase "are accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with…" contained at paragraph 85 of the judgement are almost identically reflected by the Commissioner at paragraph 29 of the draft LCR. 

The Commissioner's interpretation of the phrase "in accordance with", as "harmonious correspondence, agreement or conformity with" reflects the reasoning at paragraph 13 of Allsop CJ's judgement.

Although BHP considered a different statutory context, it is clear that the Commissioner views that the same broad principles should apply.  Therefore, the decision of the High Court, once handed down, may have an impact on the Commissioner's view of the second sub-test of influence.

Guidance on other matters

The draft LCR also provides helpful guidance in relation to the following concepts in the new sovereign entity rules:

  • returns on investment;
  • public monies;
  • public non-financial entity;
  • public financial entity;
  • when activities will be solely central banking activities; and
  • what constitutes consular functions.

Please contact a member of the KWM tax team if you would like more details regarding these aspects of the Draft Ruling, or any of the other issues raised in the Draft Ruling.

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