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Sovereign Wealth Funds and the Principle of State Immunity from Taxation. Which Implications for Economic Development?

Article by Michele Barbieri, 2010

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Taxes levied by host States on transnational investments undertaken in their territory by Sovereign Wealth Funds (SWFs) owned by other countries have a relevant impact on the financial performance of SWFs and, finally, on the amount of wealth available to the States owning SWFs. As most owners of SWFs are developing countries and economies in transition and as SWFs are tools such States can use to promote sustainable economic development, the taxation of SWFs by host countries often has an impact on the developmental policies of the States which own SWFs. Starting from the analysis of the principle of State immunity, the paper will try to elaborate a theory on the taxation of SWFs which at the same time takes into consideration the role that SWFs play in the promotion of economic development.

1


SOVEREIGN WEALTH FUNDS AND THE PRINCIPLE OF


STATE IMMUNITY FROM TAXATION. WHICH


IMPLICATIONS FOR ECONOMIC DEVELOPMENT?




Author: Michele Barbieri
1




Keywords: State immunity; taxation; Sovereign Wealth Funds; transnational investments; economic


development.




Abstract: Taxes levied by host States on transnational investments undertaken in their territory by


Sovereign Wealth Funds (SWFs) owned by other countries have a relevant impact on the financial


performance of SWFs and, finally, on the amount of wealth available to the States owning SWFs. As


most owners of SWFs are developing countries and economies in transition and as SWFs are tools


such States can use to promote sustainable economic development, the taxation of SWFs by host


countries often has an impact on the developmental policies of the States which own SWFs. Starting


from the analysis of the principle of State immunity, the paper will try to elaborate a theory on the


taxation of SWFs which at the same time takes into consideration the role that SWFs play in the


promotion of economic development.




Contents


Introduction p. 2


1. The investments undertaken by Sovereign Wealth Funds and their tax treatment in


recipient countries p. 4


2. Immunity from taxation and its relations with the main principles of State


immunities. The distinction between acta jure imperii and acta jure gestionis p. 8


3. The applicability of the principle of restricted immunity to the taxation of SWFs p.12


4. May the creation of SWF be regarded as an act jure imperii? p.13


5. May the investments of SWFs be regarded as acts jure imperii? p.16



1
PhD candidate, Università Bocconi. Teaching and research assistant, Università degli Studi di Milano and Università


Bocconi.


The present paper can be downloaded, read and used for researches, provided citation is made. The preferred quotation


is the following one: Barbieri, Michele; SOVEREIGN WEALTH FUNDS AND THE PRINCIPLE OF STATE


IMMUNITY FROM TAXATION. WHICH IMPLICATIONS FOR ECONOMIC DEVELOPMENT?; UNCTAD-


Virtual Institute digital library; January, 2010.




2


6. Immunity from taxation granted to SWFs owned by developing countries as


a form of aid to development p.19


7. International instruments governing the operations of SWFs and their relevance


with respect to tax issues p.23


Conclusions p.27


References p.29




Introduction


Sovereign Wealth Funds (SWFs) are State-owned and State-controlled investment vehicles which


invest in foreign assets at least a part of the State-owned resources under their management
2
. In the


last few years they have increased in size (according to recent estimates the assets under their


management would amount to 3,752 billion USD
3
) and they have massively invested in foreign


assets, in particular in sovereign and corporate bonds as well as in equity. In the present economic


crisis many of them have reported severe losses and some SWFs are re-considering the investment


strategies they have pursued so far
4
. Nevertheless, before the inception of the crisis, SWFs have


obtained returns on their portfolio investments overseas and such a situation is expected to occur


again as soon as the current turmoil in financial markets comes to an end. Therefore, the issue


whether SWFs should pay taxes on income earned from their investments overseas remains


important under the point of view of recipient and home States both
5
.


From the point of view of recipient countries, granting immunity from taxation to SWFs and not to


any other non-State investor could result into a discrimination of the latter and into an unreasonable



2
This is a concise definition I elaborated. See: Jen, Stephen; The Definition of a Sovereign Wealth Fund; Morgan


Stanley; 2007; Kern, Steffen; Sovereign Wealth funds; State investments on the rise; Deutsche Bank Research; 2007; p


2; Das, Dilip K.; Sovereign-Wealth Funds: Assuaging the Exaggerated Anguish about the New Global Financial


Players; Global Economy Journal; 2008; p.2. The definition provided by the International Working group for Sovereign


Wealth Funds, which in many respect is regarded as the official definition, reads as follows: "Sovereign wealth funds


(SWFs) are special purpose investment funds or arrangements that are owned by the general government. Created by


the general government for macroeconomic purposes, SWFs hold, manage, or administer assets to achieve financial


objectives, and employ a set of investment strategies that include investing in foreign financial assets". See:


International Working group for Sovereign Wealth Funds Generally accepted principles and practices - ―Santiago
Principles‖; IMF; 2008 p. 3
3
Data reported by Sovereign Wealth Funds Institute. http://www.swfinstitute.org/ visited on 30-12-2009.


Other studies suggest different figures (ranging from 2 trillion USD to 4 trillion USD) . The exact size of SWFs is


unknown, among other things because in many cases data available are provided spontaneously by the SWFs


themselves and, when they decide not to disclose such information, data are based on unreliable estimates. Moreover,


the value of assets held by SWFs can change, in particular in the current period of high volatility of financial markets.
4
Miracky, William; Bortolotti, Bernardo, ed.; Weathering the Storm: Sovereign Wealth Funds in the global economic


crisis of 2008; FEEM; 2009; p. 53-58.
5
In the present paper the expressions: "home State", "owner of SWF" and "State owning SWFs" can be used


interchangeably, given the particular nature of SWFs as State-owned entities. Clearly, in case of non-State investment


funds, like mutual funds, hedge funds and private equity funds, the owner of the fund and the home States clearly are


different entities.




3


advantage to the SWFs. This would risk to distort competition, prevent an efficient allocation of


resources and finally to damage the economies of the recipient countries
6
.


From the point of view of home countries, which are the countries owning SWFs, exemption from


source taxation in host States in principle entails relevant benefits, as a bigger share of the returns


generated by the investments of SWFs should be available for the States which own SWFs. This


would be of the utmost importance in developing countries which own SWFs and especially when


such SWFs constitute a fundamental tool to stabilize and diversify the economy, reduce the


dependency on the exploitation of natural resources, improve the management of foreign exchange


reserves and, finally, contribute to the economic development. Likewise, the same fact that SWFs


could be considered as performing a fundamental or even a vital function in the economy of the


home State may constitute a further element supporting the argument that SWFs should be exempt


from source taxation on their investment overseas. The present paper will focus on the issue of the


immunity from taxation of the investments of SWFs from the point of view of home countries, and


especially of those which can be classified as developing economies or economies in transition. It


will also discuss the extent to which the role SWFs may play with respect to the promotion of the


economic development of home States can be regarded as a valuable reason to recognize immunity


from taxation to such SWFs.


When discussing the reasons supporting or opposing the SWFs exemption from taxation, two main


arguments emerge. On one side, it could be argued that SWFs are State entities and immunity of


States (and, to a certain extent, of State entities and instrumentalities) from the jurisdiction of other


States is regarded as a principle of public international law. Therefore, SWFs should not be subject


to the jurisdiction and also to the taxation of other States, consistently with the maxim "par in


parem non habet jurisdictionem". On the other side, it could be held that, as SWFs undertake


commercial activities in a way similar to any other investor, they should be subject to the same


treatment to which any other investor is subject, also with respect to taxation.


In an attempt to address this issue, the present paper will first outline the current situation of SWFs


owned by developing countries and economies in transition and of their foreign investments. It will


also briefly review the tax policies that the main recipients of SWFs investments adopt with respect


to them. Then the paper will try to develop a theory of taxing Sovereign Wealth Funds. It will start


with the analysis of the issue of the immunity of States and of State agencies and instrumentalities.


It will discuss whether the principles developed in the field of immunity from adjudication and from


enforcement might apply to immunity from taxation as well. It will explain the development of the



6
Fleischer; Victor; A Theory of Taxing Sovereign Wealth; New York University Law Review; 2009; p. 468-476;


Desai, Mihir and Dharmapala, Dhammika; Taxing the Bandit Kings; Yale Law Journal Pocket Part, Vol. 118, 2008; p.


2.




4


law of State immunity and of its sources, highlighting the distinction which is currently drawn


between the public activities of a State (acta jure imperii) and the State activities which do not


entail the exercise of sovereign powers and which can be assimilated to commercial activities which


can be performed by non-State actors too (acta jure gestionis). It will study which of them enjoy


immunity from foreign jurisdiction and from taxation. Then it will discuss in which of the above


mentioned categories of State acts the creation of SWFs and their investment activity can fall and


this will make it possible to understand whether SWFs should be entitled to immunity from


taxation. The paper will also study whether SWFs could be exempted from taxation on grounds


other than the principle of State immunity. In particular it will be investigated whether, to the extent


SWFs play an essential role in promoting development, tax exemption for their operations could be


devised as a form of aid to development granted by the recipient States to the States which own


SWFs (at least when the latter are developing countries). The last chapter of the paper will review


the main instruments adopted by the International Community with the aim to governing the


operations of SWFs and the policies of recipient States adopted in relation to the investments


undertaken by such State-owned entities. An attempt will be made to underline their relevance with


respect to the tax treatment of SWFs and their potential role in enhancing the application of the


theory on the taxation of SWFs elaborated in the present paper.




1. The investments undertaken by Sovereign Wealth Funds and their tax


treatment in recipient countries


A SWF is created with the aim to invest State-owned wealth. In particular its establishment is a


consequence of windfall revenues a State experiences as a result of the sale of its natural resources


in a period in which commodity prices are especially high (this is the case of commodity SWFs), or


as a result of sustained and prolonged surpluses of the balance of payments which allow it to hoard


relevant amounts of foreign currency (in the case of non-commodity or forex -foreign exchange-


funds). A part of such State-owned wealth is not immediately consumed or invested in the domestic


economy, also because the economy might be unable to absorb it immediately and entirely without


the risk of waste, inefficient allocation of resources and macroeconomic backlashes like a rise of the


inflation. On the contrary, wealth "in excess" is transferred to a SWF, which will invest it also


overseas. The returns on such investments would be later available to the State owning the SWF, for


future investments also in the domestic economy or future consumption or for macroeconomic


stabilization purposes. For this reason SWFs play an important role in promoting sustainable




5


economic development in States establishing and owning them
7
. Although SWFs are owned by


developed countries too (for instance Norway, Ireland, Australia, some States of the US and


Canada) many of them are established by developing countries and economies in transition, which


are particularly dependent on the revenues from the exploitation of natural resources and/or which


are especially vulnerable to sharp and destabilizing inflows and outflows of foreign currency.


Therefore, especially in the case of developing countries and economies in transition, SWFs


constitute a fundamental tool in the hands of State authorities in the pursuit of domestic


developmental goals. The investments and the performance of SWFs are deeply intertwined with


the economic development policies of the States establishing them. Therefore, source taxes levied


by recipient States on the operations of SWFs owned by other States, as they can affect the


performance and finally the amount of wealth under the management of SWFs, have a relevant


impact on the economic development of the States owning SWFs.


As anticipated above, many SWFs are owned by developing countries and economies in transition.


Amongst the biggest SWFs, two of them are owned by China: they are the SAFE Investment


Company and the China Investment Corporation and they are reported to have assets under their


management amounting to USD 347.1 billion (bn.) and USD 288.8 bn. respectively. In Africa the


Libyan Investment Authority owns assets worth USD 70 bn., the Algeria Revenue Regulation Fund


USD 47 bn., the Nigeria Excess Crude Account USD 9.4 bn. and in 1996 the small State of


Botswana has created through the exploitation of diamonds, on which it is almost entirely


dependent, the Pula Fund, which owns assets worth USD 6,9 bn. Several Latin American States


have established SWFs: with the purpose to stabilize domestic revenues despite the high volatility


of the international price of copper, Chile has established since 1985 its Social and Economic


Stabilization Fund which now manages assets amounting to USD 21.8 bn. and in 2000 also the


small Caribbean State of Trinidad & Tobago has used its oil revenues to establish a SWF. Brazil is


currently creating its own SWFs to which almost USD 9 bn. have already been transferred.


Among the main countries regarded as economies in transition, Russia has established the National


Welfare Fund which, together with the Oil Stabilization Fund, manages assets worth USD 178.5 bn.


Other post soviet countries rich in oil reserves, like Azerbaijan and Kazakhstan, have established


SWFs too.
8


The main recipients of the investments of SWFs have been so far developed countries; in particular


from 1995 to mid 2008, 37% of the total transaction volume of the investments of SWFs has been


related to North American enterprises and 32% to Europe-based firms (especially British ones).



7
For a more detailed explanation of the macroeconomic and developmental function of SWFs in the States owning


them, see below chapter 4, 5 and 6 of the present paper and the literature quoted in the related notes.
8
All data are provided for by Sovereign Wealth Funds Institute. http://www.swfinstitute.org/ visited on 30-12-2009.




6


This choice is largely explained by the fact that European and American capital markets


traditionally offer the widest selection of investment opportunities denominated in safe currencies


and a high level of liquidity. For this reasons they have seemed particularly able to absorb the large


volumes big institutional investors like SWFs typically seek to allocate
9
. For instance, the main


investments undertaken by China Investment Corporation in the last few years have targeted


companies in the US (with the purchase of 9,9% stake in Morgan Stanley and other relevant


participations in Visa and AES) and in Canada ( a 17,2% stake of Teck Resources Limited, active in


the mining sector)
10


. Libyan SWF has acquired stakes, inter alia in two of the biggest Italian


enterprises respectively in the oil and in the banking sector: Eni and Unicredit. Investments


undertaken by SWFs owned by Gulf States in particular in the American and European financial


and banking sectors are countless.


Because so far developed countries have been the main recipients of the investments of SWFs, for


the purposes of the analysis undertaken in the present paper it will be provided a short review only


of the tax laws applicable to the investment of SWFs in developed countries. However, it should be


remarked that in 2009 a change in the investment path of SWFs seems to have occurred, with a


reduction of foreign investments in OECD countries and an increase of domestic investments and of


investments directed to emerging markets
11


. If this trend will be confirmed, the approach followed


in this chapter, which focuses on the taxation of SWFs in developed countries only, should be


changed and tax laws of many other countries should be taken into consideration.


In the USA, SWFs’ immunity from taxation is provided for in section 892 of Foreign Sovereign


Immunities Act of 1976 (―FSIA‖).12 This situation rises acute criticism and several authors argue


that in such a way State-owned investors are given undue advantages relative to private-sector


investors, thus causing distortion to free competition
13


. In any case it cannot be concealed the


paradox that, while many policymakers and commentators emphasise the threats SWFs can pose to


national security and while they ask for tougher regulation of their operation (or even a prohibition


tout court of many investments of theirs)
14


the actual legal framework governing SWFs investment,



9
Steffen Kern; SWF’s and foreign investment policies - an update; Deutsche Bank Research; 2008; p. 8-10


10
Sovereign Wealth Funds Institute. http://www.swfinstitute.org/ page: http://www.swfinstitute.org/fund/cic.php visited


on 30-12-2009.
11


Miracky and Bortolotti; ed.; cit.; p. 14-19; Miracky William, Barbary Victoria, Fotak Veljko Bortolotti Bernardo;


Sovereign Wealth Fund Investment Behavior: Analysis of Sovereign Wealth Funds Transactions during Q2 2009;


Monitor Group and FEEM; 2009; p. 14-15.
12


Joint Committee on taxation; Economic and US income tax issues raised by Sovereign Wealth Fund investments in


the United States; 2008; available at http://www.house.gov/jct/x-49-08.pdf.; p. 56; Fleischer; cit.; p. 465-467
13


Fleischer; cit.; p. 468-472; Melone, Matthew A.; Should the United States tax Sovereign Wealth Funds?; Boston


University International Law Journal; 2008; Desai and Dharmapala; cit.; p. 2. However, other authors who do not share


such a concern: Cui, Wei; Is Section 892 the Right Place to Look for a Response to Sovereign Wealth Funds; Tax


Notes, Vol. 123, 2009; available online at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1413137##
14


For a survey of the literature analyzing both the real and exaggerated dangers posed by SWFs see: Dilip K. Das;


Sovereign-Wealth Funds: Assuaging the Exaggerated Anguish about the New Global Financial Players; Global




7


at least with respect to tax issues, is much more favourable than the one applicable to other


categories of investors.


Also in the United Kingdom a SWF is exempted from taxation on passive investment income, but


only if it is an integral part of the government of a foreign State, while the exemption is denied if it


is an entity that is separate from the Government although owned by it.
15


This causes an unjustified


discrimination between SWFs on the ground of the legal status they have in the country which owns


them and irrespective of the nature of the actual activities they perform. In fact, if a State creates a


SWF which is organised as a branch of the ministry of economy or of the central bank, its


investments in UK shall be tax exempt; nevertheless the same economic operations shall be taxed in


the UK whenever they are undertaken by a SWF which is organised as a State-owned corporation.


Many other important recipients of SWFs' investments do not follow the approach of the US and


the UK. Australia and Canada, for instance, permit commercial investments by foreign sovereigns


to be taxed: therefore SWFs should pay taxes, except when a tax treaty grants immunity from


taxation to the SWFs of the other contracting party.
16


Japanese legislation provides that foreign


government shall pay taxes on incomes earned in Japan; nevertheless a custom has developed


according to which foreign States enjoy immunity de facto. There is not a specific provision related


to SWFs in Japanese law: however SWFs are treated as any other investment fund and therefore


they are liable to pay taxes
17


.


Germany and Switzerland tax foreign governments on their passive investments in the same manner


as any other foreign corporate entity. Therefore SWFs do not enjoy immunity from taxation in these


States except otherwise provided in bilateral treaty: for instance the Swiss-Norwegian tax treaty



Economy Journal; 2008; Truman, Edwin; A Blueprint for Sovereign Wealth Fund Best Practices; Peterson institute for


international economics; 2008; Truman, Edwin; The Rise of Sovereign Wealth Funds: Impacts on US Foreign Policy


and Economic Interests; Peterson Institute for international economics; 2008; Truman, Edwin; Four Myths about


Sovereign Wealth Funds; Peterson Institute for international economics ; 2008; Truman, Edwin; Sovereign Wealth


Funds: New Challenges from a Changing Landscape; Peterson Institute for International Economics; 2008; Siniscalco,


Domenico; Governi alle porte. Crisi del credito e fondi sovrani; Mercato, Concorrenza Regole; 2008; p. 82 ; Steffen


Kern; Sovereign Wealth funds; State investments on the rise; cit.; p. 14; Goldstein, Andrea and Subacchi, Paola; I fondi


sovrani e gli investimenti internazionali - Salvatori o sovvertitori? In VVAA; L’Italia nell’economia internazionale.
Rapporto ICE 2007-2008; ICE; 2008; p. 62 Biard, Jean-François; Fonds souverains; Revue de Droit bancaire et


financier; 2008; Bahgat, Gawdat; Sovereign wealth funds: dangers and opportunities; International Affairs; 2008;


p.1201; Rieltveld, Malan; ed.; New perspectives in sovereign asset management; Central Banking Publication; 2008; p.


26; Audit, Mathias; is the erecting of barriers against foreign sovereign wealth funds compatible with international


investment law?; Society of international economic law; Working Paper No. 29/08; 2008; Lossani, Marco ed.;


Osservatorio Monetario 3/2008; Laboratorio di Analisi Monetaria – Università Cattolica del S. Cuore; 2008 p. 33;
Backer, Larry Catá; The Private Law of Public Law: Public Authorities as Shareholders, Golden Shares, Sovereign


Wealth Funds, and the Public Law Element in Private Choice of Law; Tulane Law review; 2008; p. 56
15


Directorate of Legal Research for International, Comparative, and Foreign Law of the US Congress; p. 49.
16


Ibid.; p. 7 and p. 26
17


Ibid.; p. 34




8


specifically exempts Norway’s government, central bank, and oil fund from taxation on dividends


earned from investments in Swiss companies.
18






2. Immunity from taxation and its relations with the main principles of State


immunities. The distinction between acta jure imperii and acta jure gestionis


From the review of the laws and practices of the main recipients of the investments of SWFs, it


emerges quite clearly that an harmonised approach with respect to the taxation of SWFs


substantially lacks, as some States apply the principle of State or Sovereign immunity, while others


tend to treat SWFs as any other investor. In the following chapters it will be studied which should


be the most correct approach, taking into account the commercial or governmental nature of the acts


through which States create SWFs and of the acts through which SWFs carry out financial


investments. The first step in this analysis shall consist in outlining the basics of the principle of


State immunity from taxation. Only later it will be possible to study the applicability of such


principle to the particular category of investors represented by SWFs. Most doctrinal studies on


State immunity have focused on immunity from adjudication (the right not to be sued before the


Courts of another State) and from enforcement (the entitlement not to have one’s properties


attached by enforcement measures adopted by another State). The present chapter will first outline


the relation between immunity from adjudication and enforcement on one side and immunity from


taxation on the other, it will assess to what extent the principles developed in the field of the former


can apply to the latter and then it will study the current sources and the content of the principle of


State immunity.


It should be preliminarily observed that the concept of immunity depends on that of jurisdiction. If


State A is entitled to affect the right of persons by legislative, judicial and administrative means,


this implies that State A has the jurisdiction to prescribe, to adjudicate and to enforce over such


persons. Immunity of State B from the jurisdiction of State A means that B shall not be judged by


the Courts of State A and shall not be affected by enforcement measures adopted by the authorities


of State A.
19


However, with respect to the jurisdiction to prescribe, it can be denied that there is


immunity. In fact, in their activities within the territory of a State, foreign States do not operate


outside the local law and immunity is therefore not from the power of the forum to prescribe, but


from the power to enforce the rules so prescribed. To exercise substantive jurisdiction over a



18


Ibid; p. 29 and p. 45.
19


ICJ: Arrest Warrant of 11 April 2000 (Democratic Republic of the Congo v. Belgium); Separate Opinion of Judge


Koroma; par. 5.; Conforti, Benedetto; Diritto internazionale; 7. ed.; Editoriale scientifica, 2006; p. 178-179




9


foreign State is not to prescribe the rule, but it consists in applying such rule, even through the use


of coercion, when necessary.
20




According to some respects, immunity from taxation would fall within the notion of immunity from


jurisdiction to prescribe, as taxing properties or income of a State located in the territory of another


State depends on the existence of a law of the latter providing for such a possibility. Nevertheless,


the power of the territorial State to levy taxes would rather relate to the notion of enforcement


measures or rectius, to the sphere of the measures undertaken to ensure the application of the rules


prescribed. I will not get into this complex, doctrinal question, I would only like to stress that the


principle according to which foreign States and their properties should not be subject to taxation in


other States, lies on the same theoretical and functional basis as the principles of immunity from


adjudication and enforcement. They all draw from the principles of sovereignty, equality between


States and non-interference in the affairs of other Sovereigns, as well as from the functional need to


leave foreign States unencumbered in the pursuit of their mission. Once State A taxes the properties


of State B located in its territory, it behaves as if B was subject to it instead of being its peer; in


addition, this might affect the sovereignty of B and finally this might cause an undue interference in


the ability of B to manage its sovereign affairs, by reducing its ability to freely dispose of its


properties to this purpose.
21




The sources of public international law providing for the principle of State immunity are the


European Convention on State Immunity signed in Basle on 16 may 1972 and the United Nations


Convention on Jurisdictional Immunities of States and Their Property, adopted by the United


Nations on 2 December 2004. By January the 2nd 2010, the latter has not come into force yet,


therefore it could not be regarded as a treaty source strictu sensu, but rather as a manifestation of


the opinion juris of the international community about the issue of State immunity. Nevertheless,


these two documents do not deal with immunity from taxation: in fact the UN Convention never


mentions taxation and at art. 1 it specifies that it only applies to the ―immunity of a State and its


property from the jurisdiction of the courts of another State.‖ The European Convention, at art. 29


explicitly excludes tax issues from its scope, even when taxation is the object of a judicial


proceeding. Therefore in the analysis undertaken in this paper more attention must be paid to


another source of international law mentioned, inter alia, at art. 38 of the ICJ Statute: it is the


international custom, which rises when the members of the international community follow a


consistent practice for a relevant period of time (duiturnitas) with the convincement this is



20


Crawford, James; Execution of judgement and foreign sovereign immunity; American Journal of International Law;


1981; p. 854; Fox, Hazel; The law of state immunity; Oxford University Press; 2002; p. 19.
21


Fleischer; cit.; p .456-460; Brownlie, Ian; Principles of public international law; 6th ed.- Oxford: Oxford University


Press; 2003; p. 322; Fox; cit.; p. 30 and p. 170.; Desai and Dharmapala; cit.; p. 2; Crawford; cit.; p. 856.




10


necessary and this corresponds to a legal obligation (opinio juris sive necessitatis). State practice


which is particularly relevant under this point of view is constituted by the decisions of domestic


Courts establishing case by case whether they have jurisdiction in claims involving foreign States.


They should be analysed in conjunction with the reaction of other States to such practice, with a


focus on those States which are sued and on those States whose judges are required to enforce the


decisions adopted by foreign courts on these issues. Finally, it is possible to derive the basic


principles applicable to State immunity from a comparative survey of domestic legislation
22


. Such a


comparative study cannot be carried out in this paper; which therefore will refer to principles and


trends found out in the works of other authors.
23




Until the beginning of the 20
th


century the basic principle of public international law applicable to


State immunity was that of absolute immunity: States could never be sued before the courts of any


other State and no enforcement measure was possible against their properties. A State could waive


its immunity and subject itself to the jurisdiction of other States (and to enforcement measures too,


although it was even rarer), but only pursuant manifesting its explicit consent to such a limitation of


its own sovereignty. The principle of absolute immunity started to evolve during the first half of the


20
th


century. That age was characterised by the increase of the scope of State activities and of the


sphere of intervention of States in the economy. Most States, not only in the socialist world but also


in Europe and North America, undertook to directly manage an increasing number of activities


which were no more strictly related to their sovereign powers (which traditionally were, for


instance, diplomacy, war, fiscal issues) but which rather had a commercial character. This involved


problems in particular when such commercial activities were performed abroad or when they


entailed relations with other States or with persons which were nationals of other States. For


instance the national of one State which concluded a contract with a foreign State entity on


commercial matters (suppose for the sale of goods) would have not been able to sue it if this State


entity decided not to pay him. This made it necessary to develop a restricted theory of State


immunity, which today is still prevailing in State practice. It implies that immunity applies to acta


jure imperii only, which means to public, governmental, acts that a State performs as a Sovereign,


for example those related to immigration policies, the administration of justice, the conduct of war


and diplomacy. Acta jure gestionis or acta jure privatorum, i. e. commercial acts a State performs


as a private individual, like running a commercial enterprise or entering in business relations with



22


This method is in particular recommended by: Fox.; cit.; p. 67-130
23


For a comparative study of provisions applicable to State immunity from adjudication and enforcement I especially


relied on: Fox; cit.; and Dickinson, Andrew et al.; State immunity : selected material and commentary; Oxford


University Press; 2004; Conforti; cit.; p. 178-179; Brownlie cit.; p. 322-337. For a comparative study of provisions


applicable to State immunity from taxation: Directorate of Legal Research for International, Comparative, and Foreign


Law of the US Congress; cit.




11


individuals, are not entitled to immunity anymore. The private or public character of the act of a


State determines whether it can claim immunity from jurisdiction to adjudicate. Likewise, immunity


from jurisdiction to enforce should apply only to State properties which are used to perform acta


jure imperii. In the beginning States tended to follow a mixed approach, consisting in the


application of the principle of restricted immunity from jurisdiction to adjudicate and of the


principle of absolute immunity from jurisdiction to enforce. Nevertheless, this entailed the risk to


make it useless the possibility to sue a State when there was not the possibility to force it to abide


by unfavourable judicial decisions. Today most States endorse, although with some differences, the


principle of restricted immunity with respect to adjudication and enforcement both. Also the UN


Convention on Jurisdictional Immunities of States and Their Property tends to follow this approach,


providing for the possibility, at art. 19 to waiver "State immunity from post-judgment measures of


constraint" not only when the State has previously expressed its consent to this (par. a), but also


when the property which makes the object of enforcement measures "is specifically in use or


intended for use by the State for other than government non-commercial purposes and is in the


territory of the State of the forum, provided that post-judgment measures of constraint may only be


taken against property that has a connection with the entity against which the proceeding was


directed" (par. c).
24


Some authors point out that some States still apply the absolute immunity, with


the possibility to submit foreign States to domestic jurisdiction only when consent of the latter has


been previously given. Therefore, it is better to consider the principle of the restrictive immunity as


a current trend in the practice of the majority of States instead of as a well-established rule of


customary international law.
25




It might seem unclear whether the public character of a State act or of a State property depends on


the status of the entity performing it or owning it (immunity ratione personae) or on the nature and


the purpose of the act or of the property themselves (immunity ratione materiae). Nevertheless, if it


is supported the principle of restricted immunity, then it could be argued that while it is necessary,


in order to grant immunity, that an act and a property are respectively performed and owned by a


State or a State entity, it is also necessary that such act or property are directly related to a


manifestation of the sovereign and public power of the State (immunity ratione materiae). Some



24


Donoho, Justin; Minimalist Interpretation of the Jurisdictional Immunities Convention; Chicago Journal of


International Law; 2009; p. 663; Conforti; cit.; p. 227; Fox; cit.; p. 100-120; Brownlie, cit.; p. 323-326; De Meester,


Bart; International legal aspects of Sovereign Wealth Funds: Reconciling international economic law and the law of


State Immunities with a new role of the State; European Business Law Review; 2009; p. 811-812 Blane, Alexis;


Sovereign immunity as a bar to the execution of international arbitral awards; New York University Journal of


International Law and Politics; 2009; p. 454-504; Mafi, Homayoun; Iran's Concession Agreements and the Role of the


National Iranian Oil Company: Economic Development and Sovereign Immunity; Natural Resources Journal 2008; p.


421-428; Pengelley Nicholas; Waiver of sovereign immunity from execution: arbitration is not enough; Journal of


International Arbitration; 2009; p. 59-60. Foakes, Joanne and Wilmshurst, Elizabeth; State Immunity: The United


Nations Convention and its effect; ILP BP 05/01; Chatham House; 2005
25


Brownlie, cit.; p. 325; Pengelley, cit.; p. 861-871.




12


authors have finally underlined that the public character should be assessed with respect to the


nature rather than to the purpose of the act or of the property of the State, but on this point there is


neither broad consensus nor certainty
26


.




3. The applicability of the principle of restricted immunity to the taxation of


SWFs


The principles of restricted immunity from adjudication and enforcement should apply to immunity


from taxation as well, because they all lie on the same theoretical and functional basis, as it had


been explained in the previous chapter. For these reasons States, and State entities like SWFs,


should be taxed on income or on properties which are related to their commercial or business


activities and they should be entitled to immunity from taxation only with respect to assets and


incomes strictly related to governmental activities. The mere fact that SWFs are State entities is not


enough to conclude that they should be entitled to immunity from taxation. It is necessary to study


their operations and to assess whether such operations are governmental or commercial in character,


irrespective of the sovereign nature of the entity performing them. A further element which limits


the utility of an approach which is exclusively based on the definition of SWFs as State entities and


which does not consider the real nature of their activities, is related to the fact that SWFs are


organised under the law of the State owning them in very different ways and therefore also the


degree they are enshrined within the structure of the State-owner significantly varies. As it has been


pointed out by the International Working Group on SWFs
27


, many SWFs are established as separate


legal entities of public law, with full capacity to act and governed by a specific constitutive law


(first group). This is the case of the SWFs established by Kuwait, Korea, Qatar, and United Arab


Emirates (Abu Dhabi Investment Authority, ADIA). Other SWFs take the form of state-owned


corporations (second group). They are created in accordance to the corporate law of the State


owning them and they differ from other investment vehicles, for instance mutual funds, because


they are owned by the State. This solution has been adopted, inter alia, by the Singapore’s Temasek


Fund, by the Government of Singapore Investment Corporation (GIC) and by China Investment


Corporation (CIC). Finally, SWFs can consist in pools of assets without a separate legal identity,


owned and managed directly by the central bank or the ministry of economic affairs (third group).


This occurs, for instance, in Botswana, Canada (Alberta), Chile, and Norway
28


. If an approach only



26


Foakes and Wilmshurst; cit. p. 4; De Meester, cit.; p. 813-814; Fox; cit.; p. 284-286; Donoho; cit.; p. 668.; Brownlie,


cit.; p. 327; Mafi; cit. p. 421-428.
27


For further information on the International Working Group for Sovereign Wealth Funds and the documents it has


adopted see infra, chapter 7.
28


International Working Group for Sovereign Wealth Funds; Generally accepted principles and practices - ―Santiago
Principles‖; IMF; 2008; p. 11; International Working Group for Sovereign Wealth Funds; Sovereign Wealth Funds -




13


based on immunity ratione personae is followed, then there is the risk that recipient States could


consider as States, and therefore recognise as entitled to sovereign immunity, only those SWFs


belonging to the above mentioned third group and consider as corporations not entitled to immunity


those SWFs included in the second group. In other words, some SWFs might enjoy State immunity


and other might not, solely depending on the extent to which authorities of recipient States consider


SWFs embedded in the organization of the State of origin and irrespective of the fact that the


investment activities different kind of SWFs perform in the host States are actually the same
29


. In


particular it must be underlined that most States secure immunity in relation to the acts and the


properties of central banks
30


. As in some cases SWFs manage official reserves which have been


transferred to them by central banks or they are even controlled or owned by central banks, then


such SWFs would enjoy a special protection from the jurisdiction of the host State and an


exemption from its taxation, thus provoking a discrimination against those SWFs which are


established as separate entities from central banks.


This supports the need to look at the nature of the operations SWFs undertake. If SWFs' activity


falls within the notion of acta jure imperii, then their income should not be taxed. Otherwise, they


should be taxed like any other private investment fund. To address this issue, it is necessary to


distinguish between two separate categories of home State acts concerning SWFs: first, those


related to the creation of SWFs and second, those related to the investments SWFs undertake. Then


it should be studied whether either or both of such categories of State acts fall within the notion of


acta jure imperii. As SWFs, with respect to their source of financing, the reasons why they are


established and the function they are required to perform, are divided between commodity funds


and non commodity (foreign exchange or ―forex‖) funds, it will be necessary to undertake such


analysis for both categories of SWFs.




4. May the creation of SWFs be regarded as an act jure imperii?


There is a strong link between the creation of forex funds and the management of official reserves


(foreign currency reserve), which in turn falls into the scope of the conduct of the monetary policy


of a State. Usually official reserves are invested in short term and low return financial assets, for


instance US treasury bonds, in order to ensure the maximum degree of safety and liquidity. When



current institutional and operational practices; IMF; 2008; Kern, Steffen and Reisen, Helmut; Commodity and non-


commodity Sovereign Wealth funds; Deutsche Bank Research; 2008.
29


Kirchner, Stefan; State-Owned Corporations and State Immunity in Europe; Institute for Public Law, University of


Goettingen; 2006; p. 1-4; Centner, Terence J.; Discerning Immunity for Governmental Entities - Analyzing Legislative


Choices; Review of Policy Research, Volume 24, Number 5; 2007; p. 425-440; Chamlongrasdr, Dhisadee; Defining a


State for the Purposes of Immunity and Liability of a State and its Entities; European Business Law Review; 2005; p.


1287-1323; Fox; cit.; p. 323-360; Brownlie, cit.; p. 336.
30


Blair, William; The legal status of central bank investment under English law; Cambridge Law Journal; 1998; p. 374-


390; Fox; cit.; p. 360-367; Chamlongrasdr; cit.; p. 323-360




14


the amount of official reserves held by a State exceeds the level needed to effectively manage a


State’s short-term monetary policy, foreign currency in excess is transferred to a Fund controlled


and managed directly or indirectly by the government or by the central bank and whose task is to


invest such resources in a more profitable way, also purchasing riskier assets denominated in


foreign currency. In this way forex SWFs are created. Differently from what occurs with other


pools of official reserves, the main objectives the management of SWFs must pursue are the


profitability and the safety (but with an higher level of risk tolerance) of investments, while


liquidity is less important.
31


Therefore, SWFs are a tool for the management of official reserves and


the creation of SWFs can be regarded as an integral part of the conduct of the monetary policy of a


State. No one doubt that the exclusive management of the monetary policy by the State is a


fundamental feature of its sovereignty: it can be concluded that the creation of forex SWFs is an act


jure imperii.


With respect to commodity funds, it is more difficult to reach similar conclusions. Commodity


funds are created in States rich in natural resources whose sale in the international markets


determines to a great extent their level of wealth. It has been established, in particular by domestic


Courts of European States as well as by international arbitral tribunal that the mere exploration,


exploitation and sale of natural resources located on the territory of a State by the State itself cannot


be regarded as a governmental activity. Likewise, State-owned companies established with the aim


to exploiting local national resources, even though they are State entities, perform acts jure


gestionis and are not entitled to sovereign immunity
32


. However, the issue of the immunity of


commodity SWFs must be distinguished from that of State-owned companies operating in the field


of natural resources, since SWFs' activity is related to the management of the revenues obtained


from the sale of natural resources, rather than to the direct exploitation of the natural resources


themselves. Any analysis of commodity funds should start from the evidence that commodities are


very volatile assets as their price can change faster and more widely than that of many other assets


like bonds, real estate and even shares. Commodity price fluctuations may have disruptive effects



31


Johnson-Calari, Jennifer and Rieltveld, Malan, ed.; Sovereign wealth management; Central Banking publications;


2007; p. 15 -44; Rieltveld, ed.; cit.; p. 67; Goldstein and Subacchi; cit.; p. 56; Griffith-Jones, Stephany and Ocampo,


José Antonio; Sovereign Wealth funds: a developing country perspective; Columbia University; 2008; Kern, 2007; cit.;


p. 2; Kern and Reisen; cit.; p. 3; Reisen, Helmut; Fonds souverains et économie du développement; La Vie


économique- Revue de politique économique; 2008; Subacchi, Paola Capital flows and emerging market economies: a


larger playing field?; Chatham House; 2007; Van der Ploeg, Rick and Venables, Anthony; Harnessing windfall


revenues in developing economies; VOX; 2008; available online at http://www.voxeu.org/index.php?q=node/1725;


Beck, Roland and Fidora, Michael; The impact of Sovereign Wealth Funds on global financial markets; Occasional


Paper series No 91 / July 2008; European Central Bank; Lossani, ed. cit.; p. 3; Butt Shams; Shivdasani, Anil;


Stendevad, Carsten and Wyman, Ann; Sovereign Wealth Funds: A Growing Global Force in Corporate Finance; Journal


of applied corporate finance; 2008.
32


Delaume, Georges; Economic development and sovereign immunity; American Journal of International Law; 1985;


p. 319-327; Mafi, cit.; p. 415-429.




15


on economies heavily relying on the proceeds from the exploitation of their natural resources.


Therefore, States highly dependent on the proceeds of the sale of their natural resources and willing


to reduce the problems this entails, have undertaken to create stabilization funds. States will transfer


to stabilization funds a quota of the proceeds from the exploitation of natural resources when


commodity prices are high and then they will be able to draw money from such funds when


commodity prices are so low as to provoke a slump in State revenues.


A proper management of the revenues from natural resources would also require the creation of


saving funds. The rationale underlying their establishment is the following one. Most natural


resources (in particular mineral ones) are exhaustible. As their exploitation at present causes their


depletion in the future, future generations will not be able to rely on the same proceeds current and


past generations have obtained from such resources. This has severe consequences in States which


have not been able to develop profitable sectors other than those related to the exploitation of


natural resources. Saving funds allows to exploit natural resources at present and, at the same time,


to set aside a part of the proceeds in a fund. The fund shall carry out investments in sectors others


than those related to the exploitation of natural resources. The returns from such investments will


ensure that future generations will enjoy the same level of wealth of current generations even when


natural resources are exhausted.
33


When stabilization funds and saving funds invest abroad, then fall


into the definition of SWFs.


Commodity funds undertake an activity which is indispensable to ensure the stability of State


revenues related to natural resources. One could wonder whether this can be regarded as an act jure


imperii, in which there is a clear manifestation of the sovereign power of the State. Some States


establishing SWFs are low-income countries, with a relevant number of people under the threshold


of poverty and they are highly dependent on the exploitation of their natural resources. In their case


sharp fluctuations of revenues from the sale of commodities can have disruptive effects on their


safety and security. Preventing these dangers from occurring is therefore a fundamental task of a


State and the acts it undertakes to this purpose, which can consists inter alia in the creation of


stabilization and saving funds, could be regarded as acta jure imperii. However, it should be noted


that not all the States with commodity SWFs are in the conditions described above. Among the


owners of commodity funds there are also Norway, Alaska, Alberta, and it would be difficult to


assess that fluctuation of commodity prices might threaten their national security or the survival of


their populations. The situation is even more blurred in case of middle-income countries which are


not completely dependent on their natural resources (Russia, for example) or several States of the



33


Johnson-Calari; cit.; p. 47-70; Barbieri, Michele; Developing countries and their natural resources – From the
elaboration of the principle of permanent sovereignty over natural resources to the creation of Sovereign Wealth Funds;


UNCTAD -Virtual Institute; 2009; p. 26-27; Griffith-Jones, and Ocampo, cit; p. 9-12; Kern and Reisen; cit.; p. 1-10.




16


Gulf region which are even high-income countries but whose degree of dependency on oil revenues


is extreme. It is hardly conceivable that tax authorities or Courts of the States where commodity


SWFs invest might undertake, case by case, an effective and correct analyse of the level of wealth


and of dependency on natural resources of the State owner of the SWF and that on such a basis


decide whether the creation of SWFs is an act jure imperii giving rise to the obligation to accord


immunity from taxation to the income earned by the SWFs at issue.


In addition, it can be argued that the acts of a State establishing a commodity SWF are not so


different from the acts any private individual may undertake when he decides to set aside some


money during a period in which he earns more in order to be able to have easy access to liquidity in


the future if its income decreases. When an act of a State is similar to those activities private


individuals perform, this constitutes a strong evidence that it falls within the category of acta jure


gestionis. As a result, in this case a SWFs should not be entitled to sovereign immunity.


In summary, it seems that while the creation of forex SWFs can be regarded as an act jure imperii,


it can be difficult to assess that the same occurs in case of commodity SWFs. With respect to the


consequence this may entail in relation to the issue of immunity from taxation, it can be questioned


whether a different fiscal treatment of commodity and forex funds is feasible. In my view the


answer should be negative for two reasons. First, as it will be better explained in the next chapter,


the asset management and the investment activity undertaken overseas by commodity and non


commodity SWFs does not present differences which might justify different tax treatment. Second,


it is not always easy to distinguish between these two categories of SWFs in practice. For instance


the sale of oil by a State-owned enterprise in the international market entails an increase of the


governmental revenues and at the same time an increase of the reserves of foreign currency (mainly


dollars) the government itself or the central bank own. In this case, if such revenues are transferred


to a SWF it is questionable to assess that it is a commodity and not a forex fund.


The approach consisting in focusing on the reasons why SWFs are created does not allow to answer


to the question whether SWFs should be entitled to immunity from taxation. It is thus necessary to


analyse SWFs investment activity and to assess if it can be regarded as a sovereign or commercial


act.




5. May the investments of SWFs be regarded as acts jure imperii?


A popular idea, which in the last months has been dismissed by an increasing number of authors


and policymakers, is that the investments of SWFs are driven by political and not by commercial


reasons. In other words, SWFs investment strategies would not aim at maximizing returns (as any


other investment fund, like a private equity or an hedge fund might do), but at unduly pursuing




17


political and strategic advantages. For instance SWFs could be tools used by a State to seize direct


control of strategic sectors of other States (for instance the defence sector, but also the


telecommunications and the utilities), thus enabling it to obtain information related to the national


security of the host State or to unduly interfere with its domestic affairs. In addition, SWFs could


invest and divest in the financial markets of another State (maybe its enemy or its competitor) in


order to disrupt the stability of its financial markets
34


. In these cases qualification of the investments


of SWFs as acta jure gestionis would be doubtful. Although the operations of SWFs would be


formally commercial in character, actually their purpose and nature would be clearly governmental


and political. However, in these cases the host State would not admit the investment of SWFs, so


the issue of taxing the income obtained by SWFs from to their investments overseas would be no


more relevant.


Actually evidence has so far demonstrated that SWFs are mainly portfolio investors and even when


the stake they own in a foreign company allows them to appoint some members of the board, they


often do not avail themselves of such a possibility. For these reasons they have been defined as


passive investors, and they have not threatened to seize control of strategic firms. They have


invested in sectors which were supposed to ensure the higher profitability (for instance banks,


although given the losses they have reported so far, today this might sound strange), while they


have practically neglected the defence sector and other sensitive industries. They have proven long


term and counter-cyclical investors, therefore the fear they can contribute to the instability of


financial markets is ungrounded. In summary, it can be affirmed that SWFs have pursued


investment strategies similar to those of other long-term non-State investors
35


. On one side this


means that SWFs in principle do not represent a threat and therefore that their operations should not


be prevented as a rule, but only monitored, controlled and restricted in limited circumstances.

On


the other hand this implies that SWFs undertake a commercial activity which clearly falls within the


scope of acta jure gestionis: therefore, income they earn in this way must be taxed.


An objection can be made. In the case of forex funds, the performance and the return of the


investments of SWFs have direct consequences on the amount of the official reserves of a State (at


least on those transferred to the SWF itself) and, as a result, on the monetary policy of the State. In


case of commodity funds, the outcome of the investments affects the size of saving and stabilization



34


Mason, Ruth; Sovereign Wealth Funds and the Efficient Management of the Wealth of Nations; Tax Notes; 2008; p.


1321-1322; Edwin M. Truman; Four Myths about Sovereign Wealth Funds; Peterson Institute for international


economics; 2008; Edwin M. Truman; Sovereign Wealth Funds: New Challenges from a Changing Landscape; Peterson


Institute for International Economics; 2008; Goldstein; cit.; p. 63.
35


Kern, Steffen; SWF’s and foreign investment policies - an update; Deutsche Bank Research; 2008; p.6-17; Fernandes,
Nuno; Sovereign Wealth Funds: Investment Choices and Implications around the World; IMD working paper series;


2009; p. 11-20; Rose, Paul; Sovereign Wealth Funds: Active or Passive Investors?, The Yale Law Journal pocket part;


2008; p. 104-108;





18


funds ad as a result the possibility to achieve the aim that their creation pursues. As some of these


issues, in particular those concerning the management of official reserves, fall within the scope of


the sovereign activities of a State, it could be argued that investment activity of SWFs is only


apparently commercial, but actually it has a governmental character, to the extent to which its


outcome affects sovereign functions of a State. This argument should be rejected for two reasons.


First of all this approach would end up focusing again on the establishment of SWFs rather than on


their investment activity: in the previous chapter it has already been explained why this method is


unworkable. Second, it can be argued that almost any act jure gestionis performed by a State can


have an impact on the wealth and on the finances of such State and in this sense it might affect the


availability of State’s resources to finance other State activities falling within the category of acta


jure imperii. If we adopt such approach the category of acta jure gestionis shall result dramatically


restricted or it would even cease to exist. This would be inconsistent with the development of the


law of State immunity which has been described above at chapter 2.


Another reason why SWFs should not be immune from taxation is that they are the first ones to


claim that they act as any other investor. They declare they just seek to maximize the return on their


investments and they don’t pursue any political aim. Clearly such a pledge is motivated with the


fact that SWFs don’t want to be perceived as pursuing political objectives and therefore as


constituting a threat to the public security of the host State. In this way they try to convince


recipient States not to hinder or restrict their investments. Therefore, on these basis an acceptable


compromise can be found. As SWFs demand to be treated like any other commercial investor in the


sense that they require not to be subject to restrictions and controls other than those applicable to


any other foreign investor in the recipient State, they should also accept to be treated as any other


private investor also with respect to the fiscal treatment
36


. This means that it would be reasonable to


argue that income tax levied on SWFs should be the same levied on any other subject which report


similar income: SWFs should pay taxes on interests, dividends and capital gains in the countries


where they invest. In case of tax treaties in force between the State owning SWFs and the recipient


State, the benefits accorded to taxpayers of the contracting party, shall be extended to SWFs, which


should be regarded as a national of the State owning them.
37











36


De Meester, cit.; p. 814-815.
37


As regards the applicability of tax treaties to SWFs see infra, chapter 7




19


6. Immunity from taxation granted to SWFs owned by developing countries as a


form of aid to development


In chapter 4 it has been explained why commodity SWFs play an important role in the efficient


management of the wealth generated by the exploitation of the natural resources of States and it has


been investigated whether this should be sufficient to consider their creation and their subsequent


investment activity as an act jure imperii. Although it has been demonstrated that the answer to this


question must be negative, this nonetheless does not mean that a tax exemption granted by host


States to the income earned by SWFs would be irrelevant with respect to the purpose of achieving


sustainable economic and social development in the States creating SWFs.


With respect to Forex SWFs, no in depth discussion in relation to their role in promoting


development has been undertaken in chapter 4 and 5 where it only had been proved that the


establishment of forex SWFs (but not their subsequent investments) since it is intertwined with the


conduct of the monetary policy of a State, is an act jure imperii. Nevertheless forex funds also are a


fundamental tool in the hands especially of developing countries and economies in transition to


promote sustainable economic development and in the next part of the present chapter it will be


briefly explained why. As it was stressed in chapter 4, Forex SWFs are created when a State owns


foreign exchange reserves in excess and when it therefore decides to transfer a part of them to a


SWFs which shall manage them differently from the way central banks and monetary authorities


usually manage their reserves of foreign currency. The proper management of foreign exchange, be


it under the responsibility of the central bank or of a SWF, (but sometimes the distinction between


these two entities is very blurred
38


) has a relevant impact on the ability to ensure sustainable


economic and social development, as it can reduce the risk of massive and destabilising capital


inflows and outflows and of sharp fluctuations of the exchange rate with the severe effects they may


have on the competitiveness of the economy of a State, its inflation and its ability to continue to


finance its developmental policies. As developing countries and economies in transition have


traditionally proven particularly vulnerable to sudden stops in capital inflows or to massive capital


outflows accompanied by disruptive devaluation, inflation and budgetary crisis, the accumulation of


foreign exchange reserves has increasingly been regarded as a way to cope with this kind of risks.


For instance, it is not a coincidence that the accumulation of relevant foreign exchange reserves in


South East Asia has started in the aftermath of the 1997 crisis, when the States of that region,


desiring to prevent another crisis of this nature from occurring and disappointed by the support they


received in previous occasions by international economic organizations like the International



38


In several cases, the SWF is an agency of the central bank itself, so the distinction between a central bank and a WFs


is very difficult to operate in practice. See above, chapter 3




20


Monetary Fund, decided to increase and strengthen their own foreign currency reserves.
39


The issue


is to assess which is the proper level of such reserves, because while insufficient reserves are not


able to protect a State against the macroeconomic problems mentioned above, also maintaining


excessively broad reserves entails relevant economic costs. The prevailing approach in the past


suggested that reserves should cover at least 3 months of imports: in this way States would have


avoided import bottlenecks in the event of an adverse external shock in their trade balance. Since


the late 1990s, this theory has been gradually replaced by the Guidotti-Greenspan rule, which states


that reserves should equal short-term external debt (one-year or less maturity), implying a ratio of


reserves-to-short term debt of 1. This theory is considered more suitable for financially integrated


countries, as in today world most countries, even developing and in transition, are. It focuses more


on the impact of short-term financial flows than on the trade balance. The rationale of the Guidotti-


Greenspan Rule is that countries should have enough reserves to resist a sudden and massive


withdrawal of short term foreign capitals. If we apply either methods to several emerging


economies, in particular China and the countries of South East Asia, it emerges that the reserves


they have far exceed the recommended level.
40


The reserves in excess constitute the wealth which


could and should be transferred to SWFs, also in order to reduce the costs that maintaining a too


much high level of reserves might entail. The extent to which forex SWFs can smoothly carry out


their investments overseas thus affects the quality and the effectiveness of the management of the


reserves of foreign currency and, in conclusion it has an impact on the economic development of


the owners of SWFs.


In chapter 4 and 5 and in the first part of this chapter it has been explained that the the principle of


State immunity from taxation should not be used as a valid justification to exempt SWFs from


paying taxes on the income they earn from their investments overseas. However it has also been


proven that both commodity and non-commodity SWFs play a relevant role in the promotion of


economic development in the States owning them, in particular when such States are developing


countries or economies in transition. Therefore it could be discussed whether exemption from


taxation to the investments of SWFs owned by developing countries or economies in transition


could be justified not on the ground of the principle of State immunity, but to the extent it


constitutes a form of aid to development. In other words, the host States, when refraining from


taxing the returns obtained in their territories by a SWF owned by a developing country would act


as if they were facilitating the achievement of the developmental goals pursued by a SWF and as if



39


Lossani; ed. cit.; p. 3-11; Elson, Anthony; Sovereign Wealth Funds and the International Monetary System; The


Whitehead Journal of Diplomay and International Relations; 2008; p. 71-79
40


South Centre; Capital flows from south to north: a new dynamic in global economic relations; South Centre


Analytical Note SC/GGDP/AN/GEG/8; July 2008; p. 3-4; Kern and Reisen; cit.; p. 8-9




21


they were transferring to the developing country at issue a relevant quota of wealth. This theory can


also be supported by the evidence that many States owning a SWF and using it to invest overseas


are also recipients of official aid to development: this occurs for instance in the case of Algeria,


Azerbaijan, Botswana, Chile China, Kazakhstan, Libya, Nigeria, Oman, Trinidad and Tobago,


Venezuela
41


.


The idea of exempting SWFs from taxation as a form of aid to development should nonetheless be


refined and detailed, in order to prove useful in practice. Following the rationale underlined above,


only SWFs owned by developing countries and economies in transition should be exempt from


taxation. But then several doubts emerge. First: should all the SWFs established by States belonging


to such categories be exempted? Or should exemption be limited to SWFs owned by LDCs only, or


by countries particularly dependent on the exploitation of their natural resources or by those


especially vulnerable to capital outflows and where the need to keep large foreign exchange


reserves to prevent currency crisis is extremely acute? Another issue which should not be neglected


is that SWFs could be and should be a tool for the promotion of sustainable development, but this


does not mean that they always and necessarily act like this. When SWFs are opaque instruments in


the hands of corrupt and unaccountable elites which use the enormous wealth under their


management in order to pursue their personal interests or other objectives inconsistent with the


promotion of the wellbeing of the People of the State which has established the SWF (the same


People which should always be regarded as the ultimate owner and beneficiary of the SWF), then


granting a more favourable tax treatment to such SWFs would not result in an effective form of aid


to development. According to these concerns, further requirements should thus be attached to SWFs


owned by developing countries and economies in transition in order to make them eligible to tax


exemptions. For instance it should be required that they should meet certain standards of


transparency: in this way recipient States will be able to verify that tax exemption in favour of


SWFs really results in a valuable aid to development.
42


Finally it could be questioned whether only


developed countries which are the recipients of the investments of SWFs should exempt such State-


owned investors, or whether developing countries too should be encouraged to do so. For instance


the tax exemption accorded by a poor African State to the China Investment Corporation would


result into an aid to development granted by the former to China and its opportunity and fairness


could clearly rise several doubts. This last issue is getting more important as the number of



41


Keenan, Patrick J.; Sovereign Wealth Funds and Social Arrears: Should Debts to Citizens be Treated Differently than


Debts to Other Creditors?; Virginia Journal of International Law; 2009; p 440-442
42


Keenan; cit.; p. 439-471; Barbieri, Michele; Developing countries and their natural resources – From the
elaboration of the principle of permanent sovereignty over natural resources to the creation of Sovereign Wealth Funds;


UNCTAD -Virtual Institute; 2009;




22


investments by SWFs owned by emerging economies undertaken in developing countries has been


increasing in 2009
43


.


It is difficult to provide a satisfactory answer to all these questions and to decide in practice the


criteria according to which certain SWFs should be exempt from taxes to the extent they can be


regarded as tools for development. The ambition of the present paper is not to solve all these issues,


but only to stress that any attempt to consider whether SWFs could be exempt from taxes because


of their developmental function cannot escape an in depth discussion of all such problems.


However, it is even possible that at the end of such a discussion it will be concluded that the idea of


granting selective tax exemptions to SWFs in relation to their developmental function is not feasible


or useful, also because of the impossibility to properly address all the questions and concerns I have


highlighted above.


In any case one suggestion can be made. The criteria which would allow to assess which SWFs


should be entitled to tax exemptions because of their developmental functions should not be


autonomously decided host States acting individually, also because this would further jeopardise the


tax treatment of the transnational operations of SWFs and it would offer a pretext for disputes


concerning alleged unreasonable discriminations between SWFs owned by different States. It would


be better to establish at the international level some standards providing for a guidance to States


which desire to differentiate the tax treatment they mean to apply to SWFs. This would entail that


the International Community, also through the adoption of an instrument of soft law, might first of


all enhance the principle that the income earned by some SWFs from their investment overseas


should be tax exempt, to the extent such a more favourable tax treatment constitutes a form of aid to


development. The same instrument of soft law should also provide the basic criteria according to


which recipient States shall decide which SWFs are eligible to tax exemptions. The elements that


could be taken into consideration might be: the level of income of the States owning the SWFs,


their degree of dependency on a few natural resources, further particular elements of vulnerability


of its economy. In addition, also the level of transparency of the SWFs at issue, together with the


soundness and effectiveness of their legal framework and of their operational strategies, should be


considered. The next chapter will provide a short overview of the international instruments adopted


in relation to SWFs and of the ongoing works of the main international organisations on this


subject
44


. It will study the extent to which they might have a relevance in relation to tax issues too



43


Miracky and Bortolotti; cit.; p. 14-19; Miracky, Barbary, Fotak and Bortolotti; cit.; p. 14-15;
44


For a more detailed review of such works, see: Audit; cit.;. p. 3-5; Barbieri, Michele; The international regulation of


Sovereign Wealth Funds – Which role for the European Union? UNCTAD -Virtual Institute; 2009; p. 9-10; Gugler,
Philippe and Chaisse, Julien; Sovereign Wealth Funds in the European Union: General trust despite concerns; NCCR


TRADE Working Paper No 2009/4; 2009; Epstein, Richard A. and Rose, Amanda M.; The Regulation of Sovereign




23


and if they could be used as a preliminary step towards the establishment of a legal framework


governing the taxation of SWFs at the international level.




7. International instruments governing the operations of SWFs and their


relevance with respect to tax issues


A brief review of the ongoing works of international organizations in relations to SWFs should


focus on the initiatives promoted by the International Monetary Fund (IMF) and the Organization


for Economic Cooperation and Development (OECD). The IMF has supported the creation of the


International Working Group of Sovereign Wealth Funds (IWG), which is a summit of 23 IMF


member countries with SWFs trying to identify the best investment practices SWFs can voluntarily


promise to follow when they undertake investments overseas. In October 2008 the IWG has


adopted a set of general accepted principles and practices (GAPP) which have also become known


as the "Santiago Principles". Such document describes itself as a voluntary code of conduct ―that


the members of the IWG support and either have implemented or aspire to implement‖.45 On April


6, 2009 in Kuwait City the IWG reached a consensus to establish the International Forum of


Sovereign Wealth Funds. The Kuwait Declaration
46


provides that the Forum ―will be a voluntary


group of SWFs‖ whose ―purpose will be to meet, exchange views on issues of common interest, and


facilitate an understanding of the Santiago Principles and SWF activities‖. Nevertheless such


international institutionalized meetings, actually focus on the practice of SWFs and they do not


seem to be the most suitable context to deal with tax policy issues of recipient States. To the


purposes of the present paper, only one issue deserves particular attention, among those addressed


by the Santiago principles: it is the issue of transparency, to which also the GAPP devote special


consideration. In fact, the Santiago Principles leave broad discretion to SWFs as regards their


organization, structure, legal framework and investment strategies, merely recommending SWFs to


refrain from taking advantage of privileged information or inappropriate influence in the conduct of


their businesses and from abusing of their particular status in competing with private firms.


However, the GAPP require SWFs to disclose which are, inter alia, their governance framework,


their organization, investment strategies (in particular if they use derivatives and leverage), the


degree of independence of their management, their relations with the government of the State



Wealth Funds: The Virtues of Going Slow; The University of Chicago Law Review; 2009; p. 111-141; De Meester; cit.;


p. 797-800
45


IMF; Sovereign Wealth Funds—A Work Agenda; IMF; 2008; p. 3; International working group for sovereign wealth
funds; Generally accepted principles and practices - ―Santiago Principles‖; IMF; 2008; p. 3 ; Kern; 2008; cit.; p. 18;
Rieltveld; ed.; cit.; p. 55.
46


International Working Group of Sovereign Wealth Funds; ―Kuwait Declaration‖: Establishment of the International
Forum of Sovereign Wealth Funds; April 6, 2009 available online at: http://www.iwg-swf.org/mis/kuwaitdec.htm




24


owning them. In summary, SWFs are not recommended to behave in a specific way but only to


disclose how they have decided to behave. The promotion of an higher degree of transparency could


help SWFs themselves to increase their accountability and finally their effectiveness in order to


enhance their function as real tools of economic development. In addition, this could help host


States to better evaluate which SWFs should be entitled to a tax exemption because they will be


able to understand when a tax exemption to a SWF really contributes to the economic development


of the owner-State or when it simply results into a "gift" made to unaccountable elites managing the


fund and benefiting of it to the exclusion of anyone else.


The other international organisation which is undertaking important works as regards SWFs is the


OECD, which has focused on those policies and practices recipient States have adopted or are likely


to adopt in relation to the investments of SWFs in their territories. In April 2008 the OECD has


prepared a report on SWFs and Recipient Country Policies and on its basis it has adopted, on the


occasion of the Ministerial Council Meeting on 4-5 June 2008 in Paris, the ―declaration on SWFs


and Recipient Country Policies‖. This non-binding document affirms some general ideas according


to which SWFs in principle bring a beneficial contribution to the world economy and that they


could rise legitimate concerns only when they are not sufficiently transparent, they are not


economically motivated and they unduly pursue political objectives. Therefore recipient countries


should not erect protectionist barriers to foreign investment and should not discriminate among


investors in like circumstances. Foreign investments should only be restricted when they raise


national security or public policy concerns; in any case measures taken to this purpose should be


transparent, predictable and proportional to clearly-identified national security risks.
47


Tax issues


are not explicitly mentioned, nevertheless it can be argued that when the declaration stresses the


importance of ―treat[ing] similarly situated investors in a similar fashion‖ might also refer to the


principle of tax neutrality according to which persons in similar situations should be similarly taxed,


unless a competitive advantage to the less taxed person is meant to be granted. This could be


interpreted, under a fiscal point of view, as a non-binding recommendation not to apply higher taxes


on SWFs in order to discourage their investments. Actually, as it has been explained in the first


chapter, in some countries like the US and the UK there is rather the opposite problem: that SWFs


are even secured a more favourable tax treatment.


On November 25th 2009, the OECD has published a short document titled "discussion draft on the


application of tax treaties to State-owned entities, including Sovereign Wealth Funds"
48


(the



47


OECD; Sovereign Wealth Funds and recipient countries- Working together to maintain and expand freedom of


investment; OECD; 2008; available online at: http://www.oecd.org/dataoecd/0/23/41456730.pdf ; Rieltveld; ed.; cit.; p.


55.
48


OECD; discussion draft on the application of tax treaties to State-owned entities, including Sovereign Wealth Funds;


OECD; 2009, available online at: http://www.oecd.org/dataoecd/59/63/44080490.pdf




25


"discussion draft") whose aim is to start a debate on the taxation of the cross-border investments


undertaken by State-owned entities, also in relation to the need to update the OECD model tax


Convention and the related commentaries.


The first issue analysed in the discussion draft is whether tax treaties concluded by States on the


basis of the OECD model convention should apply to SWFs too and, as a result, whether SWFs


should be entitled to the same benefits accorded to other persons covered by the tax treaties.


According to art. 1 of the most recent version of the OECD model tax Convention
49


, it "shall apply


to persons who are residents of one or both of the Contracting States"; art 4 then specifies which


persons shall be regarded as residents and inter alia, it mentions contracting States themselves and


all their political subdivisions or local authorities. The discussion draft points out that "issues may


arise, however, in the case of entities set up and wholly-owned [emphasis added] by a State or one


of its political subdivisions or local authorities. Some of these entities may derive substantial


income from other countries and it may therefore be important to determine whether tax treaties


apply to them (this would be the case, for instance, of sovereign wealth funds [...])." The discussion


draft seems therefore to distinguish between SWFs on one side and the State or the State political


and local subdivisions which may establish SWFs on the other side. It also takes into consideration


that in some cases States, when concluding tax treaties based on the OECD model convention,


"modify the definition of "resident of a Contracting State‖ in paragraph 1 of Article 4 and include in


that definition a ―statutory body‖ or an ―agency or instrumentality‖ of a State, a political


subdivision or local authority, which would therefore cover wholly-owned entities that are not


considered to be a part of the State or its political subdivisions or local authorities" as it is the case


of several SWFs. In fact, as it was explained above in chapter 3, SWFs are organised under the law


of the State owning them in very different ways: some of them can be regarded as


political/administrative subdivision of the State, while others are constituted as separate legal


entities of public law or corporate law. The latter can be regarded as covered persons under a tax


treaty if a modification of the definition provided for at art. 4 of the OECD model convention is


made as suggested above. In conclusion, if States desire to ensure the application of tax treaties to


SWFs too, when they conclude a tax treaty they should specify, in the articles providing the scope


ratione personae of the treaty itself, that it shall also apply to statutory bodies or agencies or


instrumentalities of a contracting State or of its political subdivisions and local authorities as well as


to other entities owned by a contracting State or by its political subdivisions and local authorities.


This is especially important to the extent States, as it has been recommended in the present paper,


regard the operations of SWFs owned by third countries as acta jure gestionis and therefore to be



49


OECD; articles of the model convention with respect to taxes on income and on capital [as they read on 17 July


2008]; OECD; available online at http://www.oecd.org/dataoecd/43/57/42219418.pdf




26


treated like the transactions undertaken by any other investor also with respect to the applicability


of the provisions of tax treaties. However, when States grant immunity from taxation to SWFs, the


importance of ensuring them some of the benefits provided for by the articles of tax treaties is


significantly reduced; in fact, if an entity simply is not subject to taxation, it has no interest in


benefiting, for instance, of the provisions against double taxation contained in a tax treaty. The


discussion draft recognises that several States grant immunity from taxation to other States, to their


local and political subdivisions as well as to their agencies and their instrumentalities. It declares


that the tax treaties adopted on the basis of the model convention shall not "be interpreted, however,


as affecting in any way the possible application by each State of the customary international law


principle of sovereign immunity." The discussion draft reminds that "there is no international


consensus, however, on the precise limits of the sovereign immunity principle. Most States, for


example, would not recognise that the principle applies to business activities and many States do


not recognise any application of this principle in tax matters. There are therefore considerable


differences between States as regards the extent, if any, to which that principle applies to taxation "


In fact, as it was underlined in chapter 2 of the present paper, the principle of State immunity first of


all is devised with respect to immunity from jurisdiction to adjudicate and to enforcement and its


extension to taxation, although in my view recommendable and correct, rises nonetheless some


theoretical and practical difficulties. In addition, the distinction between acta jure imperii and acta


jure gestionis, whose utility and validity has been supported in the present paper, could be described


more as a prevalent trend in the practice of the international community rather than as a well


established rule of customary international law whose content is clear and well defined
50


. The


discussion draft underlines that "States often take account of various factors when considering


whether and to what extent tax exemptions should be granted, through specific treaty or domestic


law provisions or through the application of the sovereign immunity doctrine, with respect to the


income derived by other States, their political subdivisions, local authorities, or their statutory


bodies, agencies or instrumentalities." Then it provides a non-exhaustive list of such relevant


factors, which include the issue of reciprocity, the distinction between acta jure imperii and acta


jure gestionis, the distinction between income derived from a portfolio or a direct investment and


whether the assets and income of State-owned entity, like the SWFs, which are carrying out


investments overseas, are used for "public purposes". The discussion draft specifies neither the


scope of the notion of "public purposes", nor its relation with the character jure imperii an act of a


State might have
51


. However it has been explained in chapter 4, 5 and 6 of the present paper that



50


See, supra, note 25
51


In other words, it remains unclear whether, according to the discussion draft, an act performed by a State for public


purposes is for this same reason an act jure imperii and vice versa or if the notion of act jure imperii and act performed




27


both commodity and forex SWFs play an important role in the promotion of sustainable economic


development in the States owning them (especially when such States are developing countries and


economies in transition) since they contribute to the improvement, respectively, of the management


of the revenues from the exploitation of natural resources and of the conduct of monetary policy and


the use of foreign exchange reserves. The pursuit of such aims must be regarded as pertaining to the


notion of "public purposes" mentioned in the discussion draft. This could therefore support the


theory of exempting SWFs from taxation because of their role in promoting sustainable and sound


economic development in developing countries and economies in transition, as this can actually be


regarded as a public purpose.


According to the discussion draft itself, the revised version of the OECD model convention and of


the related commentaries is scheduled for the second half of 2010. From the wording of the


discussion draft it does not seem that the model convention will include provisions establishing


whether the principle of State immunity from taxation should be applied to the operations of SWFs.


It is also unlikely that it will establish whether SWFs should be exempted from taxation with


respect to other motivations. This choice shall remain in the power of States, in accordance with


their domestic law and the way in which they interpret and apply the principle of State immunity.


The proposals for the upgrading of the commentaries of the OECD model convention could suggest


States to specify in the tax treaties they conclude whether SWFs and other State-owned entities


investing overseas shall be covered persons and therefore whether the provisions of the tax treaties


shall also apply to them. In addition, the same tax treaties should specify whether contracting


parties will mean to exempt SWFs from taxation and possibly under which conditions, in order to


ensure an higher level of predictability in the tax-related aspects of the cross-border investments


undertaken by SWFs and other State-owned entities.




Conclusions


This paper has tried to answer to the following fundamental question: shall SWFs pay taxes on the


income they earn on their investments overseas?


It has explained that, with respect to this issue, the current practice of States which are the main


recipients of the capitals of SWFs is rather inconsistent, as some apply the principle of State


immunity from taxation to SWFs while others subject SWFs to income taxes as they do with any


other investor. The paper has then tried to develop a theory of taxing SWFs. It has explained why



for public purposes should remain separate. In the last hypothesis also an act which is commercial in nature could be


undertaken with the aim to pursuing public purposes. In the present paper the latter approach will be endorsed and


therefore it will be reasonable to consider that the operations of SWFs, although they are not acta jure imperii, in any


case pursue public purposes too.




28


the principles elaborated by the doctrine in the field of the immunity of foreign States from


jurisdiction to adjudicate and to enforce should be extended to immunity from taxation too. It has


supported in particular the need to distinguish between acta jure gestionis and acta jure imperii and


to grant immunity from taxation to the latter only. It has demonstrated that while the creation of


SWFs in some cases may be regarded as an act jure imperii, actually their investments activity


always fall within the notion of commercial activity. Therefore SWFs should pay taxes on income


earned from their portfolio investments overseas. This is linked to the more general concept that, to


the extent SWFs act like private investors seeking to maximize their revenues and not pursuing


political aims, they should be treated in the same way as any other investor, also as regards taxation.


Then this paper has explained the role played by SWFs in promoting sustainable development in the


countries establishing and owning them. It has underlined that such function is really fundamental


in developing countries and economies in transition and it has investigated whether this could


justify an exemption of SWFs from income taxes on an autonomous ground than the one


represented by the application of the principle of State immunity. In this way host State tax policies


exempting SWFs would be regarded as a form of aid to development. Although the present paper


has concluded that tax exemption in favour of certain SWFs owned by developing countries and


economies in transition and effectively used by them as a tool for development could be desirable in


principle, it has also stressed that this could prove extremely difficult to implement in practice. In


fact the criteria host States shall adopt in order to decide which SWFs shall be eligible to tax


exemptions risk to end up to be unpredictable and discriminatory. The best solution should be


therefore to decide such criteria at the international level, for instance through the adoption of


instruments of soft law providing standards and guidance to States desiring to grant exemptions


from taxation to some SWFs as a form of aid to development. Existing international instruments


applicable to SWFs have been quickly reviewed, but it has emerged that none of them explicitly


deal with the issue of the taxation of SWFs. However, the emphasis they put on transparency can


have an impact on tax issues too and on the possibility to implement the theory proposed in the


present paper. In fact, if tax exemptions must be granted to SWFs which actually and effectively


pursue developmental goals in the interest of the population of the States owning them,


transparency is necessary to assess whether SWFs really are tools for development and therefore


entitled to tax exemptions. Finally, the present paper has discussed the ongoing works undertaken


by the OECD with the aim to revising and upgrading the OECD model tax Convention and the


related commentaries, so that they might take into consideration the tax-related issues of the


growing cross-border investments undertaken by State owned entities like SWFs. It seems to


emerge that they will not provide a conclusive answer as to whether SWFs should be tax exempt,




29


but they could recommend States to specify, when they conclude tax treaties, whether they intend to


exempt from taxation SWFs owned by the other contracting parties. This should help to increase


the level of predictability and effectiveness of the cross-border operations of SWFs.




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