Australian Treasurer Peter Costello announced last week that new legislation will be introduced to limit the current practice of exempting foreign governments and their investment bodies from interest and dividend withholding taxes.

The exemptions will apply only to sovereign income from passive investment, such as a portfolio shareholding in an Australian listed company (that is, a holding of less than 10 per cent of the share capital of the company). No income from commercial investments will be exempt from Australian tax.

Generally accepted international practice is that sovereign governments do not pay tax to each other on income from passive investments. As the investment options and structures available to foreign governments become more diverse and complex, application of the exemption from Australian taxation of foreign government investments has become more uncertain.

New legislation will clarify which foreign government investment bodies will be exempt from Australian tax and what income will qualify for the exemption. Similar treatment for foreign government investment is provided in other countries, although practices vary considerably.

The Australian government is urging interested stakeholders to comment on the proposed legislation before 30 November, 2005.