This document contains information on the application of the foreign exchange gain and loss measures (the forex measures) to the acquisition and/or disposal of ordinary shares denominated in a foreign currency under Division 775 of the Income Tax Assessment Act 1997 (ITAA 1997).
Generally, the forex measures apply prospectively to the realisation of assets, rights and obligations acquired or assumed on, or after, the commencement date. The commencement date is usually the first day of the 2003-04 income year, which for most taxpayers will be 1 July 2003. For more information on the timing of the forex measures refer to Foreign exchange (forex): overview.
As a general rule, former Division 3B of the Income Tax Assessment Act 1936 (ITAA 1936) continues to apply to currency exchange gains and losses of a capital nature arising from 'eligible contracts' entered into on, or after, 18 February 1986, and before 1 July 2003. Although Division 3B of the ITAA 1936 has been repealed, Taxation Determination TD 94/88 considers its application to ordinary shares denominated in a foreign currency in the limited situations where it still has application. Therefore, we recommend you read this information in conjunction with TD 94/88.
The forex measures do not deal with the effect of any change in the exchange rate for the period of the ownership of foreign currency denominated ordinary shares (that is, between the time of purchase and the sale of the shares). Rather, as an example, if the shares are held on capital account, the capital gains tax (CGT) rules in Parts 3-1 and 3-3 of the ITAA 1997 will incorporate any foreign currency gain or loss which occurs between the time of acquisition and the time of disposal as part of the overall capital gain or loss made on the shares.
The forex measures will apply in respect of the acquisition or disposal of foreign currency denominated shares for an amount of foreign currency where there is a 'currency exchange rate effect' between:
- the date or time on which the contract for the acquisition or disposal is made, and
- (respectively) the date or time payment is made or disposal proceeds are received.
The forex measures will not give rise to a foreign exchange realisation (forex realisation) gain or loss where the payment for the acquisition of the shares, or receipt on disposal of the shares, occurs at the same time as the contract. After 26 April 2005, where under the purchase or disposal contract there is a requirement for settlement within two business days, the payment for the acquisition or receipt of the disposal proceeds will generally be translated at the exchange rate applicable on the date of the contract, so no forex realisation gain or loss will arise - refer to item 8C of the table in subsection 960-50(6) of the ITAA 1997.
A taxpayer has an obligation to pay foreign currency on entering into a contract to acquire shares where the consideration is payable in foreign currency. When payment is made, the obligation ceases, and a forex realisation event 4 (FRE 4) occurs.
Similarly, a taxpayer will have a right to receive foreign currency on entering into a contract to dispose of shares where the amount is receivable in a foreign currency. When the amount is received, the right ceases, and a forex realisation event 2 (FRE 2) occurs.
A forex realisation gain or loss arises under such a FRE 4 or FRE 2 when there is a currency exchange rate effect between entering into the purchase or sale contract, and settling that contract. In the context of the purchase or sale of shares denominated in a foreign currency, a currency exchange rate effect will commonly occur where a taxpayer either:
a)
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incurs an obligation to pay foreign currency under a contract for the acquisition of the shares, and there is a difference in the exchange rate at the time of the contract and the time of payment, or
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b)
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acquires a right to receive foreign currency under a contract for the disposal of the shares, and there is a difference in the exchange rate at the time of the contract and the time of the receipt - refer to section 775-105 of the ITAA 1997.
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The 12 month rule (also known as the short-term rule) generally provides that the forex measures do not apply to forex realisation gains and losses on the acquisition or disposal of capital assets where the time between that acquisition or disposal, and the due time for payment, is not more than 12 months. Such gains and losses are effectively folded into the CGT treatment of the assets. For more information refer to Foreign exchange (forex): the 12 month rule.
However, where a taxpayer has made a valid election out of the 12 month rule within the required timeframe, the 12 month rule will not apply. For more information refer to Foreign exchange (forex): election out of the 12 month rule.
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All legislative references made in the following example scenario are to the ITAA 1997.
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Tom enters into a contract on 1 July 2005 to acquire 1,000 shares in a US company at US$10.00 per share (market value) when the exchange rate is A$1.00 = US$0.70. Tom intends to hold these shares as an investment. He makes the payment on the 15 August 2005 settlement date when the exchange rate is A$1.00 = US$0.72.
Tom has previously made a valid election out of the 12 month rule.
When the contract is entered into on 1 July 2005, Tom incurs an obligation to pay an amount of foreign currency (that being the purchase price of the shares). When Tom pays the purchase price, the obligation ceases and FRE 4 occurs under subsection 775-55(1). Tom makes a forex realisation gain as a result of FRE 4 occurring if the A$ value of what he pays falls short of the proceeds of assuming that obligation, and that gain is attributable to a currency exchange rate effect under subsection 775-55(3).
The amount Tom pays, in A$ terms at the time of payment, is A$13,889 (US$10,000/0.72 = A$13,889).
The proceeds of assuming the obligation is equal to the market value of the shares calculated at the time Tom entered into the purchase contract under paragraph 775-95(b) and item 9 of the table in subsection 775-55(7). The market value of the shares at this time is US$10 per share. Tom's proceeds of assuming the obligation in respect of the 1,000 shares is therefore A$14,286 (US$10,000/0.70 = A$14,286).
Tom pays less for the shares in A$ terms ($13,889), than the value of his proceeds of assuming the obligation to pay for the shares (A$14,289). The difference between these two amounts is $397 ($14,286 - $13,889). As this difference is attributable solely to a currency exchange rate effect, it represents a forex realisation gain of $397. As Tom has elected for the 12 month rule not to apply, he must include the $397 forex realisation gain in his assessable income under section 775-15.
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All legislative references made in the following example scenario are to the ITAA 1997.
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Lisa acquires shares in a US company as a capital investment for a cost of US$15,000 on 1 July 2004 when the exchange rate is A$1.00 = US$0.50. The cost base of the shares to Lisa is A$30,000 (that being the A$ value) at the time of acquisition of what Lisa is required to pay for the shares. This falls under item 5 of the table in subsection 960-50(6).
On 1 March 2005 Lisa enters into a contract to sell the shares for US$20,000 when the exchange rate is A$1.00 = US$0.60. The capital proceeds for the disposal of the shares on that date is equivalent to A$33,333 (that being the A$ value) at the time of sale of the amount Lisa is entitled to receive under item 5 of the table in subsection 960-50(6).
Settlement of this contract occurs on 15 March 2005 when Lisa receives the sale proceeds at an exchange rate of A$1.00 = US$0.62.
Lisa makes a gain of A$3,333 on the disposal of the shares ($33,333 - $30,000). That gain is attributable to a change in the value of the shares in the US company which falls under the CGT rules in Parts 3-1 and 3-3, and not the foreign exchange (forex) measures.
Lisa has previously made a valid election out of the 12 month rule.
When Lisa enters into the sale contract on 1 March 2005, she acquires a right to receive foreign currency in return for the shares. On receiving these sale proceeds for the shares, Lisa's right to receive foreign currency ends, and FRE 2 occurs under subsection 775-45(1). Lisa will make a forex realisation loss if the A$ value of what she receives falls short of the forex cost base of the right worked out at the time of entering into the sale contract under subsection 775-45(4) and item 6 of the table in subsection 775-45(7). The forex cost base will be the market value of the shares sold under paragraph 775-85(b).
When Lisa is paid on 15 March 2005 and her right to receive the US$20,000 for the shares ceases, the US$20,000 received has a value of A$32,258 (A$1.00 = US$0.62). When the contract is entered into on 1 March 2005, Lisa's forex cost base, or market value of her shares, is equal to A$33,333 (A$1.00 = US$0.60).
In A$ terms, the amount Lisa receives falls short of her forex cost base by $1,075 ($32,258 - $33,333). As this difference is solely attributable to a currency exchange rate effect, Lisa makes a forex realisation loss of $1,075 under FRE 2.
As Lisa has previously elected under section 775-80 for the 12 month rule not to apply, this is deductible from her assessable income under section 775-30.
Last Modified: Friday, 2 December 2005