Foreign exchange (forex): functional currency - accounting and reporting
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When we say 'foreign resident', it has the same meaning as non-resident.
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This fact sheet provides an overview of the functional currency rules1, including how they affect tax accounting and reporting.
It provides information for Australian residents and foreign residents with a permanent establishment in Australia. It does not cover either:
- income from overseas permanent establishments of resident taxpayers
- income attributable to offshore banking units, controlled foreign companies (CFCs) or transferor trusts.
Eligible taxpayers who keep their accounts solely or predominantly in a particular foreign currency can choose to use that functional currency as their unit of account to calculate their taxable income or tax loss. The core foreign currency translation rules continue to apply to amounts and transactions not covered by the functional currency rules.
If you have made an effective functional currency choice, you do not translate transactions you undertake in either a foreign currency or in your applicable functional currency into A$. Rather, you translate all amounts that are not in your applicable functional currency (including amounts denominated in A$) into the applicable functional currency. At the end of the income year, you translate only your net amount of taxable income as calculated in your applicable functional currency into A$. If you have a tax loss, you simply carry this loss forward in your applicable functional currency.
Once you choose to use a non-A$ functional currency, you must use that currency as the unit of account in your day-to-day tax accounting.
All amounts included in working out your taxable income or tax loss must be in the applicable functional currency. This means you must translate all amounts you receive or pay in another currency, including A$ amounts, into the applicable functional currency.
The functional currency translation rules, including applicable exchange rates, follow the principles in the core foreign currency translation rules for translating foreign currency amounts to A$2. However, the A$ is treated as a foreign currency, while your applicable functional currency is not a foreign currency for the purposes of working out your taxable income or tax loss in the applicable functional currency3.
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A forex realisation gain or loss may arise for certain amounts if there is a difference in prevailing exchange rates at the relevant times. For example, the exchange rate applicable at the time you incur an amount may be different from the exchange rate applicable when you pay the amount. In this situation, changes in the value of the A$ against the applicable functional currency can bring about a forex gain or loss. See example 1 below.
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Example 1: Trigger of foreign currency loss
Stellar Rex Inc. (Stellar Rex), a US company with a branch in Australia, chooses to account for the taxable income of its Australian branch in a functional currency. For Stellar Rex's purposes, US$ is the applicable functional currency and A$ is a foreign currency.
Stellar Rex contracts to purchase a depreciating asset from an Australian company in A$, as follows:
Year one
Stellar Rex contracts to purchase the asset for A$10,000. Stellar Rex holds the asset from the date of contract.
At the contract time, A$1.00 = US$0.50. Therefore, the cost of the asset in the applicable functional currency is US$5,000.
Year two
Thirteen months after beginning to hold the asset, Stellar Rex pays A$10,000 for the asset.
At this time A$1.00 = US$0.55, so the A$10,000 Stellar Rex pays is equivalent to US$5,500.
As the payment was made more than 12 months after first holding the asset, the loss is not a short-term forex realisation loss - refer to section 775-75 of the ITAA 1997. Therefore, Stellar Rex makes a forex realisation loss of US$500 under Foreign exchange (forex): realisation event 44. Stellar Rex will take this loss into account when calculating its taxable income for year two. They will calculate their taxable income in US$ and translate it into A$ at the end of their income year, for the purpose of working out the amount of A$ income tax they are liable to pay.
The functional currency rules include special translation rules5 to cover relevant income tax amounts that are attributable to events that happened before your current functional currency choice took effect - that is, the pre-choice amounts.
Relevant pre-choice amounts are those that are relevant to working out your taxable income or tax loss in a post-functional currency choice year and so must be translated into your applicable functional currency.
These amounts are generally either assets - such as borrowing expenses (a prepaid expense for income tax purposes), depreciating assets, CGT assets, trading stock on hand, traditional securities - or liabilities, such as the amount of principal outstanding on a loan you received. An amount of a carry forward tax loss at the time your functional currency choice takes effect is also a relevant pre-choice amount.
If you have not previously made a functional currency choice, you should translate a relevant pre-choice amount as follows:
- firstly, into A$ at the exchange rate applicable at the time of the transaction or event
- secondly, into the applicable functional currency at the exchange rate at the time your functional currency choice took effect.
In a practical sense, the first step of the two step translation process will generally have already taken place under the ordinary foreign currency translation rules.6
If you have previously made a choice to use a non-A$ currency as your applicable functional currency, you should translate a relevant pre-choice amount:
- firstly, into the previous applicable functional currency at the exchange rate applicable at the time of the transaction or event
- secondly, into the new applicable functional currency at the exchange rate at the time your new functional currency choice took effect.
In a practical sense, the first step of the two step translation process will have already taken place under the ordinary functional currency translation rules.7
Example 2: Sale of assets acquired before making a functional currency choice
FION Inc (FION), a foreign resident corporation, operates through a permanent establishment in Australia. FION conducts its business predominantly in Japanese Yen.
In the income year ended 30 June (year one), it chooses to use Yen (¥) as its functional currency. The choice applies for the income year starting 1 July (year two).
In the income year ended 30 June (year three), FION sells a tourist resort for ¥600 million, which it had purchased before year one for ¥500 million.
As FION's functional currency is ¥ the capital gain or capital loss will be calculated in ¥. However, as FION had not made a choice to use ¥ as its applicable functional currency at the time it purchased the tourist resort - that is, it was still using A$ for income tax purposes - the ¥ cost of the resort is translated to A$ at the exchange rate prevailing at the time of the purchase. This A$ amount is then translated to ¥ at the exchange rate prevailing at the time FION's choice to use ¥ as its functional currency took effect.
Assume the exchange rates were:
This means the cost base for the purpose of calculating the capital gain or loss on the disposal of the tourist resort is:
The capital gain, calculated in FION's applicable functional currency, is:
The functional currency rules allow you to work out your taxable income or tax loss in your applicable functional currency. However, all tax reporting must still be expressed in A$. When reporting on your tax return or business activity statement, you work out the reported amounts in your applicable functional currency and then translate these amounts into A$.
For tax reporting purposes, if a translation is needed for label amounts (other than the taxable income amount) use the same translation rate as the taxable income translation rate. If you don't have a taxable income amount in a given income year (that is, you have a tax loss), you should use the same rate you would have used to translate a taxable income amount into A$.
Amount type
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Treatment
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Amounts used in working out taxable income or tax loss in the applicable functional currency.
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Include these amounts in the taxable income calculation in the functional currency before translating taxable income from the functional currency into A$.
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Amounts used to work out taxable income or a tax loss that are in a foreign currency. For example:
- the A$ amount of a dividend, including the gross-up amount for a franked dividend.8
- amounts of foreign income, including the gross-up amount for foreign tax paid for that income.9
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Translate into the functional currency using the applicable exchange rate for that amount.
As 'gross-up' amounts contribute to the calculation of your taxable income or tax loss, you must translate them into the functional currency. Include the functional currency amount in the taxable income calculation before translating taxable income from functional currency into A$ - see examples 3 and 4.
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Carry forward losses.
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Carry forward losses are allowable deductions that reduce taxable income.
Identify the carry forward loss amount in the functional currency from the previous income year.
Include these amounts (as deductions) in the taxable income calculation in the functional currency, before translating taxable income from functional currency into A$.
If you have a tax loss, you carry forward the amount of the tax loss in the functional currency to the following income year.
However, when reporting the value of a tax loss, you must translate it from functional currency into A$.
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Tax-exempt amounts that reduce carry forward losses.
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Tax-exempt amounts that reduce carry forward losses are translated into the functional currency, generally upon being derived. They are then used to absorb the loss to the extent of their value.
When reporting the value of a tax-exempt amount, translate it into A$.
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Foreign income tax offsets (FITO).10
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The value of foreign income tax offset (FITO) amounts is not used in working out taxable income, except when calculating the attributable income of a controlled foreign company (CFC) or transferor trust.
The core foreign currency translation rules apply, and the value of foreign tax paid used to calculate foreign income tax offsets is translated into A$ when the foreign tax is paid - see example 3.
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Franking credits.
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The value of franking credits is not used in working out taxable income.
Franking credits are a tax offset11. The amount of the tax offset you are entitled to as a result of receiving a franked dividend is not translated into your functional currency. Your tax offset amount will equal the A$ amount of the franking credit attached to the dividend you received before it was translated into functional currency.
Add the A$ value of franking credits to your franking account without translation into functional currency - see example 4.
You must keep your franking account in A$.
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Tax offsets and rebates.
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Tax offsets and rebates are not used to work out taxable income or a tax loss.
The core foreign currency translation rules apply.
If the amount is already in A$, then no translation takes place.
If the amount is in a non-A$ currency, translate the amount into A$.
Do not translate these amounts into functional currency first.
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Example 3: Foreign income tax offsets
In this example, you choose to use US dollars (US$) as your applicable functional currency.
To calculate your assessable income:
¥115 = US$1.00 = A$2.00.
¥11,500 is derived by you consisting of:
¥10,350 cash and ¥1,150 tax withheld in Japan.
To work out your taxable income, translate ¥11,500 into the US$ functional currency as follows:
¥11,500 = US$100 added to assessable income.
Taxable income in US$, including the amount you received in ¥, is translated into A$ at the end of the income year. If, between the time you derived the income and the end of the income year the relative value of the US$-A$ changes, this change will be reflected in the amount of A$ assessable income you will eventually bring to account. If at the end of the income year the relative value is US$1.00 = A$1.75, then you will report the A$ assessable income you received from the ¥11,500 transaction as A$175.
To calculate your FITO:
Translate the ¥1,150 tax withheld amount into A$ as follows:
¥1,150 = A$20.
A$20 is used in calculating the amount of the foreign income tax offset, being the lesser of the amount of the foreign tax paid or the Australian tax payable on the foreign income.
Example 4: Franking credits
US$1.00 = A$2.00
XYZ Corporation (XYZ) is an Australian resident company, which chooses to use US$ as its applicable functional currency.
XYZ derives a fully franked dividend as follows:
A$70 cash
A$30 gross-up amount (franking credit value).12
Assessable income calculation
XYZ translates A$100 ($70 + $30) into US$ as follows:
A$100 x 0.5 = US$50.
At the end of the income year, US$50 (and other taxable income values) are translated into A$ at regulation rate.
Franking account balance
Add A$30 to the franking account balance. No translation takes place.
Example 5: Application of translation rule to a monetary limit
Exact Limited (Exact) has made a valid choice to use US$ as its applicable functional currency. In year one, Exact purchases a car for US$40,000. At the time, the price is equivalent to A$72,700.
If the car limit under section 40-230 of the ITAA 1997 was A$60,000 in year one, Exact would apply that provision by converting the limit to US$33,012. The first element of the US$ cost of a car is; therefore, reduced to that amount.
When completing your business activity statement (BAS), you:
- calculate your instalment income in the applicable functional currency
- translate your instalment income into Australian dollars at the appropriate rate
- complete label T1 of the BAS accordingly.
For more information, visit Foreign exchange (forex) or phone us on:
- 13 28 61 for personal tax enquiries
- 13 28 66 for business tax enquiries.
If you do not speak English well and need help from the ATO, phone the Translating and Interpreting Service on 13 14 50.
If you are deaf, or have a hearing or speech impairment, phone the ATO through the National Relay Service (NRS) on the numbers listed below:
- TTY users, phone 13 36 77 and ask for the ATO number you need
- Speak and Listen (speech-to-speech relay) users, phone 1300 555 727 and ask for the ATO number you need
- internet relay users, connect to the NRS on relayservice.com.au and ask for the ATO number you need.
1 Subdivision 960-D, Income Tax Assessment Act (ITAA) 1997.
2 Refer to subsection 960-50(6) of Subdivision 960-C and also subsection 960-80(6) of Subdivision 960-D of the ITAA 1997.
3 Refer to subsection 960-80(1) of the ITAA 1997.
4 For more information about forex realisation event 4, refer to Foreign exchange (forex) realisation event 4.
5 Section 960-85 of the ITAA 1997.
6 Therefore under subsection 960-50 of Subdivision 960-C of the ITAA 1997.
7 Under section 960-80 of Subdivision 960-D of the ITAA 1997.
8 If you receive a franked dividend, section 207-20 of the ITAA 1997 requires you to 'gross-up' your assessable income by the amount of the franking credit - and it also entitles you to a tax offset equal to the amount of the franking credit.
9 If you have paid foreign income tax on an amount of foreign income (refer to section 6AB of the ITAA 1936) which is included in your assessable income, the amount of foreign income must be 'grossed-up' to include the amount of foreign income tax you paid for that foreign income.
10 Subsection 770-10(1) of the ITAA 1997 provides that you are entitled to a foreign income tax offset (FITO) for foreign income tax you paid for an amount of foreign income that is included in your assessable income in an income year. FITO for the attributable income of a CFC is not covered in this fact sheet.
11 Subsection 207-20(2) of the ITAA 1997.
12 Subsection 207-20(1) of the ITAA 1997.
Last Modified: Friday, 26 April 2013