Legislation
The foreign exchange (forex) measures are contained in Division 775 and Subdivisions 960-C and 960-D of the Income Tax Assessment Act 1997 (ITAA 1997).
These provisions were inserted into the ITAA 1997 by the New Business Tax System (Taxation of Financial Arrangements) Act (No. 1) 2003.
Foreign currency gains and losses
Division 775 of the ITAA 1997 contains rules under which foreign currency gains and losses are brought to account when they have been ‘realised’. This is the case even if the monetary elements of the transaction are not converted to Australian dollars.
These rules apply when one of the following forex realisation events happens:
- Forex realisation event 1 – Disposal of foreign currency
- Forex realisation event 2 – Ceasing to have a right to receive foreign currency
- Forex realisation event 3 – Ceasing to have an obligation to receive foreign currency
- Forex realisation event 4 – Ceasing to have an obligation to pay foreign currency
- Forex realisation event 5 – Ceasing to have a right to pay foreign currency.
These rules apply to gains or losses that are attributable to fluctuations in a currency exchange rate, or to an agreed exchange rate differing from an actual exchange rate.
If a gain or loss is brought to tax both under Division 775 and under another provision of the tax law, it is respectively assessable or deductible only under these measures.
Special rules apply to some short-term transactions if capital gains tax (CGT) and depreciating assets are acquired or disposed of, unless an election is made that these rules not apply – Capital assets and the 12 month rule.
Common forex transactions include those made through foreign currency denominated accounts, shares and hedging transactions.
Division 775 does not apply to financial arrangements that are subject to Division 230 of the ITAA 1997 – refer to Taxation of financial arrangements (TOFA).
Translation rules
Subdivision 960-C of the ITAA 1997 provides for a general translation (conversion) rule which, broadly, expresses all tax relevant amounts in Australian currency. There is a regulation-making power under which, for example, a particular translation method could be prescribed.
Subdivision 960-D of the ITAA 1997 allows certain entities to make an election to use a foreign currency (applicable functional currency) to account for its transactions.
When the forex measures started
The measures generally apply prospectively to the realisation of assets, rights and obligations acquired or assumed on or after the applicable commencement date. This is most commonly the first day of the 2003-04 income year (that is, for most taxpayers, 1 July 2003).
If, however, you have an early substituted accounting period, and the first day of your 2003-04 income year is earlier than 1 July 2003, the applicable commencement date is the first day of the 2004-05 income year.
Generally, tax consequences of gains or losses on existing forex assets, rights and obligations that were acquired or assumed before the applicable commencement date are to be determined under the law as it was before these measures.
Example scenario
ABC Pty Ltd is an early balancer that has a substituted accounting period (SAP) that operates from 1 January to 31 December. It sells trading stock to overseas buyers in a foreign currency. As the beginning of its 2003-2004 income year is 1 January 2003, the new forex measures will not apply to its foreign currency dealings until 1 January 2004. As an early balancer, this is the first day of ABC Pty Ltd's 2004-2005 income year. Therefore, the applicable commencement date of the new forex measures for ABC Pty Ltd will be 1 January 2004.
This applies equally to conversion of its foreign sourced income to Australian dollars. The new conversion rules will not apply to ABC Pty Ltd until 1 January 2004.
End of exampleTwo exceptions to the prospective application of the measures are:
Transitional election
You could choose to have the measures apply to the realisation of existing foreign currency, rights and obligations. For most taxpayers, this election had to be made by 16 January 2004. A specific anti-avoidance rule can be applied if you used this election to take undue advantage of differences in treatment between the current and previous laws.
Extension of an existing loan contract measure
If you have an existing loan that is extended by either a new contract, or a variation of the existing contract, the measures will apply after the extension.
An overview of the foreign exchange (forex) measures including transitional rules and the start date.