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  • Common forex transactions

    Foreign currency denominated bank accounts

    This foreign exchange (forex) information relates to certain foreign currency denominated bank accounts. It describes the general application of foreign currency tax laws to those accounts, and answers some frequently asked questions.

    A foreign currency denominated bank account (forex account) can be a forex deposit account or a forex loan account (including a forex credit card account).

    The foreign currency tax laws (forex measures) relevant to this information are contained in Division 775 and Subdivision 960-C of the Income Tax Assessment Act 1997 (ITAA 1997). The forex measures have broad application to transactions denominated in foreign currency.

    See also:

    ITAA 1997

    The forex measures set out rules for expressing the Australian currency values of amounts that are denominated in foreign currency, and explain how to calculate gains and losses that are attributable to currency exchange rate fluctuations. The measures treat many of those gains and losses as assessable income or allowable deductions.

    Under the forex measures:

    • assessable gains are referred to as 'forex realisation gains'
    • deductible losses are referred to as 'forex realisation losses'
    • forex realisation gains and losses only arise when 'forex realisation events' happen.

    The forex measures apply generally to the realisation of assets, rights, and parts of rights acquired, and obligations and parts of obligations assumed, on or after the 'applicable commencement date'. Bank accounts are rights or obligations. For example, if you have a savings account, you have a right (a 'chose in action') that relates to the money deposited in the account. If you have a loan account, you have an obligation to repay.

    The forex measures apply to all taxpayers except for, broadly speaking, taxpayers that are banks or similar financial institutions. However, if you hold a forex account with a bank (such as a savings or loan account in foreign currency) you will usually have to consider the application of these laws in calculating your assessable income and allowable deductions.

    The '$250,000 balance election' is an important choice that may be helpful to taxpayers who do not have large forex account balances. If you satisfy all requirements for making this election, and remain eligible to rely on it, you can disregard certain gains and losses that you would otherwise have to return.

    See also:

    Which forex accounts do the forex measures affect?

    Unless you made a 'transitional election', forex measures do not apply to transactions on your forex account if you opened that account:

    • after 19 February 1986, and
    • before your 'applicable commencement date'.

    In general, for transactions on forex accounts opened between 19 February 1986 and your applicable commencement date, any taxation consequences attributable to the effect of currency exchange rate fluctuations are determined by application of laws that were in place before the forex measures applied.

    For most taxpayers, the 'applicable commencement date' was the first day of their 2003-04 income year (which in most cases was 1 July 2003).

    Taxpayers on a substituted accounting period (SAP) for taxation purposes, and whose first day of their 2003-04 income year was before 1 July 2003, will have an 'applicable commencement date' of the first day of their 2004-05 income year.

    Forex accounts with a low balance

    The '$250,000 balance election' may be an attractive option for taxpayers who do not have large forex accounts. If you qualify for this election, you should consider whether you would like to choose to have it apply. After you make the $250,000 balance election, and continue to be eligible to rely on it, you will not realise any more assessable forex gains or deductible forex losses on withdrawals from relevant forex savings accounts or repayments on relevant loan accounts.

    See also:

    How do I make a gain or loss on my forex accounts?

    Transactions on a forex account often result in forex realisation gains or losses being made. Examples of this include withdrawing money from a foreign currency savings account, or paying all, or part, of the balance of a foreign currency loan account.

    Forex accounts with a credit balance (that is, deposit or savings account)

    A forex realisation gain or loss may arise on a forex account that has a credit balance at the time a withdrawal is made. This is due to fluctuations in exchange rates which may result in the Australian dollar value of amounts deposited into a forex account with a credit balance - measured at the time of the deposit - being more than or less than the Australian dollar value of that amount measured at the time of withdrawal.

    The difference is usually brought to account under the forex measures as assessable income if it is a gain, or an allowable deduction if it is a loss, to the extent that the gain or loss is due to currency exchange rate movements between the Australian dollar and the foreign currency. The forex realisation gain or loss represents the gain or loss in Australian dollar terms made in respect of the right that was acquired against the banker, measured between the time the right was acquired (which was at the time of deposit) and the time that right ceased (which was at the time of withdrawal).

    Forex accounts with a debit balance (that is, loan account)

    A forex realisation gain or loss may arise on a forex account that has a debit balance at the time a repayment on that account is made. A common example of such an account is a forex loan account. Due to fluctuations in exchange rates, a forex realisation gain or loss would arise if the Australian dollar value of an amount - measured at the time you received the funds - is different from the Australian dollar value of that amount measured at the time you deposited (repaid) that amount into the loan account.

    The difference is usually brought to account under the forex measures as income, or an allowable deduction, to the extent that it is due to currency exchange rate movements between the Australian dollar and the foreign currency. The forex realisation gain or loss represents the gain or loss in Australian dollar terms made in respect of the obligation owed to the banker, measured between the time that obligation was incurred (which was the time the funds were received) and the time that obligation ceases (which is at the time of deposit).

    How do I work out when I deposited the actual amounts that I am withdrawing?

    Under the ordinary operations of the forex measures, when a withdrawal is made from a forex savings account, it is essential to identify the Australian dollar value of the foreign currency amount initially deposited to the account, and its Australian dollar value on withdrawal. Similarly, when an amount on a forex loan account is repaid, it is essential to know the value of the amount initially borrowed and the value when it is repaid.

    Due to one unit of foreign exchange being identical to and interchangeable with another unit (a quality referred to as 'fungibility'), a 'first-in first-out' rule usually applies. This rule identifies the time the foreign currency amount(s) that are withdrawn from a forex savings account were originally deposited, and the time that the amount of a repayment on a forex loan account was originally borrowed. The first-in first-out rule applies under the ordinary operation of the forex measures. However, in certain circumstances, you can choose to have the forex measures apply differently to transactions on your forex accounts.

    The forex measures allow you to choose certain alternative methods that may make it easier to calculate any gains and losses on your forex account.

    Alternative methods of calculation are available by making the 'retranslation election' or the 'weighted average election'.

    See also:

    Are my ordinary accounting calculations relevant to the calculation of forex realisation gains or losses for tax purposes?

    If you are in business, you may have to apply generally accepted accounting principles to work out the notional foreign exchange gain or loss on your forex account at the end of each income year for other purposes (that is, for purposes other than taxation). This accounting exercise is generally irrelevant for the purposes of applying the forex rules.

    The forex rules will generally only bring to account a forex realisation gain or loss on your forex account when you have either:

    • withdrawn money from your forex savings account, or
    • repaid some, or all, of the balance on your forex loan account.

    However, the 'retranslation election' operates in a way that may be similar to the practices you adopt for ordinary accounting purposes.

    All my foreign currency income and expenses go through my forex account. Do I have to separately convert the income and expenses for tax purposes?

    Yes. The rules governing the translation (often called the 'conversion') of foreign currency denominated income and expenses are different from the rules relating to the calculation of forex gains and losses resulting from the effect of exchange rate fluctuations (such as those on forex accounts).

    In very general terms, the translation rules in Subdivision 960-C of the ITAA 1997 specify how and when you should translate (convert) foreign currency denominated amounts that are relevant to taxation (including income and expenses) into equivalent Australian dollar amounts. The forex measures in Division 775 of the ITAA 1997 apply to calculate gains and losses that occur as a result of the effects of currency exchange rate fluctuations. They apply to a broad range of foreign currency denominated assets and liabilities (foreign currency; and rights, parts of rights, obligations and parts of obligations that are denominated in foreign currency such as a forex account).

    You will need to apply these translation rules to properly bring those amounts to account in your income tax return. The general translation rules will apply whether or not the income is paid into, or expenses paid out of, a forex account.

    See also:

    Foreign currency denominated shares

    This document contains information on the application of the foreign exchange gain and loss Income Tax Assessment Act 1997 (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.

    Shares acquired or sold under contracts entered into before 1 July 2003

    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.

    Shares acquired or sold under contracts entered into from 1 July 2003

    What gains or losses do the forex measures apply to?

    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
    • (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.

    Acquisition of foreign currency denominated shares

    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.

    Disposal of foreign currency denominated shares

    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.

    Currency exchange rate effect

    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:

    • 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
    • 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.

    Short-term transactions – the 12 month rule

    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.

    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.

    See also:

    Example scenario 1

    All legislative references made in the following example scenario are to the ITAA 1997.

    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.

    Example scenario 2

    All legislative references made in the following example scenario are to the ITAA 1997.

    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

    End of example

    Foreign currency hedging transactions

    All legislative references made in this document are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise specified.

    Entities may be exposed to foreign currency fluctuation risk, particularly when a transaction is denominated in a foreign currency.

    To mitigate this risk, entities often enter into foreign currency hedging transactions. The purpose of a foreign currency hedge is to offset all, or part, of any currency fluctuation on an underlying transaction. This is generally achieved through the use of derivatives such as forwards, futures, options and swaps.

    For the purposes of the foreign currency gains and losses rules contained in Division 775, any forex realisation gain or loss on the underlying transaction is calculated separately to any forex realisation gain or loss arising on the hedge contract.

    See also:

    Example scenario

    On 7 July 2003 'A Co' enters into a contract with 'US Co' to sell goods to US Co for an agreed price of US$1,000,000 (the market value of the goods). On entering into the contract, A Co acquires a right to receive foreign currency (the agreed price of US$1,000,000). At the time of entering into the contract, the exchange rate is A$1 = US$0.6845. Delivery and ownership of the goods passes to US Co on 7 January 2004, and A Co receives the consideration in US dollars on that day.

    In order to mitigate the risk of an adverse movement in currency exchange rates between the date of the contract and the date of receipt of the US currency, A Co enters into a forward exchange contract on 7 July 2003 to sell US$1,000,000 to 'B Co' at an exchange rate of A$1 = US$0.6845. At the time of entering into the forward exchange contract, A Co assumes an obligation to pay foreign currency (being the US$1,000,000 payable by A Co on settlement). Settlement of this contract also occurs on 7 January 2004.

    On 7 January 2004 A Co receives US$1,000,000 from US Co. At that time, the exchange rate is A$1 = US$0.7677. At the same time, under the forward exchange contract, A Co has an obligation to sell US$1,000,000 to B Co at an exchange rate of A$1 = US$0.6845.

    The forex realisation gain or loss on these transactions is set out below.

    Sale of goods

    Contract

    Date

    US$

    Exchange rate
    A$1 = US$

    A$

    Sale of goods

    7 Jul 2003

    1,000,000

    0.6845

    1,460,920

    Proceeds from sale

    7 Jan 2004

    1,000,000

    0.7677

    1,302,592

    Loss

     

    158,328

    When A Co receives the US$1,000,000 on 7 January 2004 from US Co, forex realisation event 2 (section 775-45) happens as A Co ceases to have the right to receive foreign currency. A Co makes a forex realisation loss of A$158,328 (subsection 775-45(4)), as the amount received (A$1,302,592) is less than the forex cost base of the right (A$1,460,920) and all of the shortfall is attributable to a currency exchange rate effect.

    The forex realisation loss A Co makes is deductible in the 2003-04 income year under section 775-30.

    The gain or loss made on the forward exchange contract that A Co entered into with B Co is worked out separately to the gain or loss made on the sale of goods contract.

    See also:

    Forward exchange contract

    Contract

    Date

    US$

    Exchange rate
    A$1 = US$

    A$

    Amount paid by
    A Co under the contract

    7 Jan 2004

    1,000,000

    0.7677

    1,302,592

    AUD value of the US paid (sold) by A Co

    7 Jan 2004

    1,000,000

    0.6845

    1,460,920

    Gain

     

    158,328

    When A Co pays US$1,000,000 on 7 January 2004, forex realisation event 4 (section 775-55) happens as A Co ceases to have the obligation to pay foreign currency. A Co makes a forex realisation gain of A$158,328 (subsection 775-55(3)), as the amount paid (A$1,302,592) is less than the amount the US$1,000,000 is sold for under the contract (referred to as 'the proceeds of assuming the obligation', which is A$1,460,920), and the entire shortfall is attributable to a currency exchange rate effect.

    The forex realisation gain A Co makes is included in assessable income in the 2003-04 income year under section 775-15.

    In this example, in practical terms, the hedge is fully effective in mitigating the risk of any adverse movement in foreign currency exchange rates on the sale of goods contract during the period the sale proceeds remained outstanding. The forex realisation loss on the sale of goods will offset the forex realisation gain made on the forward exchange contract, even though the forex outcomes of each transaction have to be calculated separately.

    See also:

    End of example
    Last modified: 01 Mar 2016QC 18322