Translation of foreign currency rental expenses
This fact sheet deals with the appropriate exchange rate to use to translate foreign rental expenses into Australian dollars for tax purposes where the taxpayer has not chosen to use average exchange rates under the regulations.
A taxpayer who is an Australian resident acquires a rental property in New Zealand from which rental income is derived. The taxpayer is not in the business of renting properties, and operates on a cash basis. The rental property is managed by a real estate agent in New Zealand. The taxpayer took out a loan to acquire this property.
Deductible expenses are incurred as follows throughout the year in deriving the rental income:
1 July 2005:
- borrowing expenses of NZD1,000
- prepaid interest on loan NZD1,500
(exchange rate AUD1 = NZD1.10)
10 August 2005:
- council rates NZD600
(exchange rate AUD1 = NZD1.20)
22 October 2005:
- the taxpayer purchases and pays for an air conditioning unit for NZD2,000 and takes delivery at the same time
(exchange rate on this day is AUD1 = NZD1.05)
30 October 2005:
- the air conditioning unit is installed in the rental property
(exchange rate on this day is AUD1 = NZ1.10)
15th day of every month:
End of example
- real estate agent commission fee of NZD150
At what exchange rate should the NZD expenses be translated into Australian dollars for tax purposes?
The borrowing and interest expenses should be translated at the exchange rate prevailing on 1 July 2005, the council rates at the exchange rate on 10 August 2005, the air conditioning unit on 30 October 2005, and the commission fee on the 15th day of every month.
Tax relevant amounts denominated in a foreign currency must be translated into Australian dollars under subsection 960-50(1) of the Income Tax Assessment Act 1997 (ITAA 1997). An expense is an example of an amount under subsection 960-50(2)(b) of the ITAA 1997.
The table in subsection 960-50(6) of the ITAA 1997 sets out special translation rules that apply to various categories of expenses.
These are expenses the taxpayer can deduct, but must apportion that deduction over five years or the period of the loan, whichever is the shorter (under section 25-25 of the ITAA 1997). As the loan is for a period of greater than five years, the taxpayer will be able to deduct 1/5th of the expenditure in the year commencing 1 July 2005.
The entire NZD1,000 is translated into Australian currency at the exchange rate applicable at the time of payment, even though only 1/5th of the amount is deductible each year. This is because subsection 960-(50)(6) item 8(a) of the ITAA 1997 provides that the amount is to be translated at the earlier of when it is paid or when it becomes deductible.
The AUD equivalent of the NZD1,000 borrowing expenses is therefore AUD909 (NZD1,000/1.10). For the years ended 30 June 2005 to 30 June 2009, the taxpayer will be allowed to deduct 1/5th of this amount (that is, AUD182).
Interest, council rates, and commission fee expenses:
These are amounts that the taxpayer can deduct. As the taxpayer accounts for income and expenses on a cash basis, they are deductible at the time they are paid. Pursuant to subsection 960-50(6) item 8(a) of the ITAA 1997, the amounts are to be translated to Australian currency at the exchange rate applicable at the time of payment. The interest expense of NZD1,500 is translated at AUD1 = NZD1.10 (the rate prevailing on 1 July 2005), which results in an allowable deduction of AUD1,364.
The council rates are translated at AUD1 = NZD1.20 (the rate prevailing on 10 August 2005), which results in an allowable deduction of AUD500.
The real estate agent commission fee of NZD150 is translated on the 15th day of every month at the rate prevailing on that day.
Air conditioning unit:
The unit is a depreciating asset in respect of which deductions are allowable under Division 40 of the ITAA 1997. The cost of the asset is translated into Australian currency at the earlier of when the taxpayer begins to hold the asset, or when the obligation to pay for it is satisfied (under subsection 960-50(6) item 2(a) and (b) of the ITAA 1997). As the taxpayer begins to hold, and pays for, the unit on 22 October 2005, the exchange rate of AUD1 = NZD1.05 prevailing on this day will be used to work out the cost of the unit. The amount of AUD1,905 (AUD2000/1.05) will be used when working out the decline in value that can be claimed as a deduction (under Division 40 of the ITAA 1997).
Note: Because the taxpayer operates on a cash basis, the expenses become deductible at the same time they pay for them. As no time elapses between when the expenses become deductible, and when the expenses are paid, there are no forex realisation gains or losses on these amounts.