• Translation of notional interest amounts under a hire purchase arrangement

    This fact sheet deals with the translation of notional interest amounts which are deductible under a hire purchase arrangement.

    It does not consider any other amounts which may be deductible or assessable under Division 240 of the Income Tax Assessment Act 1997 (ITAA 1997).

    Example scenario

    Phelps Earth Movers Pty Ltd (Phelps) enters into a three year hire purchase arrangement with a US company for an item of earthmoving equipment. The arrangement is entered into on 1 January 2004 with payments in US dollars due on the 1st of each month commencing on 1 February 2004. There are 48 monthly payments - each of US$2,963.98. The cost or value of the item of equipment at the time of entering into the arrangement is US$120,000.00.

    Assume the following exchange rates:

    1 February 2004

    A$1 = US$0.71

    1 March 2004

    A$1 = US$0.70

    1 April 2004

    A$1 = US$0.69

    1 May 2004

    A$1 = US$0.71

    1 June 2004

    A$1 = US$0.70

    Phelps is an ordinary balancer for income tax purposes.

    End of example

    Are there any 'special accrual amounts' in this arrangement?

    Yes. The notional interest amounts which are deductible to the notional buyer (Phelps) under Division 240 of the ITAA 1997 are 'special accrual amounts' for the purposes of Subdivision 960-C of the ITAA 1997.

    How are the special accrual amounts worked out under Division 240 of the ITAA 1997?

    As a hire purchase arrangement, the arrangement set out in the scenario is subject to Division 240 of the ITAA 1997. Under Division 240, the hire purchase arrangement is treated as a notional sale of the earthmoving equipment by the US company, and a notional purchase of the earthmoving equipment by Phelps, financed by a notional loan provided by the US company (sections 240-10, 240-17, 240-20 and 240-25 of the ITAA 1997). Phelps is entitled to deduct notional interest (that is, the implicit interest element of each monthly payment as ascertained under section 240-60) for each income year during the hire purchase arrangement (that is, the 2003-04, 2004-05 and 2005-06 income years), pursuant to section 240-50.

    As the notional loan and amounts Phelps is required to pay under the hire purchase agreement are denominated in a foreign currency, the notional interest that is deductible will be denominated in a foreign currency.

    How are the special accrual amounts translated under Subdivision 960-C of the ITAA 1997?

    The deductible notional interest payments are calculated in US$ first - by applying the method statement in subsection 240-60(1) of the ITAA 1997.

    The notional interest amounts which are deductible for each income year are then translated into Australian currency at the exchange rate applicable at the time of each monthly payment under Subdivision 960-C of the ITAA 1997.

    For the purpose of the tax law, any amount in a foreign currency must be translated into Australian dollars (pursuant to subsection 960-50(1) of the ITAA 1997). Subsection 960-50(5) requires that special accrual amounts be calculated first (without any translation) before the calculated amount is then translated into Australian dollars.

    A 'special accrual amount', as defined in subsection 995-1(1) of the ITAA 1997, means an amount that is included in assessable income, or an amount that is a deduction from assessable income, under certain provisions, including Division 240 of the ITAA 1997.

    Accordingly, the notional interest amounts as ascertained under section 240-60 of the ITAA 1997 constitute special accrual amounts to the extent they are deductions from the assessable income of Phelps under Division 240 of the ITAA 1997.

    For the purpose of working out how much notional interest in Australian dollars it may deduct in an income year in its income tax return, Phelps will use the method statement in subsection 240-60(1) of the ITAA 1997. Pursuant to subsection 960-50(5), it will do this calculation in US dollars.

    The figure calculated is then translated into Australian currency at the exchange rate applicable at the time of payment or when it became deductible, whichever occurs first, under Item 8 of the table in subsection 960-50(6).

    Subsection 240-50(2) provides that a taxpayer is entitled to deduct notional interest for all 'arrangement payment periods' or parts thereof, in the relevant income year. The arrangement payment periods for Phelps will be monthly, commencing on 1 February 2004.

    In Phelps' case, each monthly payment consisting of the deductible notional interest amount, and the non-deductible capital amount, is paid at the same time the deductible notional interest amount is incurred and becomes deductible. Therefore, each deductible notional interest amount is to be translated at the time of the monthly payment in accordance with item 8(a) in the table in subsection 960-50(6) of the ITAA 1997.

    Example

    Phelps' deductible notional interest amounts for the five monthly payments in the 2003-04 income year are translated into a total of A$4,881.87. See table below.

    Deductible notional interest amounts - Phelps case

    Monthly payment due

    Monthly payment (US$)

    Arrangement payment period

    Deductible notional interest amount (US$)

    Exchange rate when monthly payment due

    Deductible notional interest amount (A$)

    1 February 2004

    2,963.98

    1-29 February 2004

    0.00

    @ US$0.71

    0.00

    1 March 2004

    2,963.98

    1-31 March 2004

    877.77

    @ US$0.70

    1,253.96

    1 April 2004

    2,963.98

    1-30 April 2004

    862.12

    @ US$0.69

    1,249.45

    1 May 2004

    2,963.98

    1-31 May 2004

    846.36

    @ US$0.71

    1,192.06

    1 June 2004

    2,963.98

    1-30 June 2004

    830.48

    @ US$0.70

    1,186.40

     

     

     

     

     

    4,881.87

    Note that both the deductible notional interest amounts and the exchange rates are adopted for the purposes of this fact sheet only.

    End of example

    See also:

      Last modified: 01 Mar 2016QC 18190