Tax treatment
Where a fair value election applies to a financial arrangement, the gains or losses for an income year will be determined by the accounting principles.
Where the Australian accounting principles, or comparable standards made under a foreign law, require that a fair value measurement through profit or loss be used to determine accounting profits or losses on financial arrangements for an income year, these gains and losses shall be used to determine the taxpayer's gain or loss for an income year from those financial arrangements.
Franked distributions
Franked distributions (received either directly by the taxpayer or indirectly through a partnership or trust) and rights to receive franked distributions (either directly or indirectly) must not be included as a gain or loss that is brought to account according to the fair value method.
Excluding franked distributions from the scope of the fair value election ensures these distributions will remain assessable according to section 44 of the ITAA 1936. Assessing the distribution under section 44 rather than under TOFA will ensure that the imputation system works appropriately for distributions such that franking credits allocated to such distributions are available to the recipient in the income year in which the distribution is taxed to the recipient.
See also:
Valuation issues
The term fair value is not defined in the tax acts. The term should take its ordinary commercial meaning. In this regard, AASB 139 defines fair value as '… the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date'.
The valuation methods used, and the guidance, definitions and requirements for the elective fair value method generally should be the same as those used for the fair value valuation in relevant accounting principles. As a result, if taxpayers use fair value estimates in their profit or loss accounts that accord with commercially acceptable valuation techniques, they can generally use the same estimates for the elective fair value method.
Example: Applying the fair value method to an option
Apple Co meets the eligibility requirements and makes the fair value method election.
Apple Co paid $10 to purchase an option to acquire a share in Banana Co.
The fair value method will apply to Apple Co's option to acquire a share in Banana Co as the option is a derivative recognised at fair value through profit or loss for accounting purposes.
The fair value of the option at the end of each year is set out in the table below. Apple Co sells the option at the end of year three for $20.
Apple Co makes a fair value gain of $5 in year one ($15 – $10), a fair value gain of $8 ($23 – $15) in year two. At the end of year three, when Apple Co disposes of its option for $20, it performs a balancing adjustment calculation under Subdivision 230-G and works out that it makes a $3 loss.
During the term of the arrangement, Apple Co recognises a net gain of $10, which is brought to account for tax purposes, reflecting the $10 overall economic gain overall; that is, a cost of $10 and proceeds of $20.
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Year 1
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Year 2
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Year 3
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Acquisition cost
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$10
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Fair value of option price at year end
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$15
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$23
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Disposal of option
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$20
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Tax treatment under the fair value method
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$5 ($15 –$10)
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$8 ($23 –$15)
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– $3*
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* Subdivision 230-G balancing adjustment applies when the financial arrangement ceases.
End of example