Documentation requirements
The recording requirements an entity must make under section 230-355 include both:
- details that are required under the accounting principles
- terms of the determinations it makes under section 230-360.
The terms of the determinations that an entity makes under section 230-360 must show the basis on which the entity will allocate gains and losses from a hedging financial arrangement for tax purposes.
The determinations must be objective and result in a record of both the:
- time at which the gain or loss from the hedging financial arrangement is taken into account for TOFA purposes
- way in which the gain or loss will be dealt with under section 230-310.
To satisfy the requirement of recording the terms of the determinations an entity makes under section 230-360, it can do either of the following:
- separately record the details required by that section for each of its hedging financial arrangements
- make a common record, such as a hedge master documentation, for each of several identified classes of hedging financial arrangements that the entity has. This will be sufficient where there is an objective link between the common record and the hedging financial arrangement.
An example of the terms of a determination made under paragraph 230-355(1)(c) is provided in Appendix – Sample tax hedging documentation.
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When the record must be made
The time by which the documentation must be in place differs for existing hedging financial arrangements (under a transitional election) and hedging financial arrangements starting from the time TOFA begins.
Existing hedging financial arrangements – transitional election
If an entity started to have a hedging financial arrangement before entering into TOFA, the entity could have elected to have TOFA apply to that arrangement (sub-item 104(2) of Schedule 1 to the TOFA Act).
Pursuant to sub-item 104(9)(c) of Schedule 1 to the TOFA Act, the hedging record must be in place:
… at, or soon after, the time you make the election, you have in place records in relation to the arrangement that satisfy the requirements of section 230-355 and section 230-360 (other than subparagraph 230-360(2)(c)(ii)).
In general, the necessary hedging documentation for existing hedging financial arrangements must be in place at, or soon after, the time the hedging election is made.
Hedging financial arrangements from 1 July 2010
For hedging financial arrangements the entity started to have from the time TOFA begins to apply to its financial arrangements, subsection 230-355(3) states:
The record must be made or in place, either:
(a) at, or soon after, the time when you create, acquire or apply the hedging financial arrangement
(b) at such other time as is provided for in the regulations for the purposes of this paragraph.
If TOFA begins to apply to the entity from 1 July 2010 and the hedging financial arrangements method is elected, the required records for the hedging financial arrangements must be in place at the same time the hedging financial arrangement is created, acquired or applied. It is not sufficient to put relevant tax documentation in place when the hedging election is made.
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Regulations allowing for an extension of time
The Income Tax Assessment Amendment Regulations 2011 (No. 4) (80 of 2011) extended the time for recording details of the basis for allocating gains and losses for certain hedging financial arrangements for income tax purposes until 30 June 2011.
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Hedge effectiveness requirements
It is a requirement of section 230-365 that the hedge be expected to be highly effective within the meaning of the accounting principles. Hedge effectiveness is addressed in Taxation Determination TD 2011/23.
If the hedge proves to be ineffective, this will result in a balancing adjustment under section 230-375.
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Tax treatment
The gain or loss from a hedging financial arrangement is equal to the overall gain or loss from the arrangement pursuant to subsection 230-300(2). This will be the case whether a gain or loss results from, among other things, the expiration, sale, termination or exercise of a hedging financial arrangement (see Taxation Determination TD 2012/13).
A gain or loss under subsection 230-300(2) will be allocated to income years in accordance with the determination made under section 230-360 (see Tax-timing and tax-status matching).
The exception to this is if a hedging event under section 230-305 applies, in which case the gain or loss is identified in subsection 230-300(5).
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Hedging events under section 230-305
Where an event in the table under subsection 230-305(1) happens (for example, revocation of the hedge or the hedge is ineffective), pursuant to subsection 230-300(5) the gain or loss from the hedging financial arrangement is the gain or loss that would have been made from the hedging financial arrangement if the entity ceased to have the arrangement for its fair value at the time of the event.
This gain or loss will either be allocated according to the determination made under section 230-360, or to the income year in which the event happens, depending on which item of the table in section 230-305 applies to the event.
Paragraph 230-300(5)(b) states that TOFA applies as if the arrangement had been acquired (or reacquired) for its fair value immediately after the event. This requires a reassessment of whether the arrangement will continue to satisfy the definition of hedging financial arrangement in subsection 230-335(1) after the time of the deemed reacquisition.
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Tax-timing and tax-status matching
Under the hedging financial arrangements method, the timing of the gains or losses on the hedging financial arrangement is matched with the timing of gains or losses on the hedged item (section 230-360). Similarly, the tax status of the gains or losses on the hedging financial arrangement is generally matched with the tax status of the gains or losses on the hedged item (subsection 230-310(4)).
The tax-timing matching rule ensures that gains and losses made from a hedging financial arrangement are allocated on an objective, fair and reasonable basis. The gains and losses allocated must fairly and reasonably correspond with the basis on which gains, losses and other amounts in relation to the hedged item are recognised or allocated for tax purposes (subsection 230-360). There might be more than one way to fairly and reasonably do this, but the basis of allocation must correspond to the basis of taxation for the hedged item.
Under the tax-status matching rule, the tax classification of gains and losses from hedging financial arrangements are generally matched with the classification of the hedged item (section 230-310). For example, as a result of the tax-status matching rule, a gain or loss made on a hedging financial arrangement might be classified as on capital or revenue account, depending on the classification of the hedged item.
The tax-status matching rules do not apply to gains and losses made from an existing hedging financial arrangement. As a result, gains and losses made from these existing arrangements will be on revenue account and tax status or classification will be determined in the manner set out in subsection 230-310(3).
Example: Applying the hedging financial arrangement method
Ben Co is an Australian company with a foreign subsidiary that has an active business in a foreign jurisdiction. Ben Co's interest in the net assets of the foreign subsidiary is a net investment in a foreign operation as defined in AASB 121 being:
- the net assets of the foreign subsidiary in the consolidated financial report of Ben Co
- long-term intra-group debt lent by Ben Co to the foreign subsidiary.
The only election Ben Co has made is the hedging financial arrangement method election.
Ben Co takes out a series of rolling foreign exchange forward contracts to hedge the exchange rate risk in relation to its interest in the net assets of the foreign subsidiary.
Ben Co will recognise a relevant portion of the gains and losses from these forward contracts for the purposes of section 230-360. The time of recognition will be when any of the following occur:
- a dividend is paid by the foreign subsidiary
- part of the loan principal is repaid
- there is a capital return from this investment, for example on disposal of shares.
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