• Question 10

    Attention

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    This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.

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    This question examines the transfer pricing risks associated with Australian taxpayers' derivative transactions with international related parties. We seek the total amount of these transactions and an indication of the principal derivative transaction types undertaken.

    The term derivative takes on its ordinary meaning within the context of commercial and accounting practices.

    Broadly, a derivative instrument is a contractual right that derives its value from the value of something else, such as a debt security, equity, commodity or specific index. The most common derivative instruments are forwards, options, swaps and credit derivatives. Unlike traditional debt and equity securities, these instruments generally do not involve a return on an initial investment.

    The disposal and the acquisition of a derivative would constitute a 'derivative transaction'.

    All your derivative transactions with international related parties should be recorded under this question including transactions for trading, hedging, speculation and arbitrage. International related parties are defined in appendix 2, and include permanent establishments.

    You should not include exchange traded options and futures in this question. However, where exchange traded options are not separated from other options in your records they may be included.

    The dollar amounts or values asked for this question are all based on your accounting records.

    The amounts reported at this question may be reported in the financial statements as revenue/gains or expenses/losses, depending on the accounting treatment of your derivatives (and this includes amounts relating to derivatives that are part of a hedging relationship). Therefore for the purposes of this question, the terms: 'expenditure and losses' and 'revenue and gains' are interchangeable.

    For many derivative instruments such as notional principal contracts (for example, interest rate swaps), the parties to the contract will often only exchange net cash flows at certain specified times during the term of the contract. In completing this question in respect of such derivative instruments only net cash flows should be recorded. Do not record any gross cash flows or any notional principal amounts associated with such transactions (that is exclude principal and principal repayment amounts).

    In some cases, only one party to the derivative instrument transaction may make a payment (for example, settlement amounts in respect of forward rate agreements, or option premiums). In such cases, the gross amount of the derivative instrument transaction should be recorded.

    Mark-to-market/fair value accounting may be used for recording amounts in respect of derivative instruments where this is used by a taxpayer for financial accounting purposes.

    If you had derivative transactions with international related parties during the income year, answer yes to this question and complete the required fields.

    To complete this question, you need to:

    • identify the derivative transactions undertaken with international related parties
    • total the expenditure incurred and the revenue earned in respect of these derivative transactions with international related parties
    • determine the principal arm's length pricing method used to set or review consideration in respect of these derivative transactions
    • work out the three types of derivative transactions entered into by you with international related parties with the highest dollar value of dealings (expenditure plus revenue).

    In the first column at C, provide the total amount of expenditure incurred in respect of your derivative transactions with international related parties.

    In the second column at D, provide the total amount of revenue earned in respect of your derivative transactions with international related parties.

    In the third column at E, specify the principal arm's length pricing method used to set or review consideration in respect of your derivative transactions with international related parties.

    Further Information

    For the list of pricing methodologies codes, see Appendix 6.

    End of further information

    At F, G and H, specify the three types of derivative transactions entered into by you and international related parties with the highest dollar value of dealings.

    Further Information

    For the list of type of derivative transactions and codes, see Appendix 7.

    End of further information

    Example

    During the income year an Australian taxpayer undertook the following derivative transactions.

    Derivative transaction type

    Related to taxpayer

    Dominant pricing methodology

    Expenditure

    Revenue

    Interest rate swaps

    Yes

    CUP*

    5,395,000

    5,465,000

    Cross currency interest rate swaps

    Yes

    CUP

    7,320,000

    7,150,000

    Currency swaps

    Yes

    CUP

    6,453,000

    6,780,000

    Options

    Yes

    CUP

    2,750,000

    3,100,000

    Swaps - other

    No

    CUP

    3,850,000

    3,200,000

    Other

    No

    CUP

    1,345,000

    1,800,000

    Other

    Yes

    CUP

    3,660,000

    4,250,000

    * Comparable uncontrolled price method.

    Note: The Australian taxpayer disregarded the derivative transactions with unrelated parties.

    The Australian taxpayer extracts the relevant data from the information above.

    Derivative transaction type

    Related to taxpayer

    Expenditure

    Revenue

    Total

    Interest rate swaps

    Yes

    5,395,000

    5,465,000

    10,860,000

    Currency swaps

    Yes

    13,773,000

    13,930,000

    27,703,000

    Options

    Yes

    2,750,000

    3,100,000

    5,850,000

    Other

    Yes

    3,660,000

    4,250,000

    7,910,000

    Total

     

    25,578,000

    26,745,000

    52,323,000

    Note: The Australian taxpayer records the cross currency interest rate swap as a currency swap in accordance with the derivative codes contained in Appendix 7.

    With this information the Australian taxpayer completes question 10 as follows.

    Example of question 10 completed

    Last modified: 09 Nov 2011QC 24292