Forex elections

Foreign exchange (forex) elections include:

• Election out of the 12-month rule
• $250,000 balance
• Facilities rollover election
• Functional currency election
• Retranslation election.

Election out of the 12-month rule

Special rules apply to some short-term transactions if capital gains tax (CGT) and depreciating assets are acquired or disposed of, unless you make the Election out of the 12-month rule.

If you make the election, gains and losses that would otherwise fall under the rule will not be folded into the capital treatment of the asset, but will generally be determined to be assessable or deductible under the general provisions of the measures.

The election must be in writing and is irrevocable. It has effect from the applicable commencement.

Most taxpayers in existence at the applicable commencement date will no longer be able to make an election out of the 12-month rule unless we allow a longer period in which to make the election.

Your applicable commencement date is the first day of the 2003–04 income year, or if that day is earlier than 1 July 2003, the first day of the 2004–05 income year.

How to make the election out of the 12-month rule

An election out of the 12-month rule must be made in writing and should be kept with your tax records. The election should not be sent to us.

There is no prescribed form for the making of an election out of the 12-month rule, but it should include all the following information:

• your name and tax file number (TFN) if you are the taxpayer making the election
• a statement that you choose, under section 775-80 of the Income Tax Assessment Act 1997 (ITAA 1997), not to have section 775-70 and 775-75 of the ITAA 1997 apply
• your signature
• the date the election was made.

Groups affected by the tax consolidation regime

Tax consolidation provisions may affect particular forex elections if entities are members of a consolidated group. For more information, see Subdivision 715-J of the ITAA 1997.

Acquisition of a CGT asset (election out of 12-month rule)

In the following example, an investor acquires a capital gains tax (CGT) asset and elects not to have the 12-month rule apply.

When will the forex realisation gain or loss arise?

In the above example, Art Ltd will make a forex realisation gain of A$375,000 when it pays for the painting on 1 June 2004.

When Art Ltd enters the contract to purchase the painting, but before it makes any payment to the seller for the painting, it has an obligation to pay foreign currency to the seller.

When Art Ltd pays for the painting, it ceases to have an obligation to pay foreign currency of US$500,000. This obligation was incurred in return for the acquisition of a CGT asset (see subparagraph 775-55(1)(b)(iv)). Therefore, foreign exchange realisation event 4 occurs on 1 June 2004 when Art Ltd ceases to have an obligation to pay foreign currency (subsection 775-55(2)).

Whether the transaction gives rise to a forex realisation gain or loss requires a comparison to be made (in Australian dollar value) between the amount Art Ltd pays for the event happening, and

the proceeds Art Ltd receives for assuming the obligation calculated at the tax recognition time (subsections 775-55(3) and (5)).

Any difference in the amounts due to a currency exchange rate effect will result in a forex realisation gain or loss (section 775-105, and paragraphs 775-55(3)(b) and (5)(b)).

The US$500,000 amount Art Ltd paid as a result of the event happening, is translated into A$625,000 (US$500,000 divided by 0.80) at the time of payment (subsection 960-50(6) Item 11).

The tax recognition time, for the purposes of calculating the proceeds of assuming the obligation, is when Art Ltd acquired the painting on 1 August 2003 (subsection 775-55(7) Item 9).

The proceeds of assuming the obligation is the market value of the painting Art Ltd acquired, being the non-cash benefit it receives for incurring the obligation (paragraph 775-95(b)(i)). The market value of the painting on 1 August 2003 is the sale price of the painting (US$500,000). Art Ltd's proceeds of assuming the obligation calculated at the tax recognition time is, therefore, A$1,000,000 (US$500,000 divided by 0.50) (subsection 960-50(6) Item 5).

The difference between the amount Art Ltd paid as a result of the event happening and the proceeds of assuming the obligation is A$375,000 (A$1,000,000 minus A$625,000). As this amount arises solely as a result of the currency exchange rate effect, the difference represents a forex realisation gain (subsection 775-55(3)).

How should the forex realisation gain or loss be assessed?

As Art Ltd has elected (under section 775-80) for the 12-month rule not to apply, it must include the A$375,000 forex realisation gain in its assessable income.

The 12-month rule generally provides that the measures do not apply to forex gains and losses on the acquisition or disposal of capital assets if the time between that acquisition or disposal and the due time for payment is not more than 12 months. Such gains and losses are effectively folded into the CGT and/or capital allowances treatment of the assets.

The election out of the 12-month rule, however, overrides this exemption.

Disposal price of CGT asset denominated in foreign currency (election out of 12-month rule)

In the following example, an investor disposes of foreign shares and elects not to have the 12-month rule apply.

This example does not discuss the capital gains tax (CGT) consequences of the disposal of the shares.

When will the forex realisation gain or loss arise?

Eleanor will make a forex realisation loss of A$400 when she receives payment on 1 August 2005.

When Eleanor is paid foreign currency on 1 August 2005, forex realisation event 2 occurs. At this time, Eleanor ceases to have the right to receive foreign currency (subsections 775-45(1)(a) and (2)).

Eleanor acquires the right to receive the US$1,200 foreign currency in return for the disposal of her US shares. On disposal of those shares, a realisation event occurs for a CGT asset Eleanor owns (subparagraph 775-45(1)(b)(iv)).

Any forex realisation gain or loss on the cessation of Eleanor's right to receive foreign currency is determined by any difference between the Australian dollar value of the amount she receives when the event happens and the forex cost base of her right to receive foreign currency, calculated at the tax recognition time (subsections 775-45(3) and (4)). Generally, the tax recognition time for disposal by contract of a CGT asset is when the disposal contract is entered into, and not when the contract is completed.

Any differences in the amounts due to a currency exchange rate effect will result in a forex realisation gain or loss (section 775-105 and paragraph 775-45(3)(b) and (4)(b))).

The amount Eleanor receives as a result of the event happening is A$2,000 (US$1,200 divided by 0.6) (subsection 960-50(6) Item 11).

The tax recognition time for the purposes of calculating the forex cost base is when Eleanor enters into the contract to dispose of the shares. This occurred on 1 July 2005 (subsection 775-45(7) Item 6).

The forex cost base of Eleanor's right to receive foreign currency is the market value of her US shares, being the non-cash benefit she provides for that right (paragraph 775-85(b)(i)). The market value of the US shares on 1 July 2005 is the price at which the shares were sold (US$1,200). The forex cost base of Eleanor's right calculated at the tax recognition time is, therefore, A$2,400 (US$1,200 divided by 0.50) (subsection 960-50(6) Item 5).

The difference between the amount Eleanor receives when the event happens and the forex cost base of her right to receive foreign currency is A$400 (A$2,400 minus A$2,000). As this amount arises solely as a result of a currency exchange rate effect, the difference represents a forex realisation loss (subsection 775-45(4)).

How should the forex realisation gain or loss be assessed?

As Eleanor had previously elected under section 775-80 for the 12-month rule not to apply, she may deduct the A$400 forex loss from her assessable income.

Disposal of CGT asset denominated in foreign currency – incidental costs (election out of 12-month rule)

Issue

An investor disposes of foreign shares.

Facts

Eleanor acquires USA shares on 1 July 2004 and disposes of them for US$1,200 on 28 July 2005, when the exchange rate is A$1.00 = US$0.50. On disposal of her shares, she incurs brokerage of US$30.

Eleanor receives payment (after deducting brokerage) at settlement on 1 August 2005 when the exchange rate is A$1.00 = US$0.60. Eleanor elects not to have the 12-month rule apply.

Will a forex realisation gain or loss arise when Eleanor receives payment at settlement?

Eleanor will make a forex realisation loss of A$400 on receipt of payment, on 1 August 2005.

Will a forex realisation gain or loss arise when Eleanor pays for the brokerage?

Eleanor will make a forex realisation gain of A$10 on 1 August 2005 when brokerage is paid.

When Eleanor uses the services of a broker to dispose of her shares, she incurs an obligation to pay the brokerage fees for the disposal. When she pays for the brokerage on 1 August 2005, forex realisation event 4 occurs. This is because when the payment is made, Eleanor ceases to have an obligation to pay foreign currency to the broker (US$30) and she incurs the obligation as part of the second element of the cost base of a CGT asset (subparagraph 775-55(1)(b)(v); paragraph 110-25(3)(b)).

Although Eleanor has not actually paid for the brokerage, she is taken to have paid for it as these amounts have been deducted from the sale proceeds of the shares and have been applied in satisfaction of her obligation to the broker (section 775-110).

Whether the transaction gives rise to a forex realisation gain or loss requires a comparison to be made (in Australian dollar value) between the amount Eleanor paid when the event happened and the proceeds of assuming the obligation calculated at the tax recognition time (subsections 775-55(3) and (5)). Any difference in the amounts due to a currency exchange rate effect will result in a forex realisation gain or loss (section 775-105 and paragraphs 775-55(3)(b) and (5)(b)).

The amount Eleanor paid when the event happened was A$50 (US$30 divided by 0.60) (subsection 960-50(6) Item 5).

The tax recognition time for the purposes of calculating the proceeds of assuming the obligation is when Eleanor incurred the obligation to pay the brokerage on 28 July 2005 (subsection 775-55(7) Item 10).

The proceeds of assuming the obligation to pay the brokerage is the market value of the brokerage service provided to Eleanor, being the market value of the non-cash benefit she acquired in return for incurring the obligation (paragraph 775-95(b)(i)).

The market value of the brokerage service provided to Eleanor on 28 July 2005 is the brokerage amount charged by the broker (US$30). The proceeds of Eleanor assuming the obligation to pay the brokerage calculated at the tax recognition time is therefore A$60 (US$30 divided by 0.50) (subsection 960-50(6) Item 5).

The difference is A$10 (A$60 minus A$50). As this amount arises solely as a result of the currency exchange rate effect, the difference represents a forex realisation gain.

As Eleanor has elected under section 775-80 for the 12-month rule not to apply to her, she must include the A$10 forex realisation gain in her assessable income.

$250,000 balance election

The ordinary operation of the foreign exchange (forex) measures, as contained in Division 775 of the ITAA 1997, is that deposits to, and withdrawals from, foreign currency denominated accounts may give rise to a gain or loss that is realised under the measures.

Withdrawals from an account with a credit (positive) balance will also generally have a consequence under the capital gains tax (CGT) provisions.

However, the $250,000 balance election broadly enables you to disregard certain foreign currency gains and losses on certain foreign currency denominated transaction accounts and credit card accounts (called qualifying forex accounts) with balances below a specified limit.

An election can be made for a qualifying forex account. A qualifying forex account is an account that is:

• denominated in a foreign currency
• either a credit card account, or an account held for the primary purpose of facilitating transactions.

You can elect (in writing) to have the election apply for any number of qualifying forex accounts. An election can be varied (in writing) by adding or removing one or more qualifying forex accounts. Removing an account, or withdrawing an election, does not prevent a fresh election being made for the same account at a later time.

An election generally applies for a particular account from the time the election is made, and continues in force for that account until one of the following applies:

• you cease to hold the account
• the account ceases to be a qualifying forex account
• the election is varied by removing the account
• the election is withdrawn.

However, if you made an election between 17 December 2003 and 16 January 2004, you could specify it to apply from a date between 1 July 2003 and the making of the election. A withdrawal of an election will not have effect before it was made.

An election made after 16 January 2004 will only have prospective effect.

What is the limited balance test?

The limited balance test applies to all of the accounts for which a $250,000 balance election is in force. Credit and debit balances of these accounts are separately added, without netting, to arrive at the total credit balance and the total debit balance.

The limited balance test is passed at a particular time if the total credit balances, and the total debit balances, of all qualifying forex accounts for which an election is in force are each not more than the equivalent of A$250,000.

For the purposes of this test, the foreign currency amounts are translated into Australian currency at the average exchange rate for the third month before the start of the income year.

There is an additional buffering provision. If either the total credit balance, or the total debit balance, is more than the equivalent of A$250,000, but not more than the equivalent of A$500,000, for – subject to certain conditions – a maximum of 2 periods of 15 days or less in an income year, the limited balance test is still passed during such buffering periods.

A forex realisation event 1 that arises on depositing foreign currency to an account is not affected by this election.

However, the election does have the effect that, while the limited balance test is passed, the following gains and losses for qualifying forex accounts for which an election is in force are ignored for tax purposes:

• A forex gain or loss under forex realisation event 2 resulting from you withdrawing an amount from a foreign currency denominated account with a credit balance.
• A forex gain or loss resulting from you depositing an amount into a foreign currency denominated account with a debit balance, but only to the extent that the reduction in the debit balance is a forex realisation event 4 (forex realisation event 1 will still apply to any disposal of foreign currency that occurs by making the deposit).
• A gain or loss under the CGT provisions resulting from you withdrawing an amount from an account with a credit balance, to the extent that gain or loss is attributable to fluctuations in exchange rates.

An election will not necessarily apply to an account for an entire income year. It will depend on when the election takes effect, and when (if at all) the election ceases to have effect.

How do you make a limited balance election?

A limited balance election must be made in writing and should be kept with your tax records. The election should not be sent to us. There is no prescribed form for making a limited balance election, but it should include all the following information:

• your name and TFN (if you are the taxpayer making the election)
• a statement that you elect under section 775-230 of the ITAA 1997 to have Subdivision 775-D of the ITAA 1997 apply to one or more specified qualifying forex accounts held by you
• details of your specified qualifying forex accounts (such as your account numbers and the institutions with which they are held)
• if the election was made on, or before, 16 January 2004, the day on which the election was to come into effect (this cannot be earlier than 1 July 2003)
• your signature
• the date the election was made.

How are limited balance test breaches treated?

Once a limited balance election is made, meeting the A$250,000 limit is measured on an ongoing basis.

If the balance of the account or accounts that are the subject of the election breaches the A$250,000 limit, the exemption treatment under the election will cease for the period of the breach. This is subject to a buffering rule, which allows you to retain the $250,000 balance exemption if the breach is remedied within a short period of time.

The buffering rule allows you to continue to meet the limited balance test if all of the following apply:

• The A$250,000 equivalent balance limit is breached no more than 2 times in any one income year.
• All breaches, including those (if any) extending into or beyond the relevant income year, are remedied within 15 days of occurring.
• The balance does not exceed the equivalent of A$500,000.

During the period of the breach, if any of the above conditions are not met, you will become subject to forex realisation gains and losses on both:

• withdrawals from foreign currency denominated accounts with a credit balance (forex realisation event 2)
• deposits into a foreign currency denominated account with a debit balance (forex realisation event 4).

This will be the case from the time the conditions were failed. That is, any forex realisation gains or losses made on withdrawals and deposits during the period after the buffering period has expired will be brought to account during the period of continued breach.

Additionally, any withdrawals made from an account with a credit balance during the time after the buffering period has expired may result in a gain or loss under the CGT provisions during any period of continued breach.

Facilities rollover election

The ordinary operation of the forex measures is that all tax-relevant foreign currency amounts are converted to Australian currency.

To raise finance, a taxpayer may issue securities under a facility agreement. In these circumstances, taxpayers will often treat the securities in a similar way to loans. If these securities are denominated in a foreign currency, the forex measures will apply.

Therefore, the forex gain or loss realised on the face value of each security issued under a facility (when the obligation to pay the face value of the security is discharged) is brought to tax.

The facilities rollover election allows the issuer of certain securities (that is, the borrower) under certain facility agreements to defer the realisation of gains or losses where the obligation to pay the face value of each such security is discharged by issuing a new security under the facility agreement. Broadly, the effect is to tax the electing issuer as if it had borrowed by means of a term loan.

An election must be in writing, is irrevocable, and continues to apply until the facility agreement ends.

The facilities rollover election is only available in respect of certain facilities agreements – namely those where:

• the taxpayer has the right to issue eligible securities under the agreement
• another entity or entities must acquire the securities
• the effect of the agreement is that during its term, the taxpayer is able to obtain finance in a particular foreign currency up to the amount specified in the agreement.

The rollover provisions only apply where the facility agreement has a 'must acquire' aspect. If the eligible security is obtained through a 'best endeavours' tender then the security is not treated as analogous to a term loan.

An 'eligible security' can be either a bill of exchange or a promissory note that is:

• non-interest bearing
• issued at a discount
• denominated in a foreign currency
• for a fixed term.

Typically, a bill of exchange will have the features of:

• being an unconditional order in writing
• being addressed by one person to another (and signed by the person giving it)
• requiring the drawee (the person to whom it is addressed) to pay a specified sum of money on demand or at a particular time.

Typically, a promissory note will have the features of:

• being an unconditional promise in writing
• being made by one person to another (and signed by the person making the promise)
• engaging the maker of the promise to pay a specified sum of money on demand or at a particular time (this is usually fixed)
• being typically issued for 90, 120 or 180 days.

A facilities rollover election must be made within 90 days of the first eligible security being issued under the facility agreement, or within 90 days of the applicable commencement date. However, taxpayers with an applicable commencement date of 1 July 2003 could also make the election between 17 December 2003 and 16 January 2004.

If an election is made within 90 days of the first eligible security being issued under the facility agreement, the election is taken to have been in effect from immediately before that security is issued.

If an election is not made within 90 days of the first eligible security being issued under the facility agreement, but is made within 90 days of the applicable commencement date or between 17 December 2003 and 16 January 2004 (whichever is later), the election takes effect from the applicable commencement date.

Making a facilities rollover election

A facilities rollover election must be made in writing and should be kept with the taxpayer's tax records.

The election should not be sent to the ATO.

There is no prescribed form for the making of a facilities rollover election, but it should include:

• the name and TFN of the taxpayer making the election
• a statement that, under section 775-195 of the ITAA 1997, the taxpayer chooses rollover relief for a specified facility agreement
• details of the specified facility agreement (sufficient details to identify, or a copy of the agreement)
• the signature of the person making the election
• the date the election was made.

Functional currency election

The ordinary operation of the foreign currency translation measure is that, broadly, all tax-relevant amounts are translated into Australian currency.

The functional currency election (choice) allows certain entities or parts of entities that keep their accounts solely or predominantly in a particular foreign currency, to choose that foreign currency as their functional currency to work out their annual net income, which is then translated into Australian dollars.

Who can make a functional currency election?

Entities that can make a functional currency election are:

• residents who must prepare financial reports under section 292 of the Corporations Act 2001
• residents carrying on a business at or through an overseas permanent establishment
• foreign residents carrying on a business at or through an Australian permanent establishment
• offshore banking units
• attributable taxpayers of a controlled foreign company (CFC)
• transferor trusts.

A functional currency election must be in writing.

When does an election start?

For entities other than attributable taxpayers of CFCs, an election applies from the start of a particular income year if either:

• the relevant entity is in existence at the start of an income year and the election is made within 90 days of the start of that income year, or between 17 December 2003 and 16 January 2004
• the entity comes into existence during an income year and the election is made within 90 days of the entity coming into existence, or between 17 December 2003 and 16 January 2004.

If neither of these apply, the election applies from the start of the following income year.

For attributable taxpayers of CFCs, an election applies from the start of the CFC's particular statutory accounting period if either:

• you are an attributable taxpayer at the start of a statutory accounting period and the election is made within 90 days of the start of that statutory accounting period, or between 17 December 2003 and 16 January 2004
• you become an attributable taxpayer for the CFC during the CFC's statutory accounting period and the election is made within 90 days after the beginning of the CFC's statutory accounting period or between 17 December 2003 and 16 January 2004, whichever is later.

If neither of these apply, the election applies from the start of the following statutory accounting period.

An election to use a functional currency continues in force until one of the following occurs:

• if an entity withdraws the election immediately after the end of the income year (or, in the case of attributable taxpayers of CFCs, the end of the statutory accounting period) in which the withdrawal is made
• immediately after the end of the income year in which the entity ceases to be required to prepare financial reports under section 292 of the Corporations Act 2001.

Groups affected by the tax consolidation regime

Tax consolidation provisions may affect particular forex elections if entities are members of a consolidated group. For more information, see Subdivision 715-J of the ITAA 1997.

For more information around functional currency, see Guide to functional currency rules.