Non-functional currency amounts you receive or pay
All amounts included in working out your taxable income or tax loss must be in the applicable functional currency. This means you must translate all amounts you receive or pay in another currency, including A$ amounts, into the applicable functional currency.
The functional currency translation rules, including applicable exchange rates, follow the principles in the core foreign currency translation rules for translating foreign currency amounts to A$ This is covered in subsection 960-50(6) of Subdivision 960-C and also subsection 960-80(6) of Subdivision 960-D of the ITAA 1997.
However, the A$ is treated as a foreign currency while your applicable functional currency is not a foreign currency for the purposes of working out your taxable income or tax loss in the applicable functional currency. This is covered in subsection 960-80(1) of the ITAA 1997.
A FOREX realisation gain or loss may arise for certain amounts if there is a difference in prevailing exchange rates at the relevant times. For example, the exchange rate applicable at the time you incur an amount may be different from the exchange rate applicable when you pay it. In this situation, changes in the value of the A$ against the applicable functional currency can bring about a FOREX gain or loss – an example follows.
Trigger of foreign currency loss
Example 1: trigger of foreign currency loss
Stellar Rex Incorporated (Stellar Rex), a USA company with a branch (permanent establishment) in Australia, chooses to account for their Australian branch's taxable income in a functional currency. For Stellar Rex's purposes, US dollars (US$) is the applicable functional currency and A$ is a foreign currency.
Stellar Rex contracts to purchase a depreciating asset from an Australian company in A$ as follows:
Stellar Rex contracts to purchase the asset for A$10,000. Stellar Rex holds the asset from the date of contract.
At the contract time, A$1.00 = US$0.50.
Therefore the cost of the asset in the applicable functional currency is US$5,000.
Thirteen months after beginning to hold the asset, Stellar Rex pays A$10,000 for the asset.
At this time A$1.00 = US$0.55, so the A$10,000 Stellar Rex pays is equivalent to US$5,500.
As the payment was made more than twelve months after first holding the asset, the loss is not a short-term FOREX realisation loss – refer to section 775-75 of the ITAA 1997. Therefore, Stellar Rex makes a FOREX realisation loss of US$500 under Foreign exchange (FOREX): realisation event (FRE) 4. Stellar Rex will take this loss into account when calculating their taxable income for year 2. They will calculate their taxable income in US$ and translate it into A$ at the end of their tax year for the purpose of working out the amount of A$ income tax they are liable to pay.
End of example
Events that happened before an effective functional currency choice takes effect
The functional currency rules include special translation rules to cover 'relevant' income tax amounts that are attributable to events that happened before your current functional currency choice took effect – that is, the 'pre-choice' amounts. 'Relevant' pre-choice amounts are those that are relevant to working out your taxable income or tax loss in a post functional currency year and so must be translated into your applicable functional currency.
If you have not previously made a functional currency choice, you should translate a relevant pre-choice amount as follows:
- firstly, into A$ at the exchange rate applicable at the time of the transaction or event
- secondly, into the applicable functional currency at the exchange rate at the time your functional currency choice took effect.
If you have previously made a choice to use a non-A$ currency as your applicable functional currency, you should translate a relevant pre-choice amount:
- firstly, into the previous applicable functional currency at the exchange rate applicable at the time of the transaction or event
- secondly, into the new applicable functional currency at the exchange rate at the time your new functional currency choice took effect.
Sale of assets acquired before making a functional currency choice
Example 2: sale of assets acquired before making a functional currency choice
Fion Incorporated (FION), a non-resident corporation, operates through a permanent establishment in Australia. FION conducts most of its business in Yen (¥).
In the year ended 30 June – year 1 – FION chooses to use ¥ as its applicable functional currency. The choice applies for the year commencing 1 July – year 2.
In the year ended 30 June – year 3 – FION sells a tourist resort for ¥600 million, which it had purchased before year 1 for ¥500 million.
As FION's applicable functional currency is ¥, the capital gain or capital loss on the disposal of the tourist resort will be calculated in ¥. However, as FION had not made a choice to use ¥ as its applicable functional currency at the time it purchased the tourist resort – that is, it was still using A$ for tax purposes – the ¥ cost of the resort is translated to A$ at the exchange rate prevailing at the time of the purchase. This A$ amount is then translated to ¥ at the exchange rate prevailing at the time FION's choice to use as its applicable functional currency took effect.
For the purposes of this example, the exchange rates were:
- A$1.00 : ¥68.50 at the time FION purchased the resort
- A$1.00 : ¥62.00 at the time FION's functional currency choice took effect.
This means the cost base for the purpose of calculating the capital gain or loss on the disposal of the tourist resort is:
= A$7,299,270 x 62.00
The capital gain calculated in FION's applicable functional currency is:
End of example