Financial arrangements subject to this method
The hedging financial arrangements method will apply to a financial arrangement if the following criteria are satisfied:
- the arrangement is a hedging financial arrangement
- the entity starts to have the arrangement in the income year in which the election is made or later income years.
The hedging financial arrangements method will not apply to a financial arrangement if the arrangement is:
- a financial arrangement as defined under section 230-50 unless it is issued by the relevant entity and is a foreign currency hedge
- subject to an exception contained in subsection 230-330(3), (4) or (5).
Hedging financial arrangement
A financial arrangement is defined in section 230-335 to be a hedging financial arrangement if:
- it is a derivative financial arrangement or a foreign currency hedge
- the entity creates, acquires or applies the arrangement for the purpose of hedging a risk or risk in relation to a hedged item
- at the time the entity creates, acquires or applies the arrangement, it is a hedging instrument for accounting purposes
- it is recorded as a hedging instrument in the entity's financial reports in the income year in which the rights and/or obligations are created, acquired or applied.
Derivative financial arrangement
A derivative financial arrangement is defined in section 230-350 as a financial arrangement where:
- its value changes in response to changes in a specified variable or variables
- it requires no net investment, or there is such a requirement but the net investment is smaller than would be required for other types of financial arrangements that would be expected to have a similar response to changes in market factors.
Foreign currency hedge
A foreign currency hedge is defined in section 230-350 as a financial arrangement where:
- its value changes in response to changes in a specified variable or variables but is not a derivative financial arrangement
- it hedges a risk in relation to movements in currency exchange rates.
Tax extension hedges
Generally, only those hedging arrangements that satisfy the hedge accounting rules will satisfy the requirements of the hedging financial arrangements method. However, in limited situations, the hedging financial arrangements method will apply to hedging financial arrangements that would not ordinarily meet accounting hedging treatment (subsection 230-335(3)).
Generally the whole financial arrangement must be a hedging financial arrangement. However, section 230-340 treats a part of a financial arrangement as a separate financial arrangement where it is used for a partial hedge (such as a forward contract or a proportionate hedge).
A hedged item is defined in subsection 230-335(10) to be one of the items listed in that subsection (for example, an asset, a liability, a firm commitment), or a part of such an item, in which an entity hedges a risk.
An anticipated dividend is deemed to be a hedged item if it is of the kind referred to in subsection 230-335(4).
Where the hedged item is a net investment in a foreign operation that is carried on through a company in which an entity holds shares, or through a subsidiary company of the entity, the hedged item is deemed for the purposes of tax classification or status matching in the table in subsection 230-310(4) to be either the shares or some other interest (such as long-term intra-group debt) in that company.
'One-in, all-in' principle
A fundamental principle underlying the hedging election is that the election applies to all accounting hedges and would-be accounting hedges (those where the entity does not satisfy the documentation requirements under this method) on a 'one-in, all-in' basis. This also applies to anticipated hedges in the same manner.
Under this principle, an entity that makes an election to apply the hedging financial arrangements method must apply this method to all of its hedging financial arrangements.
Failure to comply with method
Failure to comply with the record-keeping requirements in sections 230-355 and 230-360, and the requirement in section 230-365 that the effectiveness of the hedge be assessed, can have the following implications (pursuant to section 230-385):
- The hedging financial arrangements method election will not apply to hedging financial arrangements the entity starts to have after the time those requirements are not met until such time as determined by the ATO.
- Where section 230-360 has not been satisfied for an existing hedging financial arrangement, we may determine the appropriate basis of allocation for gains and losses from the hedging financial arrangement in a way that satisfies section 230-360.
Where this occurs, pursuant to section 230-380 we may still:
- treat the requirements of section 230-355, 230-360 or 230-365 as having been met
- impose additional record-keeping requirements
- determine the appropriate basis of allocation for gains and losses from the hedging financial arrangement in a way that satisfies section 230-360.
Existing hedging financial arrangements
If an entity made a transitional election for TOFA to apply to its existing financial arrangements, it can also elect to apply the hedging financial arrangements method to those existing hedging financial arrangements if:
- the election to apply the hedging financial arrangements method is made on or before the first lodgment date that occurs after the start of the income year in which TOFA begins to apply
- at or soon after making the election, the entity satisfies the record-keeping requirements in section 230-355 and section 230-360
- the entity satisfies the hedge-effectiveness requirements in section 230-365 at all times from when they created, acquired or applied the arrangement.
However, the tax status matching rules under subsection 230-340(4) cannot apply to existing hedging financial arrangements that have been transitioned into TOFA. Instead, tax classification or status is determined pursuant to subsection 230-310(3).