ATO Interpretative Decision
ATO ID 2005/319
Income tax
Foreign exchange (forex) gains and losses: effect on grantor of lapsed foreign currency denominated call optionFOI status: may be released
This ATOID provides you with the following level of protection:
If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Is a forex realisation gain made under subsection 775-55(4) of the Income Tax Assessment Act 1997 (ITAA 1997) when a foreign currency denominated call option a taxpayer has granted lapses?
Decision
Yes. A forex realisation gain is made under subsection 775-55(4) of the ITAA 1997 when a foreign currency denominated call option a taxpayer has granted lapses.
Facts
The taxpayer entered into a business transaction requiring it to pay United Sates dollars (USD) at a future date.
As part of a hedging strategy to protect against adverse movements in the Australian dollar (AUD)/USD exchange rates, the taxpayer sold a twelve month USD call option which gave it the obligation (if the buyer exercised the option) to sell a predetermined amount of USD in exchange for a predetermined amount of AUD.
The taxpayer received a premium of AUD 40,000 on granting the option.
The USD call option had an expiry date of 31 May 2005.
Due to unfavourable movements in exchange rates, the option holder did not exercise its rights under the option. The rights and obligations under the option continued to subsist until the option lapsed on 31 May 2005.
Reasons for Decision
On granting the option, the taxpayer had an obligation to pay foreign currency incurred in return for it acquiring a right to receive AUD. Subsection 775-140(2) of the ITAA 1997 provides that an 'obligation to pay foreign currency' includes an obligation subject to a contingency.
Under subsection 775-55(1) of the ITAA 1997, forex realisation event 4 (FRE 4) happens if an entity ceases to have the obligation to pay foreign currency. Subsection 775-55(2) of the ITAA 1997 provides that FRE 4 happens when an entity ceases to have the obligation. The taxpayer ceased to have the obligation to pay foreign currency when the option lapsed.
The taxpayer made a forex realisation gain under subsection 775-55(4) of the ITAA 1997, as the option expired without having been exercised and, immediately before FRE 4 happened, had the option been exercised the taxpayer would have been obliged to pay the foreign currency.
The forex realisation gain is the AUD 40,000 received by the taxpayer for granting the option (the premium received). This gain is included in the taxpayer's assessable income under subsection 775-15(1) of the ITAA 1997 in the income year ended 30 June 2005.
Date of decision: 11 November 2005Year of income: Year ended 30 June 2005
Legislative References:
Income Tax Assessment Act 1997
subsection 775-15(1)
subsection 775-55(1)
subsection 775-55(2)
subsection 775-55(4)
subsection 775-140(2)
ATO ID 2005/318
Keywords
Call options
Financial derivatives
Foreign currency
Foreign currency obligations
Foreign exchange gains and losses
Forex realisation event
Forex realisation gain
Hedging
Date reviewed: 4 September 2017
ISSN: 1445-2782