Edited version of private ruling

Authorisation Number: 1011497592605

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Ruling

Subject: Foreign exchange realisation loss

Question 1

Are the foreign exchange losses made on repayment or conversion of your foreign currency loan in respect of your Australian investment property, deductible in your Australian tax return?

Answer

Yes.

Question 2

If so, are the losses deductible in full the income year the relevant foreign exchange realisation event occurred?

Answer

Yes.

This ruling applies for the following periods:

Income year ended 30 June 2009

Income year ended 30 June 2010.

Relevant facts and circumstances

You purchased a rental property in Australia in Australian dollar (AUD).

The purchase was fully funded via an AUD mortgage loan with the rental property and another property you already owned provided as security for the loan.

The property has been rented since acquisition and remains rented today.

In the relevant income year, you refinanced your AUD loan with a foreign currency loan to take advantage of the lower interest rate available on the foreign currency.

The new foreign currency loan was with a different banking institution and the foreign currency loan was used directly to fully extinguish the original AUD loan.

In the following income year you converted your foreign currency loan back to AUD to prevent any further foreign exchange (forex) losses which arose as a result of the rapid decline in the value of the AUD during the year. As the security of the loan was the Australian property denominated in AUD and the terms of the loan limited the amount of the borrowing to 80% of the value of the security, the decline in the value of the AUD relative to the foreign currency meant you had reached the borrowing limit and had to put more security in the form of cash to prevent any further calls.

You converted your foreign currency loan to AUD through the currency switching option offered under your loan facility. A new AUD loan was drawn down with a new account number and the proceeds from the loan were used directly to fully extinguish the foreign currency loan.

You incurred foreign exchange loss from refinancing the foreign currency loan.

You repaid part of the AUD loan but the balance remains outstanding today.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 775-55

Income Tax Assessment Act 1997 subsection 775-55(1)

Income Tax Assessment Act 1997 paragraph 775-55(1)(a)

Income Tax Assessment Act 1997 subparagraph 775-55(1)(b)(ix)

Income Tax Assessment Act 1997 subsection 775-55(3)

Income Tax Assessment Act 1997 subsection 775-55(5)

Income Tax Assessment Act 1997 subsection 775-55(7) item 8(a)

Income Tax Assessment Act 1997 subsection 960-50(6) item (11)

Reasons for decision

Forex gains or losses from 1 July 2003 are covered by Division 775 of the Income Tax Assessment Act 1997 (ITAA 1997).

The general principle is that foreign currency gains or losses have a revenue character rather than a capital nature. Foreign currency gains or losses are assessable or deductible when they are realised. They are realised when a Forex realisation event (FRE) happens.

Forex realisation event 4 (FRE 4) occurs when a taxpayer ceases to have an obligation, or part of an obligation, to pay foreign currency- commonly when the foreign currency borrowing is repaid. The obligation, or part of the obligation, must cease, and be one of the following:

- obligations that represent an expense the taxpayer can deduct

- obligations that are an element in the calculation of a net assessable or deductible amount

- obligations that are incurred and (broadly speaking) form elements of the cost base of a capital gains tax (CGT) asset, or

- obligations incurred in return for receiving Australian or foreign currency, or the right to receive such currency.

Since the obligation to repay foreign currency was incurred in return for receiving an amount of foreign currency, FRE 4 will happen each time some or all of the foreign currency borrowings are repaid (paragraph 775-55(1)(a) and subparagraph 775-55(1)(b)(ix) apply of the ITAA 1997). FRE 4 will happen at the time of each repayment or when the foreign currency loan is converted to AUD, pursuant to subsection 775-55(1) of the ITAA 1997.

In this case, when you converted the AUD loan to a foreign currency loan, you constructive received foreign currency. In return for receipt of this foreign currency, you incurred an obligation to repay foreign currency to the financier. When you repay all or part of this foreign currency borrowing with an AUD loan, your obligation to pay foreign currency to the financier will cease to the extent of that repayment or conversion.

Whether a FRE 4 arises on a repayment by the taxpayer, of some or all of the borrowings give rise to a forex realisation gain (under subsection 775-55(3) of the ITAA 1997) or a forex realisation loss (under subsection 775-55(5)), requires a comparison to be made between:

(a) the amount the taxpayer repays, translated into Australian currency at the exchange rate applicable at the time of repayment (pursuant to subsection 960-50(6) item 11 of the ITAA 1997),

and

(b) the amount of that part of the borrowings repaid, translated into Australian currency at the exchange rate applicable at the time when the foreign currency borrowed was received by the taxpayer (pursuant to section 775-95, subsection 775-55(7) item 8(a) and subsection 960-50(6) item 11 of the ITAA 1997).

Where the amount in paragraph (a) above is smaller than the amount in paragraph (b) above, so much of that shortfall that is attributable to a currency exchange rate effect (as defined in section 775-105 of the ITAA 1997), is a forex realisation gain of the taxpayer (pursuant to subsection 775-55(3) of the ITAA 1997). Conversely, if the amount in (a) is bigger than the amount in (b) so much of the excess attributable to the exchange rate effect is a forex realisation loss of the taxpayer (pursuant to subsection 775-55(5) of the ITAA 1997).

During the relevant income year, you converted your foreign currency loan to an AUD loan. To the extent that the foreign currency loan amount translated into AUD at the exchange rate applicable at the time of repayment, exceed the foreign currency loan taken out translated to AUD at the exchange rate applicable at the time when the foreign currency loan was received, is attributable to a currency exchange rate effect (as defined in section 775-105 of the ITAA 1997), is a forex realisation loss to you under subsection 775-55(5) of the ITAA 1997.

To determine the link or nexus between forex realisation losses or gains that arise on a complete or partial repayment of the foreign currency loan borrowings, it is necessary to consider the purpose for, or use to which, you put those borrowings. That is, whether they are 'made in gaining or producing assessable income'. This is because you only incurred the obligation in relation to which forex realisation losses or gains arose (the obligation to repay the borrowings) in return for receiving the amount of those borrowings.

Since the loan was in respect of your investment property that was rented since acquisition, the forex gains or losses that arose when you ceased to have an obligation or part of an obligation to pay foreign currency, are incomes and outgoings from gaining or producing your assessable income.

Therefore, you are entitled to a deduction in your Australian tax return if you made forex realisation losses on repayment or conversion of the foreign currency loan for your Australian investment property. The forex loss is deductible to you pursuant to subsection 775-55(5) of the ITAA 1997.

The forex gains or losses that arose from the FRE4 event are assessable or deductible in the income year the forex realisation event occurred - that is when the obligation or part of the obligation, to pay foreign currency ceased.

Note:

The FOREX 4 gains or losses are calculated by comparing:

- the amount the taxpayer repays, translated into Australian currency at the exchange rate applicable at the time of repayment or conversion (pursuant to subsection 960-50(6) item 11 of the ITAA 1997),

and

- the amount of that part of the borrowings repaid, translated into Australian currency at the exchange rate applicable at the time when the foreign currency borrowed was received by the taxpayer (pursuant to section 775-95, subsection 775-55(7) item 8(a) and subsection 960-50(6) item 11 of the ITAA 1997).

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