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Ruling

Subject: Foreign exchange gains and losses

Question 1

Is a gain properly regarded as being 'of a private or domestic nature' under section 775-15(2) of the Income Tax Assessment Act 1997 (ITAA 1997) if the gain arises from currency fluctuation in respect of the proceeds of sale held in a foreign currency of a migrants private residence in the country X, so as to exclude the forex provisions?

Answer

Yes. Any forex gain or loss you make will be disregarded as the gain or loss is referable to funds which are of a private or domestic nature under section 775-15(2) of the ITAA 1997.

Question 2

If an overseas bank account was opened prior to 20 September 1985, is any capital gain or loss arising from a CGT event C2 dealing with deposits made at any time into the bank account to be disregarded?

Answer

No. Forex realisation gains and losses made as a result of the withdrawal of funds from a foreign currency denominated bank account opened before 19 February 1986 are taken into account in determining taxable income but only to the extent that they are made as a result of withdrawal of funds deposited on or after 1 July 2003. However if the bank account is not a 'qualifying forex account' transactions will not be subject to the forex provisions of Division 775 of the ITAA 1997.

Relevant facts

My spouse and I have been granted permanent residence in Australia. We have accepted an offer for our house where we have lived for the last Y years and the sale is in the hands at our solicitors. We anticipate the sale to be completed (Settled) whereupon we intend to come to Australia and take up permanent residence.

Since the exchange rate is so adverse at present we would hope to be able to keep most of the proceeds of our house in a bank account in country X in sterling until the rate improves. We would therefore rent a property until it is more appropriate to transfer the money and at that point we would transfer the money and purchase a property in Australia.

However, we are concerned that we will have to pay tax either under the forex provisions or under the capital gains tax provisions if as we anticipate, the exchange rate improves in our favour. The amount involved takes us over the $250,000 balance election of which we are aware.

The bank account we would use to hold the money was opened before 20 September 1985 and in the circumstances it seems possible that CGT might not apply, but the forex rules would seem to apply Instead unless it is correct to say that any gains were of a 'private or domestic nature'.

Reasons for decision

Foreign exchange (forex) gains and losses

In 2003, the Government passed legislation which resulted in the inclusion of Division 775, foreign currency gains and losses in the Income Tax Assessment Act 1997 (ITAA 1997).

The general principle of the Division is that foreign currency gains are included in a taxpayer's assessable income, and foreign currency losses are deductible if they occur as a result of a forex event (sections 775-15 and 775-30 of the ITAA 1997).

Forex gain or loss on fluctuation between the currencies

Australia's forex provisions may bring to account gains or losses made in respect of gains or losses that are attributable to a currency exchange rate fluctuation.

A mere fluctuation between the currencies without a forex realisation event does not generate an assessable forex gain or a deductible forex loss.

Forex gains and losses for accounts opened before 1 July 2003

Paragraph 775-165(2) (a) of the ITAA 1997 disregards any forex gains or losses as a result of forex realisation events 1, 2 or 5 happening to a right or part of a right if the right or part of the right was acquired before the eligible commencement date, that is, 1 July 2003 (section 775-155 of the ITAA 1997), and the taxpayer has not made an election under section 775-150 of the ITAA 997, the transitional election.

In your case

You did not make any transitional election in relation to your accounts in country X for your accounts opened before 1 July 2003. Accordingly, any forex realisation gains or losses you made as a result of forex realisation events happening to your foreign bank account that opened prior to 1 July 2003 will be disregarded.

Bank accounts opened after 1 July 2003

Foreign currency is a capital gains tax (CGT) asset. Foreign currency assets that are of a private nature are personal-use assets. However, bank accounts denominated in a foreign currency are not foreign currency but rather a chose in action, or more specifically a debt (or debts) owed by the bank that are denominated in a foreign currency.

When a customer deposits money into a bank account the customer acquires contractual rights as the creditor of the bank. Similarly, when an amount is withdrawn from a bank account some or all of these previously acquired rights are extinguished or satisfied. The nature of the contractual relationship remains constant. That is, there is a single chose in action in respect of the customer's right to be repaid the amount previously deposited.

Each bank account is a separate asset for CGT purposes, regardless of what currency the account is held in.

The rights arising upon the making of a deposit into the foreign account will have arisen under the foreign account contract, which is an eligible contract.

In your case

You have not made a transitional election, any forex realisation gains or losses made by you as a result of forex realisation event 2 happening upon a withdrawal, transfer or payment out of the foreign account will be disregarded (see subsection 775-165(2) of the ITAA 1997), as the account was used solely for private purposes.

Capital gains and capital losses and becoming an Australian resident

Under section 108-5 of the ITAA 1997, foreign currency is a CGT asset. Foreign currency assets that are private in nature are personal-use assets. However, bank accounts denominated in a foreign currency are not foreign currency but rather a chose in action, or more specifically a debt (or debts) owed by the bank that are denominated in a foreign currency.

When a customer deposits money into a bank account the customer acquires contractual rights as a creditor of the bank. Similarly, when an amount is withdrawn from a bank account some or all of these previously acquired rights are extinguished or satisfied. The nature of the contractual relationship remains constant. That is, there is a single chose in action in respect of the customer's right to be repaid the amount previously deposited.

Therefore bank accounts are assets for CGT purposes, regardless of what currency the account is held in.

If you become an Australian resident there are rules relevant to each CGT asset that you owned just before you became an Australian resident, except those asset that have the necessary connection with Australia. The first element of the cost base and reduced cost base of the asset at the time you become an Australian resident is its market value at that time.

Choosing to convert your foreign currency entitlement into Australian dollars regardless of whether you leave it in your foreign bank account or transfer it to your Australian bank account will result in CGT event C2 occurring (section 104-25 of the ITAA 1997).

A capital gain or capital loss is calculated by deducting the cost base from the capital proceeds. The cost base is the amount that you paid in respect to acquiring the asset (the amount of your deposits translated to Australian dollars on the date of the deposits).The capital proceeds are the amount in Australian dollars that you receive due to the closure of each country X bank account. The cost base is based on the balance in each of your country X bank accounts on the date you become an Australian resident (translated into Australian dollars on that date). The cost base can also include any costs that you incurred in exchanging foreign currency for Australian currency.

A net capital gain is included in your taxable income for the income year and is subject to income tax. Income tax is charged at varying rates depending on the taxable income. Credits may also be allowed for tax paid in country X due to the closure of these bank accounts.

In your case

You are taken to have acquired the bank account for its market value at the time you became an Australian resident. This will form the first element of your cost base when calculating any capital gain or capital loss.

Each bank account is a single CGT asset. Each deposit or withdrawal will constitute a CGT event happening to the relevant part of the asset, that is, the amount deposited or withdrawn.

In other words, each transfer of money from one bank account to another bank account will trigger a CGT event.

Private and domestic

For most individual taxpayers forex gains or losses will generally be ignored if the gain or loss is of a private or domestic nature, but where the gain or loss results from carrying on a business or a profit-making undertaking or plan, the gain or loss will be assessable income or an allowable deduction.

There are limited circumstances where forex gains or losses of a private or domestic nature are subject to Australia's capital gains tax (CGT) provisions. Foreign currency bank accounts are a CGT asset and may be subject to the capital gains provisions each time a CGT event happens to them. CGT event C2 happens each time an amount is withdrawn from a foreign currency bank account. If the gain is assessable, or the loss is allowable, under the CGT provisions the forex gain or loss will be subject to the forex provisions.

Where the forex provisions do apply there is a provision that may allow the taxpayer to disregard any forex gain or loss. The '$250,000 balance' or 'limited balance' election enables a taxpayer to disregard specified forex gains or losses on certain foreign currency denominated bank accounts with low balances. Any capital gain or loss made as a result of CGT event C2 happening is also disregarded.

Qualifying forex account

A 'qualifying forex account' is an account denominated in a particular foreign currency, and is maintained in Australia or a foreign country with an Authorised Deposit -Taking Institution (ADI), or is maintained in a foreign country with a financial institution similar to an ADI. The account must have the primary purpose of facilitating transactions, or must be a credit card account (subsection 995-1(1) of the ITAA 1997).

However if the primary purpose of the account is to hold the taxpayer's money as an investment for a period of time, and not to facilitate transactions, the account is not a 'qualifying forex account' under Division 775 of the ITAA 1997.

Bank account in Australian dollars in Australia

Each bank account is a single CGT asset as stated above. Each withdrawal will constitute a CGT event happening to the relevant part of the asset, that is, the amount withdrawn.

Where the bank account is denominated in Australian dollars, the capital proceeds from the withdrawal will equal the cost base of the amount withdrawn. Hence, you will not make a capital gain or a capital loss from the withdrawal.

Therefore there are no forex or CGT consequences from holding Australian dollars in your Australian bank account.

Application to your circumstances

If your bank account is not a credit card account or established for the purpose of facilitating transactions, the account will not be a qualifying forex account. Therefore the forex rules will not apply to your account.

It is also considered that your bank account will be exempt from the forex rules as it of a private or domestic nature. The current purpose of the account is to hold the funds which were the proceeds from the sale of your main residence.

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