Edited version of private ruling

Authorisation Number: 1011658852904

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Ruling

Subject: Foreign Exchange and Hedging Transactions

Issue 1

In ascertaining its taxable income, must AC include in its assessable income, or deduct from its assessable income, any forex realisation gains or losses made on the transfer of monies to and from OPC?

Yes.

Issue 2

Are forex realisation gains and losses made as a result of the withdrawal of funds from AC's Australian USD bank account taken into account in determining AC's taxable income?

Yes. Forex realisation gains and losses made as a result of the withdrawal of funds from AC's USD denominated bank account are taken into account in determining its taxable income. Forex gains and losses are calculated using either the first-in first-out (FIFO) method, or, where an appropriate election has been made, the weighted average basis.

Issue 3

Are forex realisation gains and losses made upon payment of USD to third parties for the acquisition of stock taken into account in determining AC's taxable income?

Yes.

Issue 4

Are any forex realisation gains and losses made as a result of entering into short-term inter-company loans with OPC taken into account in determining AC's taxable income?

Yes.

This ruling applies for the following periods:

A substituted accounting period applies:

Year ended 31 December 2010

Year ended 31 December 2011

The scheme commences on:

1 January 2009

Relevant facts and circumstances

OPC is the parent company of AC subsidiary. AC commenced trading after the registration date as an importer and wholesaler.

Until 2010, OPC held 100% of the shares in AC. In 2010, this was reduced to 90% as an Australian managing director was appointed. OPC has a profit sharing arrangement with AC.

AC controls and operates two Australian bank accounts:

· an Australian dollar (AUD) bank account which is used for sales within Australia and for the purchase of USD through OPC, and

· an Australian US dollar (USD) Account used for purchasing and importing stock internationally and paying other invoices such as commissions to a broker, freight, customs and so on.

When AC receives a USD invoice from a third party, OPC instructs AC to transfer sums of AUD to OPC. OPC has control of AC thereby imposing this arrangement. The AUD amount transferred to OPC is based on hedging undertaken by OPC. This is a risk management tool OPC undertakes for all its worldwide subsidiaries. OPC does not derive any profits from these hedging transactions.

OPC applies worldwide hedging exchange (WHE) rates based on reducing risk in the worldwide market. Your tax agent states that WHE rates are not favourable to AC compared with Reserve Bank of Australia (RBA) rates and hence AC is losing money.

OPC then transfers the USD into AC's Australian USD bank account. On the same day the USD is received, AC converts it to AUD using RBA exchange rates. Any resultant gains or losses are calculated by reference to the difference between the WHE rate and the RBA rates on that date.

A timeline of actual transactions were provided by you.

Reasons for decision

Issue 1

Detailed reasoning

At the time of paying AUD to OPC, AC acquires the right to receive an amount of USD.

Under subsection 775-45(1) of the Income Tax Assessment Act 1997 (ITAA 1997), forex realisation event 2 (FRE 2) happens if an entity ceases to have a right to receive foreign currency. Subsection 775-45(2) of the ITAA 1997 provides that FRE 2 happens when the entity ceases to have the right. AC ceased to have the right to receive foreign currency when OPC transferred USD into AC's Australian USD bank account.

Subsection 775-45(3) of the ITAA 1997 provides that a forex realisation gain is made if the AUD equivalent of the amount received in respect of FRE 2 happening exceeds the forex cost base of the right as determined at the 'tax recognition time' (TRT).

Subsection 775-45(4) of the ITAA 1997 provides that a forex realisation loss is made if the AUD equivalent of the amount received in respect of FRE 2 happening falls short of the forex cost base of the right as determined at the TRT.

The amount of forex realisation gain or loss is so much of the excess or shortfall that is attributable to a currency exchange rate effect. A 'currency exchange rate effect' is defined in subsection 775-105(1) of the ITAA as any currency exchange rate fluctuation or the difference between an expressly or implicitly agreed currency exchange rate for a future time, and the actual currency exchange rate at that time.

The TRT is when an event occurs which creates tax consequences. Item 4 of the table to subsection 775-45(7) of the ITAA 1997 provides that for a right acquired in return for agreeing to pay AUD, the TRT is when the amount is paid.

The AUD equivalent of the USD received by AC in July 2009, is translated using the spot rate on the day the amount is received (item 11 of the table in subsection 960-50(6) of the ITAA 1997). The forex cost base, as determined under section 775-85 of the ITAA 1997, in June 2009 is the AUD AC paid for acquiring the right to receive the USD from OPC.

As the amount AC received fell short of the forex cost base of the right, AC has made a forex realisation loss in respect of this transaction. This forex realisation loss is deductible from AC's assessable income, pursuant to subsection 775-30(1) of the ITAA 1997, in the income year in which FRE 2 happens.

The same process of calculation is applied to all other transactions of this nature in order to determine the forex realisation gains or losses made by AC on an annual basis.

Issue 2

Detailed reasoning

Subsection 775-45(1) of the ITAA 1997 provides that FRE 2 happens if an entity ceases to have a right, or part of a right, to receive foreign currency which is created or acquired in return for paying an amount of Australian currency or foreign currency. Subsection 775-45(2) of the ITAA 1997 provides that the time of FRE 2 is when the right or part of the right ceases.

The relationship between banker and customer in respect of a bank account is that of debtor and creditor: Foley v. Hill and Ors (1848) 2 HL Cas 28; [1843-60] All ER Rep 16. Thus, 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.

This does not mean that each deposit made by a customer represents a new contract. Rather, 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: Hart (Inspector of Taxes) v. Sangster [1957] 1 Ch 329; [1957] 2 All ER 208.

Section 775-110 of the ITAA 1997 provides that if a payer does not actually pay an amount to a recipient but applies that amount on the recipient's behalf or as the recipient directs, then the payer is taken to have paid the amount as soon as it is applied or dealt with and the recipient is taken to have received the amount as soon as it is applied or dealt with.

As the funds were deposited by OPC, at AC's direction, into AC's Australian USD bank account, AC has a right to receive foreign currency as against the bank which was created or acquired in return for AC paying an amount of foreign currency (subparagraph 775-45(1)(b)(iii) of the ITAA 1997).

Pursuant to subsection 775-45(2) of the ITAA 1997, FRE 2 happens each time AC withdraws all, or part, of the credit balance from the account.

Interest income

Any interest amounts credited to AC's Australian USD bank account are receipts of ordinary income.

Item 6 in the table in subsection 960-50(6) of the ITAA 1997 provides that an amount of ordinary income denominated in a foreign currency must be translated to Australian currency at the earlier of when it is received or derived. AC derives the interest income at the time it is credited into its Australian USD bank account.

Accordingly, AC must translate each amount of interest credited to the Australian USD bank account into AUD at the exchange rate applicable at the time the interest is credited to the account.

Use of FIFO or weighted average method for fungible assets, rights and obligations

Currency within a bank account is regarded as 'fungible' because one unit of currency is identical to and interchangeable with any other unit. At the time of withdrawing funds from a foreign currency denominated bank account it is difficult to identify which particular units of currency are being withdrawn.

In order to allocate a cost base or value to a particular unit of foreign currency, subsection 775-145(1) of the ITAA 1997 provides that a FIFO method be applied to determine from which deposits a particular withdrawal is made. Alternatively, subsection 775-145(2) provides that a weighted average basis may be adopted.

A withdrawal of funds from a foreign currency denominated bank account that has a credit balance will result in FRE2 happening as there will be a cessation of the right to receive the amount of foreign currency withdrawn from the account. Conversely, the deposit of an amount into an account which is in debit will result in forex realisation event 4 (FRE4) happening. FRE 4, in brief, happens when there is a cessation of an obligation to pay foreign currency.

Examples of how to use the FIFO and weighted average methods are available at www.ato.gov.au/corporate/content.asp?doc=/content/59214.htm

Issue 3

Detailed reasoning

At the time of entering into an agreement with the third party supplier of stock, AC assumes the obligation to pay an amount of USD.

Under subsection 775-55(1) of the ITAA 1997, FRE 4 happens if a taxpayer ceases to have an obligation, or part of an 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. AC ceases to have the obligation to pay USD to the third party supplier of stock when it pays the invoice.

Subsection 775-55(3) of the ITAA 1997 provides that a forex realisation gain is made if the AUD equivalent of the amount paid in respect of FRE 4 happening falls short of the AUD equivalent of the proceeds of assuming the obligation at the TRT.

Subsection 775-55(5) of the ITAA 1997 provides that a forex realisation loss is made if the AUD equivalent of the amount paid in respect of FRE 4 happening exceeds the AUD equivalent of the proceeds of assuming the obligation as determined at the TRT.

The amount of forex realisation gain or loss is so much of the shortfall or excess that is attributable to a currency exchange rate effect. A currency exchange rate effect is defined in subsection 775-105(1) of the ITAA 1997. It is described as any currency exchange rate fluctuation or as the difference between an expressly or implicitly agreed currency exchange rate for a future time and the actual currency exchange rate at that time.

The TRT is when an event occurs which creates tax consequences. Item 2 of the table to subsection 775-55(7) of the ITAA 1997 provides that for an obligation assumed in return for the acquisition of trading stock, the TRT is when the item becomes part of your trading stock on hand.

The amount paid in respect of FRE 4 happening (payment to the third party supplier of stock) is converted to AUD using the spot rate applicable on the date the payment is made (item 11 of the table in subsection 960-50(6) of the ITAA 1997). The proceeds of assuming the obligation, as determined under section 775-95 of the ITAA 1997 is the market value of any non-cash benefit AC received for incurring the obligation. This is represented by the value of the stock AC received in exchange for the USD, translated into its AUD equivalence at the exchange rate applicable when the item became on hand (Item 3 of the table to subsection 960-50(6) of the ITAA 1997).

The amount of forex realisation gain or loss is so much of the excess or shortfall that is attributable to a currency exchange rate effect. This will occur if the AUD equivalent of the amount received in respect of FRE 4 happening falls short of or exceeds the AUD equivalent of the amount the entity was entitled to receive as determined at the TRT.

Any resultant forex realisation gain made as a result of FRE 4 happening will be included in AC's assessable income by virtue of subsection 775-15(1). Conversely, any forex realisation loss made will be an allowable deduction from assessable income pursuant to subsection 775-30(1) of the ITAA 1997. These gains or losses will be included in ascertaining AC's taxable income in the income year in which FRE 4 happens.

Issue 4

Detailed reasoning

At the time of making a borrowing under the inter-company loan, AC assumes the obligation to pay an amount of USD.

Under subsection 775-55(1) of the ITAA 1997, FRE 4 happens if a taxpayer ceases to have an obligation, or part of an 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. Each time AC makes a partial or full repayment of an amount outstanding on the loan, its obligation to pay foreign currency will cease to the extent of that repayment.

Subsection 775-55(3) of the ITAA 1997 provides that a forex realisation gain is made if the AUD equivalent of the amount paid in respect of FRE 4 happening falls short of the AUD equivalent of the proceeds of assuming the obligation at the TRT.

Subsection 775-55(5) of the ITAA 1997 provides that a forex realisation loss is made if the AUD equivalent of the amount paid in respect of FRE 4 happening exceeds the AUD equivalent of the proceeds of assuming the obligation as determined at the TRT.

The amount of forex realisation gain or loss is so much of the shortfall or excess that is attributable to a currency exchange rate effect. A currency exchange rate effect is defined in subsection 775-105(1) of the ITAA 1997. It is described as any currency exchange rate fluctuation or as the difference between an expressly or implicitly agreed currency exchange rate for a future time and the actual currency exchange rate at that time.

The TRT is when an event occurs which creates tax consequences. Item 8 of the table to subsection 775-55(7) of the ITAA 1997 provides that for an obligation assumed in return for receiving foreign currency, the TRT is when the currency is received.

The amount paid in respect of FRE 4 happening (repayment of all, or part, of the borrowing to the lender) is converted to AUD using the spot rate applicable at the time the payment is made (item 11 of the table in subsection 960-50(6) of the ITAA 1997). The proceeds of assuming the obligation, as determined under section 775-95 of the ITAA 1997 is the money AC received for assuming the obligation. This is represented by the amount of USD received under the loan, translated into its AUD equivalence at the exchange rate applicable at the time of receipt (item 11 of the table to subsection 960-50(6) of the ITAA 1997).

The amount of forex realisation gain or loss is so much of the excess or shortfall that is attributable to a currency exchange rate effect. This occurs if the AUD equivalent of the amount received in respect of FRE 4 happening falls short of or exceeds the AUD equivalent of the amount the entity was entitled to receive as determined at the TRT.

Any resultant forex realisation gain made as a result of FRE 4 happening will be included in AC's assessable income by virtue of subsection 775-15(1). Conversely, any forex realisation loss made will be an allowable deduction from assessable income pursuant to subsection 775-30(1) of the ITAA 1997. These gains or losses will be included in ascertaining AC's taxable income in the income year in which FRE 4 happens.

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