Edited version of private ruling

Authorisation Number: 1011725607173

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Ruling

Subject: Non-assessable non-exempt dividends, deductibility of business expenditure, tax treatment of forex gains and losses.

Questions:

1. Will dividends received by Company X be non-assessable non-exempt income (NANE income) under section 23AJ of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer:

Dividends received by Company X from Company Y will be NANE income under section 23AJ of the ITAA 1936, provided Company X does not have an attribution surplus in respect of Company Y at the time of receiving the dividend.

2. Will general corporate and administration expenses otherwise deductible under subsection 8-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) be non-deductible as they are incurred in the course of deriving NANE income?

Answer:

General corporate and administration expenses necessarily incurred by Company X in deriving NANE income to the extent they are otherwise deductible under paragraph 8-1(1)(b) of the ITAA 1997, are not deductible pursuant to paragraph 8-1(2)(c) of the ITAA 1997.

3. Will business capital costs, otherwise deductible under section 40-880 of the ITAA 1997 be non-deductible as they are incurred in relation to deriving NANE income?

Answer:

Business related capital expenditure, to the extent to which they were incurred by Company X:

· in acquiring shares in its Country Z subsidiaries; and

· in relation to deriving NANE income,

are not deductible pursuant to paragraph 40-880(5)(j) of the ITAA 1997.

4. Are realised foreign exchange gains or losses excluded from being assessable or deductible under section 775-25 or section 775-35 of the ITAA 1997 respectively, as they are incurred in relation to deriving NANE income?

Answer:

When Foreign Realisation Event 4 (FRE4) applies Realised foreign exchange (forex) gains or losses are excluded from being assessable or deductible to Company X under section 775-25 or section 775-35 of the ITAA 1997. The exclusion is restricted to the extent to which the forex gain or loss results from the discharge in whole or in part of an obligation by Company X to repay foreign currency borrowed to acquire shares in its Country Z subsidiaries to generate NANE income.

This ruling applies for the following periods:

Period ended 30 June 2008

Period ended 30 June 2009

Period ended 30 June 2010

Period ending 30 June 2011

The scheme commenced on

1 July 2007

Relevant facts and circumstances

Background

Company X is an Australian resident company. Company X's goal was to raise initial seed funding, primarily from Australian investors and employ the funds to acquire a number of businesses in Country Z. Accordingly, Company X issued convertible notes to be converted upon the occurrence of certain events, including the listing of its shares on the ASX.

Convertible note subscription agreement (Agreement)

The salient terms of the subscription agreement between Company X ('the company') and the Subscribers in respect of the issue of the convertible notes ('Notes'), are summarised as follows:

· At a meeting of the Directors of the company, the Directors approve to issue Notes to Subscribers.

· The Notes will bear a maturity date as stipulated in the Agreement.

· The company acknowledges that on and from the issue date of a Note and at all times before the redemption or conversion (as the case may be) of the Note, it will be indebted to the note holder (Subscriber) to the extent of the moneys owing.

· Interest calculated at a rate of a% per annum on the principal amount is payable by the company to the Subscribers during the period of the Notes and is payable in arrears on stipulated dates as provided under the Agreement ('Payment Dates'). Any interest accrued and that remains unpaid as at the next Payment Date will itself bear interest.

· The company undertakes to not pay or declare any dividend or distribution while any amount payable under the Notes is overdue and unpaid, without the consent of the note holders.

· The Notes can be redeemed by a note holder by giving the company a written notice to that effect. On the maturity date, if the company has not received a notice of conversion from the note holder as provided under the Agreement, the company must redeem the Notes by paying the note holder the moneys owing.

· The Notes will convert into fully paid ordinary shares in the company through the provision of a Conversion Notice issued to the company by the note holder on the occurrence of certain events as provided in the Agreement. On receipt of a duly completed Conversion Notice, the company must issue the Note holder the number of ordinary shares calculated based on the Conversion Price.

· The Notes will convert automatically, and the company must take steps to issue Ordinary Shares, on allotment of Ordinary Shares under any prospectus issued by the company for an 'initial public offering.

· Notwithstanding anything in the above terms, the company may, with the prior written approval of each note holder, make any amendment or addition to these terms.

Company X also entered into a Stock Purchase Agreement to purchase all the shares in certain Country Z entities.

Consideration for the shares in the Country Z entities was paid partly from the capital raised through the convertible notes issue and the issue of shares in Company X.

Additionally, Company X raised capital through the issue of promissory notes.

Promissory note subscription agreement ('agreement')

In summary the agreement provides that:

· Company X will be indebted to the note holders to the extent of moneys owing from the date of issue of the promissory notes at all times until the redemption of those notes in the normal course, on the maturity date stipulated in the agreement.

· no interest is payable by Company X on the promissory notes.

· prior to the maturity date on which date Company X must redeem the promissory notes by paying the moneys owing to each note holder:

- a note holder may seek to redeem all or any of its notes by providing a written notice to Company X; or

- Company X may at any time redeem the notes by paying the moneys owing on the maturity date.

· Company X undertakes to not pay or declare any dividend or distribution while any amount payable under the promissory notes is overdue and unpaid without the consent of the note holders.

· notwithstanding anything in the agreement, Company X may, with the prior written approval of each note holder, make any amendment or addition to the terms of the agreement.

Business related costs

Company X incurred 'capital raising costs' consisting of accounting and audit fees, consultant fees, legal fees and travel expenses to acquire shares in its Country Z subsidiaries. Further, ASX listing costs were also incurred as part of Company X's capital raising costs.

Legal costs, accounting and auditing fees were incurred in relation to participation in meetings related to Company X's initial public offering and prospectus.

The issue of shares in Company X under the terms of the convertible notes subscription agreement was subject to Company X's listing in the ASX and this gave rise to ASX listing costs.

Company X has incurred general and administrative costs in the nature of bank fees, stationery, telephone expenses, insurance, ongoing ASX listing costs, accounting fees, legal fees, auditor's fees, director's fees and travel expenses during the years under consideration.

Legal costs were incurred in drafting confidentiality deeds in relation to various transactions entered into between Company X and other entities subsequent to the acquisition of its Country Z subsidiaries.

Audit fees were incurred in relation to the ongoing audits of the company. Accounting and management fee expenses relate to consultants used to keep the company's internal books and management of accounts.

Director's fees were incurred to remunerate the non-executive directors of Company X. The Directors are working to maximise the value of the Country Z subsidiaries and as a result increase the value of Company X for its shareholders.

The majority of general and administrative costs have been incurred in maintaining Company X, as the Australian head entity, including its compliance and activities to increase the value of its Country Z investments.

Post acquisition business of Company X

As a result of acquiring the shares in the Country Z entities, Company X owned 100% of the issued capital of its Country Z subsidiaries. Following this, a holding company in Country Z, Company Y, was interposed between Company X and each of its Country Z subsidiaries.

Company Y does not trade and acts as the head entity for Country Z tax consolidation purposes. Company Y does not carry on business in Australia.

Following the initial acquisition transactions, Company X lent funds to its subsidiaries to effectively carry on their business in Country Z.

Once Company X had lent all of its funds raised from the issue of the convertible notes to its Country Z subsidiaries, the subsidiaries would transfer funds back to Company X in the nature of loan repayments to allow Company X to cover its administrative costs in Australia.

Subsequently, Company X issued shares to raise further capital to expand the business of its subsidiaries in Country Z. Following this, Company X's shares were approved for listing in the ASX.

As a consequence of Company X's shares being approved for listing by the ASX, the convertible notes on issue converted into shares under the terms of the convertible note subscription agreement.

The shareholders of Company X currently include Country Z and Australian individual and non-individual investors.

Since its incorporation Company X has not actively traded, it has only operated as a head investment entity. Its only income thus far has been small amounts of interest from deposits held with financial institutions.

In the future, Company X expects to receive dividends from its Country Z subsidiaries. In this regard, the Company X representatives have advised that at present any profits made by the subsidiaries are reinvested to strengthen the business and that delays in building up the business is a nature of the industry. This in turn would delay the distribution of dividends to Company X by its subsidiaries in Country Z.

The receipt of dividends, apart from foreign exchange movements, is the only expected source of income for Company X.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 Section 23AJ

Income Tax Assessment Act 1936 Section 23AI

Income Tax Assessment Act 1936 Subsection 317(1)

Income Tax Assessment Act 1936 subsection 318(2)

Income Tax Assessment Act 1936 subsection 327A(3)

Income Tax Assessment Act 1936 subsection 334A

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Paragraph 8-1(2)(c)_

Income Tax Assessment Act 1997 Section 40-880

Income Tax Assessment Act 1997 Section 40-880

Income Tax Assessment Act 1997 Subsection 40-880(2)

Income Tax Assessment Act 1997 Section775-25

Income Tax Assessment Act 1997 Section 775-35

Income Tax Assessment Act 1997 Section 775-55

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies, the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is a part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Question 1

Will dividends received by Company X be NANE income under section 23AJ of the Income Tax Assessment Act 1936 (ITAA 1936)?

Company X is an Australian resident company that holds shares in Company Y, a company incorporated in Country Z.

Company Y is a company that is not a resident of Australia for Australian income tax purposes. Company Y does not carry on its business in Australia.

The shares are not 'eligible finance shares' or 'widely distributed finance shares' for the purposes of the definition of non-portfolio dividend in subsection 317(1) of the ITAA 1936. This is because Company X is an 'associate' of Company Y for the purposes of the meaning of that term in subsection 318(2) of the ITAA 1936.

'Eligible finance share' is defined in section 327 of the ITAA 1936 and includes the requirement that the shareholder is not an associate of the company.

The term 'widely distributed finance share' has the meaning given by section 327A of the ITAA 1936 and requires inter alia, that the share be a 'recognised finance share' which is defined in subsection 327A(3) and includes the requirement that the shareholder is not an associate of the company.

Company X is considered to hold the rights associated with ownership of its shares in Company Y for its own benefit for the purposes of subsection 334A(1) of the ITAA 1936.

The return paid to Company X out of the profits of Company Y is a distribution by a company to its shareholder and is therefore a 'dividend' under subsection 6(1) of the ITAA 1936.

As Company X has a 100% interest in Company Y, it has a voting power of at least 10% in that company. Therefore, any distributions received by Company X from Company Y are non-portfolio dividends as defined in subsection 317(1) for the purposes of section 23AJ of the ITAA 1936.

The distributions would satisfy the remaining requirements of section 23AJ because:

· Company X does not receive the distribution in the capacity of a trustee; and

· Company Y is not a Part X Australian resident as it is not a resident of Australia for the purposes of section 6 of the ITAA 1936.

As all of the elements of section 23AJ of the ITAA 1936 are satisfied in the present case, the distributions received by Company X out of the profits of Company Y are non-assessable non-exempt income under that section.

Paragraph 1 of Taxation Determination TD 2006/51 states that section 23AJ of the ITAA 1936 does not apply to dividends to the extent that a dividend is non-assessable non-exempt income under section 23AI of the ITAA 1936.

If Company X has an attribution surplus pursuant to the attribution of profits under the Controlled Foreign Company (CFC) provisions in respect of Company Y, an attribution debit arises under section 372 of the ITAA 1936 when a dividend is subsequently paid by Company Y.

In the above circumstances, it is section 23AI of the ITAA 1936 and not section 23AJ that would apply to make the dividend non-assessable non-exempt income of Company X.

Question 2

Will general corporate and administration expenses otherwise deductible under subsection 8-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) be non-deductible as they are incurred in the course of deriving NANE income?

Expenses necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income are deductible under paragraph 8-1(1)(b) of the ITAA 1997. However, no deduction is allowed under subsection 8-1(1) for expenses to the extent to which they are incurred in gaining or producing exempt or non-assessable non-exempt income, pursuant to paragraph 8-1(2)(c) of the ITAA 1997.

It is not necessary that expenditure that qualifies for a deduction under subsection 8-1(1) of the ITAA 1997 should be incidental to income derived in the same year in which the expenditure is incurred, particularly in the case of a continuing enterprise activity.

Taxation Ruling TR 2004/4 (TR 2004/4), among other issues, deals with the deductibility of interest expenditure incurred prior to the gaining or producing of assessable income. In this regard TR 2004/4 provides that, expenditure can satisfy the deductibility tests even though it is incurred in a period prior to any expected resultant income. This is so provided temporal delays do not suggest that the outgoing was incurred for some purpose other than the gaining or producing of assessable income.

At paragraph 9, TR 2004/4 considers that interest incurred in a period prior to the derivation of relevant assessable income will be 'incurred in gaining or producing the assessable income' in the following circumstances:

· the interest is not incurred 'too soon', is not preliminary to the income earning activities, and is not a prelude to those activities;

· the interest is not private or domestic;

· the period of the relevant outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost;

· the interest is incurred with one end in view, the gaining or producing of assessable income; and

· continuing efforts are undertaken in pursuit of that end.

In the present circumstances, general and administrative costs in the nature of bank fees, stationery, telephone expenses, insurance, accounting and legal fees, auditor's fees, director's fees and travel expenses have been incurred by Company X in the income years under consideration.

These expenses have been incurred on account of the following:

Audit fees were incurred in relation to the ongoing audits of the company.

Accounting and management fee expenses relate to consultants used to keep the company's internal books and management of accounts.

Director's fees were incurred to remunerate the non-executive directors of Company X. The Directors are working to maximise the value of the Country Z subsidiaries and as a result increase the value of Company X for its shareholders.

The representatives of Company X have stated that the majority of general and administrative costs have been incurred in maintaining Company X, as the Australian head entity, including its compliance, and other activities to increase the value of Company X's Country Z investments.

In reference to the indicators that determine the relevance of an expense to the derivation of future income (as provided in paragraph 9 of TR 2004/4 and stated previously), it is considered that, based on the information provided by the representatives of Company X:

· the general and administrative expenses incurred by Company X are directed to the growth of future income from its Country Z subsidiaries and therefore cannot be considered as incurred 'too soon' or as 'preliminary expenses';

· the expenses are not private or domestic;

· the period of Company X's outgoings prior to the derivation of relevant future income is not so long that the necessary connection between outgoings and the future income is lost. This is taking into account the advice from the representatives of Company X that any profits made by the subsidiaries are currently reinvested to strengthen the business and that delays in building up the business were a nature of the industry. This in turn is expected to delay the distribution of dividends to Company X.

· the expenses are incurred with one end in view, the gaining or producing of future income for Company X's subsidiaries; and

· continuing efforts are undertaken to maximise the value of Company X's Country Z subsidiaries in the expectation of generating future income.

Consequently, to the extent that general and administrative expenses as detailed previously are necessarily incurred by Company X to derive future income from its Country Z subsidiaries and those expenses are not incurred at a 'point too soon', they will be considered to be deductible under paragraph 8-1(1)(b) of the ITAA 1997.

However, based on the information provided by the representatives of Company X, the income to be derived by Company X from the maintenance of its Country Z subsidiaries will constitute mainly of dividends. As discussed elsewhere in this report, these dividends are non-assessable non-exempt income for the purposes of section 23AJ of the ITAA 1936.

Accordingly, the general and administrative expenses incurred by Company X that are considered to be otherwise deductible under paragraph 8-1(1)(b) of the ITAA 1997 are however denied deductibility pursuant to paragraph 8-1(2)(c) of the ITAA 1997. Paragraph 8-1(2)(c) of the ITAA 1997 precludes a deduction for expenses to the extent to which they are incurred in gaining or producing non-assessable non-exempt income.

Question 3

Will business capital costs, otherwise deductible under section 40-880 of the ITAA 1997 be non-deductible as they are incurred in relation to deriving NANE income?

Section 40-880 of the ITAA 1997 applies to business related capital expenditure incurred on or after 1 July 2005.

Subsection 40-880(1) of the ITAA 1997 describes the object of section 40-880 which is to make certain business capital expenditure deductible over five years.

Paragraph 40-880(2)(a) of the ITAA 1997 gives an entitlement to a deduction for capital expenditure the taxpayer incurs in relation to an existing business.

Subsection 40-880(3) of the ITAA 1997 limits the deduction for the expenditure to the extent that the business is carried on for a taxable purpose.

Paragraph 40-880(5)(j) of the ITAA 1997 provides that the taxpayer cannot deduct anything under section 40-880 of the ITAA 1997 for an amount of expenditure they incur to the extent that it is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income.

Draft Taxation Ruling TR 2010/D7 (the draft ruling) sets out the Commissioner's views on the interpretation of the operation and scope of section 40-880 of the ITAA 1997 as follows:

If expenditure produces some asset or advantage of a lasting character for the benefit of the business it will be considered to be capital expenditure (paragraphs 46 and 47).

The words 'in relation to' as they appear in paragraph 40-880(2)(a) of the ITAA 1997 whilst positing a test that is not as strict as the 'in carrying on business' test under the second positive limb of section 8-1, however require that the expenditure satisfies the ends of the relevant business so as to have the character of a business expense (paragraphs 53 to 58).

As a general rule, the extent to which a business is to be carried on for a taxable purpose is determined by comparing the amount of any exempt income and non-assessable non-exempt income the business has derived or will derive in relation to its total income. This percentage is then applied to the amount of expenditure to reduce the deduction (paragraph 136).

ATO Interpretative Decision 2009/91 (ATO ID 2009/91) deals with the application of paragraph 40-880(5)(j) of the ITAA 1997 to business related costs incurred by a taxpayer in relation to producing exempt income or non-assessable non-exempt income.

In determining the extent to which a taxpayer's business related costs are incurred in relation to gaining or producing exempt or non-assessable non-exempt income, the view contained in ATO ID 2009/91 requires consideration of the taxpayer's particular use of the capital that it has raised.

In the circumstances of the taxpayer cited in ATO ID 2009/91, the taxpayer raised funds specifically to fund the acquisition of the shares in an offshore company. The object of that capital raising was targeted and specific: that is, a rights issue and share placement to provide the funds to purchase the shares in the offshore company. There was no real relationship between the acquisition of the shares in the offshore company and revenue growth to the taxpayer as revenue growth in Australia was not expected to be significant.

Accordingly, ATO ID 2009/91 concludes that, as the only income the taxpayer can possibly derive from the acquisition of the shares in the offshore company is dividends, there is a real connection, albeit an indirect one, between the holding of the shares in the offshore company and the receipt of dividends by the taxpayer. Any such dividends received by the taxpayer, however, would be non-assessable non-exempt income under section 23AJ of the ITAA 1936.

As there is a sufficient and relevant connection between the acquisition of the shares in the offshore company and the gaining or producing of non-assessable non-exempt income, capital raising costs were incurred by the taxpayer wholly in relation to the gaining or producing of non-assessable non-exempt income.

Ultimately, paragraph 40-880(5)(j) of the ITAA 1997 will therefore apply to exclude any deduction otherwise available under section 40-880 of the ITAA 1997 in respect of the capital raising costs that the taxpayer has incurred.

In the present circumstances, capital raised by Company X through the issue of promissory notes, the allocation of shares in Company X and partly through the issue of convertible notes were applied to acquire shares in a number of Country Z companies. Company X incurred capital raising costs in the nature of accounting and audit fees, consultant fees, legal fees and travel expenses.

Further, the issue of shares in Company X under the terms of the convertible notes subscription agreement was subject to Company X's listing in the ASX. This gave rise to additional expenses associated with the raising of capital in the nature of ASX listing costs.

The capital raising costs, attributable to the capital employed in acquiring shares in the Country Z entities, were incurred by Company X to obtain an enduring benefit, i.e. Company X's ownership of its Country Z subsidiaries and would therefore be correctly categorised as business related capital expenditure for the purposes of paragraph 40-880(2)(a).

The acquisition of the shares in the Country Z entities was not in relation to revenue growth opportunities for Company X in Australia. Company X does not carry on business operations in Australia other than acting as a holding company for its subsidiaries. Accordingly, the receipt of income by Company X from its Country Z subsidiaries in the nature of dividends has a real connection with its shareholding in the relevant entities. Any such dividends received by Company X, however, would be non-assessable non-exempt income under section 23AJ or 23AI of the ITAA 1936 as established previously.

In accordance with the ATO view contained in ATO ID 2009/91, capital raising costs incurred by Company X in the nature of accounting and audit fees, consultant fees, legal fees, travel expenses and ASX listing costs in Australia are related to the deriving of non-assessable non-exempt income.

Consequently, capital raising costs to the extent to which they were incurred by Company X in acquiring shares in its Country Z subsidiaries and therefore in relation to deriving NANE income, are not deductible pursuant to paragraph 40-880(5)(j) of the ITAA 1997.

Question 4

Are realised foreign exchange gains or losses made under Forex Realisation Event (FRE) 4 excluded from being assessable or deductible under section 775-25 or section 775-35 of the ITAA 1997 respectively, as they are incurred in relation to deriving NANE income?

Classification of the convertible notes and promissory notes issued by MAD

For the purposes of the Commissioner's view as expressed in TR 2008/3, the convertible notes issued by Company X constitute a debt interest under Division 974 of the ITAA 1997 as Company X has an 'effectively non-contingent obligation' to return to the note holders an amount at least equal to the amount invested.

Similarly, the 'scheme' to raise funds by Company X through the issue of promissory notes gives rise to a 'debt interest' as all the requirements of the debt test, as set out in subsection 974-20(1) of the ITAA 1997, are met.

Forex Realisation Event (FRE) 4

Where a taxpayer incurs an obligation to repay foreign currency in return for receiving an amount of foreign currency, Forex Realisation Event 4 (FRE4) will occur at the time of each repayment of the borrowing, pursuant to subsection 775-55(2).

The repayment of foreign currency borrowed by the taxpayer will give rise to either a forex realisation gain (under subsection 775-55(3) of the ITAA 1997) or a forex realisation loss (under subsection 775-55(5) of the ITAA 1997).

This will depend on whether the amount of foreign currency repaid when translated into Australian currency at the exchange rate applicable at the time of repayment, is lesser or greater than an equivalent amount foreign currency translated into Australian currency at the exchange rate applicable at the time when the foreign currency was received by the taxpayer.

A forex realisation loss made by a taxpayer under FRE 4 on a complete or partial repayment of the borrowings will be disregarded under subsection 775-35(2) of the ITAA 1997 to the extent that:

· it is made in gaining or producing exempt income or non-assessable non-exempt income (the first limb), and

· the obligation to repay the borrowings, or that part of the borrowings, does not give rise to a deduction (the second limb).

On the other hand, a forex realisation gain made by the taxpayer under FRE 4 on a complete or partial repayment of the borrowings will be non-assessable non-exempt income to the taxpayer if, had the forex gain been a forex realisation loss, it would have been made in gaining or producing non-assessable non-exempt income (section 775-25 of the ITAA 1997).

ATO Interpretative Decision 2004/572 (ATO ID 2004/572) provides that, to determine the link or nexus between a forex realisation loss that arises on a complete or partial repayment of the borrowings, and that it is 'made in gaining or producing' non-assessable non-exempt income, the purpose for, or use to which, the taxpayer put those borrowings must be considered.

ATO ID 2004/572 concludes that the nexus is established where the amounts borrowed were used to acquire shares in a foreign company. This is due to the fact that non-portfolio dividends as defined in section 317 of the ITAA 1936 that are non-assessable non exempt income are derived by a taxpayer directly in relation to the taxpayer's shareholding in the foreign company.

Accordingly, any forex realisation loss arising on a complete or partial repayment of the borrowings will be made by the taxpayer in gaining or producing non-assessable non-exempt income, satisfying the nexus requirement in paragraph 775-35(2)(a) of the ITAA 1997.

In the present circumstances, Company X's borrowings in Country Z currency from the issue of promissory notes and partly from the issue of convertible notes were applied to acquire shares in certain Country Z entities. Company X's shareholdings will generate income in the nature of non-portfolio dividends that are non-assessable non-exempt income under section 23AJ or 23AI of the ITAA 1936.

Any forex realisation loss arising on a complete or partial repayment of the borrowings by Company X to acquire shares in its Country Z subsidiaries is made in gaining or producing non-assessable non-exempt income, thereby satisfying the nexus requirement in paragraph 775-35(2)(a) of the ITAA 1997.

A forex loss made by Company X in gaining or producing non-assessable non-exempt income will also satisfy paragraph 775-35(2)(b) which requires that the discharge of the obligation, or part of the obligation, (in this case, to repay the borrowings), does not give rise to a deduction.

The repayments of the borrowings (principal amount) by Company X are capital in nature and will not give rise to a general deduction under section 8-1 of the ITAA 1997 pursuant to paragraph 8-1(2)(a).

Additionally, a specific statutory deduction provision, in particular, section 25-90 of the ITAA 1997 which applies to expenses of interest or amounts in the nature of interest, will not apply to allow Company X a deduction in respect of repayments of the principal amount of a loan.

As both limbs of subsection 775-35(2) of the ITAA 1997 are satisfied, any forex realisation loss incurred by Company X, in respect of a FRE4 event is disregarded in the following circumstances:

(a) Company X's obligation to repay foreign currency borrowed under the convertible notes subscription agreement to acquire shares in the Country Z subsidiaries is discharged in full or in part; and

(b) Company X's obligation to repay foreign currency borrowed under the promissory notes subscription agreement to acquire shares in the Country Z subsidiaries is discharged in full or in part.

Also, any forex gain made in the above circumstances will be treated as non-assessable non-exempt income, pursuant to subsection 775-25 of the ITAA 1997 as discussed previously.

Forex Realisation Event (FRE) 2

However, a forex realisation loss incurred or a gain made by Company X will be considered to be deductible or assessable respectively, in the following circumstances:

c) Obligation of Company X's Country Z subsidiaries to repay monies lent by Company X is discharged in whole or in part by actual payment by the subsidiaries; and

d) Fluctuations in the value of the Australian dollar against the Country Z currency in respect of Country Z currency held by Company X in bank accounts, between the time of depositing the funds into the accounts and subsequent transfer of those funds to the Country Z subsidiaries.

In the situations described in c) and d) above, the forex gain or loss is not the result of FRE 4 in respect of Company X i.e. discharge of an obligation by Company X to repay foreign currency borrowed.

The circumstance in c) causes a forex loss or gain to occur as a result of the cessation of Company X's right to receive foreign currency through actual receipt of foreign currency from its subsidiaries under forex realisation event 2.

The circumstances described in d) also gives rise to a forex gain or loss under forex realisation event 2 where Company X withdraws an amount from a foreign currency denominated bank account with a credit balance. This is because Company X's right against the bank, represented by the account balance, ends to the extent that a withdrawal is made.

Forex realisation event 2 is not subject to the operation of subsections 775-25 or 775-35 of the ITAA 1997 that respectively cause a forex gain to be treated as non-assessable non-exempt income and a forex loss to be disregarded.

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