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Authorisation Number: 1012394406832

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Ruling

Subject: Foreign exchange realisation

Questions and answers:

1. Will a capital gains event occur when you sell an overseas residential property?

Yes.

2. Will the main residence exemption apply to the capital gain in relation to the sale of your overseas property?

Yes.

3. Will there be a foreign exchange realisation event when you discharge your latest foreign mortgage?

Yes.

4. Will there be a partial exemption available from the foreign exchange realisation event?

Yes.

This ruling applies for the following periods:

Year ended 30 June 2012.

Year ended 30 June 2013.

Year ended 30 June 2014.

The scheme commenced on: 1 July 2011.

Relevant facts:

You are an Australian citizen.

You are married to a foreign citizen.

You were living overseas until the 2006-07 financial year.

You consider you recommenced your Australian residency from when you returned to Australia.

You and your spouse jointly purchased a home overseas after 20 September 1985.

In order to purchase this property, a joint mortgage was taken out with bank 1.

Thereafter you both lived in the property.

You jointly refinanced the original mortgage (with a different provider, bank 2) for a further amount.

The mortgage with bank 2 was increased to fund home improvements and living expenses.

You returned to Australia to work in the 2006-07 financial year.

Your spouse and child continued to live in the overseas property for several months, after which they joined you in Australia.

After your family joined you in Australia you purchased your spouse's 50% share of the overseas property, increasing your ownership to 100%. In order to finance this purchase the mortgage with bank 2 was refinanced with a new financer - bank 3. The mortgage balance was increased and was wholly in your name.

Your spouse then purchased an Australian property.

All the mortgages have been on an interest only basis.

In the 2006-07 financial year the overseas property first became available for rent.

The property stayed available for rent until the 2012-13 financial year.

You have claimed interest deductions on the overseas property, both in Australia and overseas.

You have not claimed any interest deductions on the Australian property.

The overseas property is now available for sale.

You intend to discharge the current mortgage with bank 3.

You expect to make a gain based on exchange rates and property value.

You intend to elect to treat your overseas house as being your main residence for your entire ownership period.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Subsection 104-10(1).

Income Tax Assessment Act 1997 Subsection 108-5(1).

Income Tax Assessment Act 1997 Subsection 108-5(2).

Income Tax Assessment Act 1997 Section 118-20.

Income Tax Assessment Act 1997 Subdivision 118-B.

Income Tax Assessment Act 1997 Subsection 118-145(1).

Income Tax Assessment Act 1997 Division 775.

Income Tax Assessment Act 1997 Subsection 775-15(2).

Income Tax Assessment Act 1997 paragraph 775-10(b).

Income Tax Assessment Act 1997 paragraph 775-105(1)(a).

Income Tax Assessment Act 1997 Subsection 118-145(2).

Income Tax Assessment Act 1997 Subsection 855-45(2).

Reasons for decision

Capital Gains Tax (CGT)

A capital gain or loss will occur where a CGT asset is subject to a CGT event, and the capital proceeds from the event are greater than or less than the applicable cost base, respectively.

CGT event A1, the disposal of a CGT asset subsection 104-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997), occurs where a change of ownership occurs from the taxpayer to a different entity.

The time of the event is taken to occur when any contract for the disposal is entered into, or where there is no contract, when the change of ownership occurs.

CGT assets are defined in subsection 108-5(1) of the ITAA 1997. The definition is very broad and states that a CGT asset is (a) any kind of property; or (b) a legal or equitable right that is not property. Subsection 108-5(2) specifies that the following are CGT assets:

· part of, or an interest in, any assets covered by items (a) or (b) above;

· goodwill or an interest in it;

· an interest in an asset of a partnership; and

· an interest in a partnership other than an interest in a an asset of a partnership.

Specific examples of CGT assets include land and buildings, shares in a company, units in a unit trust, options, debts owed to the taxpayer, rights to enforce contractual obligations and foreign currency. Australian currency however is not regarded as a CGT asset: see Taxation Determination (TD) 2002/25 Income tax: capital gains: is Australian currency a CGT asset under section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997) if it is used as legal tender to facilitate a transaction? (As at 20 November 2002.).

Real estate acquired on or after 20 September 1985 is a CGT asset.

Section 118-20 of the ITAA 1997 prevents double taxation by excluding from CGT any amount that has also been included in the taxpayer's assessable income under another provision of the ITAA 1997 or the Income Tax Assessment Act 1936 (ITAA 1936) as a result of a CGT event.

In your case, when you sell your overseas property (purchased post 1985) CGT event A1 will occur.

Main residence exemption

Subdivision 118-B of the ITAA 1997contains the rules for applying the CGT main residence exemption to the disposal of a property used as your main residence.

As a general rule, the main residence exemption can only be applied to one dwelling at a time and if you own and occupy more than one dwelling in a particular period of time, you must choose which dwelling the main residence exemption will apply to. You make this choice in the income year in which the CGT event happens to the property you wish the exemption to apply to.

Section 118-110 of the ITAA 1997 provides that the following conditions must be met to qualify for a full main residence exemption (a partial exemption may be available in cases where any of the conditions are not met):

· the dwelling must have been your home for the whole period you owned it,

· you must not have used the dwelling (or the land on which it is situated and adjacent to) to produce assessable income, and

· the land on which the dwelling is situated must be 2 hectares or less.

Continuing to treat a dwelling as your main residence after it ceases to be your main residence

In some circumstances you may choose to have a dwelling treated as your main residence even though you ceased to use it as such (subsection 118-145(1) of the ITAA 1997.) You can continue to treat the dwelling as your main residence where you meet the following criteria:

(a) At any time either:

· You use the part of the dwelling that was your main residence for the purpose of producing assessable income (for example renting it out); up to a maximum of six (6) years at any one time.

· If you do not use the dwelling that was your main residence for the purpose of producing assessable income but leave it vacant, then you can extend the exemption indefinitely.

(b) You do not treat any other dwelling as your main residence for the time you are applying the extension.

(c) You make the necessary election(s) for the extensions of the main residence period to that property. The election must be made either by the time you lodge your income tax return for the income year in which the relevant CGT event occurred or within such further time that the Commissioner allows.

In your case, you had used your overseas residence as your main residence continuously from when you first acquired it until you made the property available for rent in the 2006-07 financial year. You have elected to keep treating this property as your main residence until it is sold. Therefore, any gain arising from CGT event A1 will be exempt from CGT.

For Australian CGT purposes you are deemed to have acquired your initial 50% interest the property at market value on the day you became an Australian resident for taxation purposes (Subsection 855-45(2) of the ITAA 1997).

Foreign exchange

The Foreign Exchange (Forex) basic rule follows that your assessable income for an income year includes a Forex realisation gain you make as a result of a Forex realisation event that happens during the year. A Forex realisation event means any of the Forex realisation events described in Division 775.

The exceptions to this rule are where your assessable income does not include a Forex realisation gain to the extent that it is (a) a gain of a private or domestic nature; and (b) is not covered by an item of the table as per subsection 775-15(2).

One of the objects of Division 775 of the ITAA 1997 is to quantify a Forex realisation gain or loss solely by reference to the change in the Australian dollar value of rights and obligations (paragraph 775-10(b) of the ITAA 1997). There is no requirement for an actual conversion of foreign currency, any Forex realisation gain or loss will arise purely from a currency exchange rate effect which is described in paragraph 775-105(1)(a) of the ITAA 1997 as any currency exchange rate fluctuations. That is, a Forex realisation gain or loss arises from the comparison between the Australian dollar equivalent amounts of foreign currency at two points in time.

Foreign exchange realisation

Forex realisation event 4 occurs when a taxpayer ceases to have an obligation, or part of an obligation, to pay foreign currency. An obligation to pay foreign currency includes an obligation to pay an amount of Australian currency that is calculated by reference to an exchange rate. The term 'obligation' includes an obligation that is contingent upon something happening.

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 CGT asset,

· certain obligations that are incurred in relation to a depreciating asset, or a project amount, under the capital allowances regime, or

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

The event happens when a taxpayer ceases to have the obligation, or part of the obligation - commonly when a taxpayer actually makes the payment of foreign currency.

Taxpayers make a Forex realisation gain if the amount paid to satisfy the obligation is less than the 'proceeds of assuming the obligation', measured at the 'tax recognition time'. This is to the extent that the gain is due to a 'currency exchange rate effect'.

The proceeds of assuming the obligation are, broadly, the consideration the taxpayer is entitled to receive in return for incurring the obligation, less any amounts already brought to account as assessable income.

The underlying CGT asset which will result in a Forex event is the expected sale of your foreign property. We have considered the following tax consequences as result of the sale of this asset:

1. CGT event A1 at the time of sale.

2. Forex event 4 at the time of discharging your obligation to repay your foreign mortgage with bank 3.

Available exemptions

CGT exemption

In your case, you have elected to treat your foreign property as your main residence and as per the six year rule, regardless of renting this property for several months; your property can be treated as your main residence for the entire period and thus exempt from CGT.

Forex exemption

For most individual taxpayers Forex gains or losses will generally be ignored if the gain or loss is of a private or domestic nature as per section 775-15(2) of the ITAA 1997, 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 is no definition for private or domestic in the Forex legislation. Each case is determined on the facts of individual arrangements.

Therefore, in order to determine if your Forex gain is of a private and domestic nature we need to consider the use of the loan to which the Forex event relates. In your case your foreign loan was used for a number of purposes to:

· repay the previous loan with bank 2, and

· to acquire half of a residential property.

The previous loan with bank 2 was used to:

· repay the previous loan with bank 1, and

· to pay for improvements to the residential property.

Up until this point 100% of the foreign loan relates to ownership of the foreign property used for private purposes i.e. as a home/residence. At this point you owned the property jointly with your spouse.

The final loan with bank 3 was used to:

1. pay the amount outstanding on your spouse's share of the loan,

2. refinance your previous ownership share, and

3. finance the purchase of your spouse's initial interest in the property.

Use of the property

Your overseas property was:

initially a jointly owned home with your spouse,

· you then acquired your spouses interest and rented the property out, and

· It is now currently vacant, awaiting sale.

The amount of loan 3 used to repay your spouse no longer relates to the use of the current property, but was used purely to repay your spouse's outstanding debt on the property. As such this amount is considered private and domestic in nature, and will not be considered in the calculation of a Forex realisation gain.

The remainder of the loan that relates to the refinance of your share of the property and the purchase of your spouse's interest in the property will not have a private nature as it relates to income producing purposes from the date the property was available for rent.

You have been claiming rental deductions as allowable under Section 8-1 of the ITAA 1997, namely interest deductions of the percentage of the loan relating to the use of property for income producing purposes ie the rental of the property. Therefore, for Forex purposes, the percentage of the loan for which interest is an allowable deduction will not be exempt from a Forex realisation gain calculation.

Although you have elected to treat your overseas property, as your main residence for the entire period of ownership, this is a CGT exemption election only, and does not affect your liability to being assessed on a Forex realisation gain.

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