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Edited version of your written advice

Authorisation Number: 1051458965822

Date of advice: 7 December 2018

Ruling

Subject: Application of Division 775 of the Income Tax Assessment Act 1997 (ITAA 1997) to a related party loan from an overseas company

Question 1

Does Division 230 of the ITAA 1997 apply to the loan from an Overseas company to its related Australian company?

Answer

No

Question 2

For the purpose of calculating the forex realisation gain or loss under Division 775 of the ITAA 1997 in respect of the loan, did the ‘proceeds for assuming an obligation to pay foreign currency’ include the opening balance at inception of the principal amount?

Answer

Yes

Question 3

Did the relevant ‘forex realisation event’ under Division 775 of the ITAA 1997 happen on repayment of the loan?

Answer

Yes

Question 4

Is the deductible forex realisation loss incurred in accordance with section 775-30 of the ITAA 1997 on repayment of the loan, included in the opening carry forward tax loss balance as at 1 January 2018?

Answer

Yes

This ruling applies for the following periods:

From income year ended 31 December 2004 to income year ending 31 December 2018

The scheme commences on:

DD January 2004

Relevant facts and circumstances

Assumption(s)

Company A satisfies the Continuity of Ownership Test or Same Business Test under Division 166 of the ITAA 1997 as at 31 December 2018 in respect of the tax losses.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 subsection 230-45(1)

Income Tax Assessment Act 1997 subsection 230-55(4)

Income Tax Assessment Act 1997 subsection 230-455(7)

Income Tax Assessment Act 1997 section 36-17

Income Tax Assessment Act 1997 Division 775

Income Tax Assessment Act 1997 subsection 775-15(1)

Income Tax Assessment Act 1997 section 775-25

Income Tax Assessment Act 1997 section 775-30

Income Tax Assessment Act 1997 section 775-55

Income Tax Assessment Act 1997 section 775-75

Income Tax Assessment Act 1997 section 775-95

Income Tax Assessment Act 1997 section 775-105

Income Tax Assessment Act 1997 section 775-140

Income Tax Assessment Act 1997 subdivision 960-C

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Regulations 1997 Schedule 2 Part 1

Reasons for decision

Consolidation

Company A is the provisional head company of the Company A MEC Group for Australian income tax purposes (section 703-5). By virtue of the single entity rule (section 701-1), the transactions entered into by Company B will be considered transactions of Company A for Australian income tax purposes.

Question 1

Summary

Division 230 Taxation of Financial Arrangements (TOFA) does not apply to the loan from an overseas company to its related Australian company.

Detailed reasoning

The Taxation of Financial Arrangements (TOFA) rules under Division 230 provides a comprehensive framework for taxing financial arrangements that certain taxpayers start to have in an income year commencing on or after 1 July 2010 unless the entity is:

An entity may, notwithstanding that Division 230 does not apply to them based on the above thresholds, irrevocably elect under subsection 230-455(7) to have Division 230 apply to financial arrangements that it has entered into after the beginning of the income year in which the election is made.

Financial Arrangement

Under the TOFA rules, it is necessary to first identify a “financial arrangement” of an entity for the purposes of Division 230.

Under subsection 230-45(1), an arrangement is a ‘financial arrangement’ if under that arrangement there is:

Arrangement

An ‘arrangement’ is defined broadly in section 995-1 of the ITAA 1997 to mean “any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings”.

Application of the TOFA rules under Division 230

The loan was entered into prior to the introduction of the TOFA regime and is not subject to the TOFA rules in Division 230. Further, Company A has not made a transitional election to be subject to the TOFA rules. Therefore, Division 230 only applies to any financial arrangements Company A started to have from 1 January 2011, given its substituted accounting period of 31 December.

The broad definition of “financial arrangement” means that Division 230 extends to a wide range of arrangements including loans.

However, it is necessary to consider whether there have been any changes to the terms of the loan since its commencement, to determine whether the rights and obligations under the loan gave rise to a change in the financial arrangement which bring the loan into the TOFA regime.

Whether the rights and obligations under the loan form a single arrangement under subsection 230-55(4) of the ITAA 1997

Subsection 230-55(4) states that, whether a number of rights and/or obligations form an arrangement or are two or more separate arrangements is a question of fact and degree that to be determined having regard to the following:

Taxation Ruling TR 2012/4 Income tax: the operation of subsection 230-55(4) of the Income Tax Assessment Act 1997 (ITAA 1997) in determining what is an 'arrangement' for the purposes of the taxation of financial arrangements under Division 230 of the ITAA 1997 discusses the operation of subsection 230-55(4) of the ITAA 1997 in determining whether a number of rights and/or obligations are themselves an arrangement or are 2 or more separate arrangements for the purposes of Division 230. Paragraphs 64 –121 of TR 2012/4 provide an example of how Division 230 applies in relation to lending facility agreements. The Commissioner considered that the advance of funds under a lending agreement and associated obligations to repay principal and capitalised interest should generally form a single financial arrangement under Division 230 where the rights and obligations are created under a single contractual arrangement and are directed toward a single commercial purpose.

Having regard to the background and purpose of the Loan, it is considered that the rights and obligations under the Loan comprise one single financial arrangement.

Conclusion

Company B entered into the Loan prior to the commencement date of the TOFA rules, and the loan comprised one single financial arrangement; therefore Division 230 does not apply to any aspect of the arrangement.

Question 2

Summary

To calculate the forex realisation gain or loss under Division 775 of the ITAA 1997 in respect of the Loan, the ‘proceeds for assuming an obligation to pay foreign currency’ include the opening balance of the principal loan amount.

Detailed reasoning

Section 775-95 defines the ‘proceeds of assuming an obligation to pay foreign currency’ as follows:

‘Obligation’

The term 'obligation' was not defined for the purposes of section 775-55; however, it was intended by Parliament to have its ordinary legal meaning. Explanatory Memorandum to the New Business Tax System (Taxation of Financial Arrangements) Bill (No.1) 2003 (Cth) (which introduced Division 775 into the ITAA 1997) states at paragraph 2.108:

Section 775-140 extends the definition of the term obligation to pay foreign currency to include:

and

‘Foreign currency’

Section 995-1 provides that ‘foreign currency means a currency other than Australian currency’. The terms ‘currency’ and ‘Australian currency’ are not defined in the Assessment Acts and therefore take their ordinary meaning having regard to their context and the legislative purpose.

In Taxation Determination (TD) 2014/25 Income tax: is bitcoin a 'foreign currency' for the purposes of Division 775 of the Income Tax Assessment Act 1997? at paragraph 32, the Commissioner considers that when defining ‘foreign currency’ as ‘a currency other than Australian currency’ in section 995-1, Parliament intended to use the term ‘currency’ in the same sense that ‘currency’ is used in the Currency Act – namely, a currency legally recognised and adopted under the laws of a country as the monetary unit and means of discharging monetary obligations for all transactions and payments in that country. Consistent with the Currency Act, this concept of currency is in turn divided into two types for the purposes of the ITAA 1997:

Application of section 775-95

The opening balance of the Loan was the money company B received, when it was translated into Australian currency and recorded on the financial statements of Company B.

In return for receiving this overseas currency, Company B incurred an obligation to repay the overseas currency to the related overseas Company. Although the Loan was not formally documented in a loan agreement, the agreement between Company B and the related overseas Company was noted in the audited financial statements of Company B, and was evidenced by the implied conduct of both parties.

Conclusion

To calculate the forex realisation loss under Division 775, the “proceeds for assuming an obligation to pay foreign currency” include the opening balance at inception of the loan.

Question 3

Summary

Forex Realisation Event 4 (FRE 4) happened on repayment of the principal loan amount to the related overseas Company.

Detailed reasoning

Division 775 – Foreign Currency Gains and Losses

Division 775 operates to recognise foreign currency gains and losses for income tax purposes and to quantify those gains or losses by reference to the change in the Australian dollar value of rights and obligations.

Subsection 775-15(1) states:

Similarly, subsection 775-30(1) states:

“Forex realisation event” is defined in subsection 995-1(1) as:

FRE 4

Subsection 775-55(1) states that FRE 4 happens if:

Subsection 775-55(2) states that the time of the event is when you cease to have the obligation or part of the obligation.

Application of section 775-55

It has been established that Company B received the loan in return for incurring an obligation to pay foreign currency. Company B’s obligation to make repayments in foreign currency was incurred at the time that it received the overseas dollars.

Company B discharged its obligations in full repayment of the Loan. At this time, any obligations it had assumed in return for receiving Australian currency or foreign currency in respect of the Loan ceased for the purposes of section 775-55.

Therefore, the repayment of the principal loan amount was a Forex Realisation Event 4 as it satisfied subsection 775-55(1)(a) and (b)(ix). The time of the event was when the loan was repaid on 31 December 2015 (section 775-55(2)).

Conclusion

Forex realisation event 4 happened to Company A as Company B satisfied subsection 775-55(1)(a) and (b)(ix) in relation to the principal loan amount.

Question 4

Summary

The carry forward loss position of Company A as at 31 December 2018 includes the deductible forex realisation loss incurred in accordance with section 775-30 of the ITAA 1997 on repayment of the loan.

Detailed reasoning

Forex realisation loss

For each forex realisation event, a forex realisation loss is worked out in the way described in the event: subsection 995-1(1).

In relation to FRE 4, section 775-55(5) ITAA 97 states that you make a forex realisation loss if:

The amount of the forex realisation loss is so much of the excess as is attributable to a currency exchange rate effect.

Tax recognition time

Tax recognition time for FRE 4 is defined in section 775-55(7) according to the type of obligation:

For the purposes of this section, the tax recognition time is worked out using the table:

Currency Exchange rate Effect

Section 775-105 states:

Application

The proceeds of assuming the obligation is the opening balance of the loan under Section 775-95.

The tax recognition time is when Company B received the loan: the applicable items in the table under subsection 775-55(7) are Item 8 for the principal of the loan.

Company A did not make a transitional election under section 775-150 of the ITAA 1997, therefore Company A is required to apply the standard translations rules in section 960-50 of the ITAA 1997 (subsection 775-105(2)).

Under item 1 of the table in subsection 960-50(6), the amount of an obligation is to be translated to Australian currency at the exchange rate applicable at the tax recognition time. Under subsection 960-50(7) however, the above is subject to any modifications made under the regulations, including where Company B relies upon the audited accounts method in regulation 1.1 of Schedule 2 of the ITAR 1997. For the purposes of Company B’s audited financial statements, foreign currency transactions were initially translated into Australian currency at the rate of exchange at the date of the transaction. It is therefore appropriate to calculate the foreign currency exchange rate effect using the spot rate at the time of each relevant event.

The deductibility of the forex realisation loss as at 31 December 2018

A forex realisation loss arising under FRE 4 is generally deductible in the year the event occurred (section 775-30(1)), except to the extent:

A tax loss of a corporate tax entity for a loss year can be carried forward to be deducted in a later income year according to section 36-17, and none of the above exclusions apply.

The relevant forex realisation loss should therefore have been available to Company A under section 775-30 as a deduction for the 2015 income year. This has not been included in the tax return lodged by Company A for the income year ended 31 December 2015.

Company A has been in a tax loss position as at 31 December 2015, 31 December 2016 and 31 December 2017. On the assumption that Company A satisfies the Continuity of Ownership test or Same Business Test as at 31 December 2018, the change to the carry forward losses for the income year ended 2015 as a result of the recognition of the forex realisation loss should be reflected in the income tax return and losses schedule of Company A for the income year ending 31 December 2018.

Conclusion

The carry forward loss position of Company A as at 31 December 2018 should include the deductible forex realisation loss incurred in accordance with section 775-30 of the ITAA 97 on repayment of the loan on 31 December 2015.

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