Edited version of private advice

Authorisation Number: 1051533763975

Date of advice: 4 July 2019

Ruling

Subject: Foreign income tax offset limit

Question 1

Is the 'Net gain' resulting from a 'Cross currency hedging transaction' (CCHT) assessable income for the Fund under subsection 230-15(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. The 'Net gain' resulting from a CCHT is assessable income for the Fund under subsection 230-15(1) of the ITAA 1997.

Question 2

If the answer to Question 1 is yes, does paragraph 770-75(4)(a) of the ITAA 1997 apply to disregard the 'Net gain' resulting from a CCHT, to the extent it is foreign sourced, for the purposes of calculating the foreign income tax offset limit under subsection 770-75(2) of the ITAA 1997?

Answer

Yes. Paragraph 770-75(4)(a) of the ITAA 1997 applies to disregard the 'Net gain' resulting from a CCHT, to the extent it is foreign sourced, for the purposes of calculating the foreign income tax offset limit under subsection 770-75(2) of the ITAA 1997.

This ruling applies for the following periods:

A number of income years

The scheme commences on:

The start of an income year

Relevant facts and circumstances

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified.

The Fund

1.               The Fund is a complying superannuation fund within the meaning of section 45 of the Superannuation Industry (Supervision) Act 1993.

2.               The fund currently has a percentage of funds under management invested outside of Australia.

3.               The Fund may relevantly appoint:

·                a custodian

·                one or more bodies corporate (Investment Manager) to manage the investments of the Fund.

The Custodian

4.               The Custodian is engaged by the Fund as the custodian for the Fund's assets.

5.               The Custodian provides various custodial services and records and reports transactions for and on behalf of the Fund, including the provision of accounting and taxation reporting.

Investment Managers

6.               The Fund engages Investment Managers, through Investment Management Agreements (IMAs), to provide investment management services and, where applicable, foreign currency services, in respect to a specified portfolio(s) of assets.

7.               IMAs outline the responsibilities of the Fund and Investment Managers and relevantly provides:

·                that the Australian dollar (AUD) is the base currency for the Fund

·                 if applicable, the Fund's allocation of a portfolio of assets to the Investment Manager

·                if applicable, how the Fund determines an underlying portfolio that represents a proportion of the dollar value of the Fund's international assets

·                the duties of the Investment Manager in respect to the management and implementation of services related to the assigned portfolio of assets

·                if applicable, the provision of the source of a transaction to the Custodian within the agreed cut of time each month

·                limitations to be imposed on the Investment Manager.

Currency policy for the Fund

8.               The Fund defines the relevant currency policy for Investment Managers.

9.               The currency policy defines all the relevant mandate parameters covering both assumptions for determining the underlying FX exposure of the Fund and the trading rules for the Investment Manager.

10.             Relevantly, the currency policy provides:

·                currencies that are allowed to be traded

·                for the use of proxy currency relationships (and specifies allowable proxies)

·                if a currency is not specified, a specified foreign currency may be used as a proxy for that currency in certain circumstances

·                a list of counter-parties

·                if applicable, the currency exposure for each of the Fund's investment.

11.             Further, the currency policy allows Investment Managers to enter into aggregate deals to complete a hedging transaction.

Cross currency hedging transaction

12.             A 'Cross currency hedging transaction' (CCHT):

·                 is entered into by an Investment Manager in accordance with an IMA to offset foreign currency fluctuation risk

·                is conducted on either a FX spot or FX Forward basis

·                 involves the exchange of one foreign currency for a different foreign currency

·                pre-defines, at the trade date, the amount of each currency to be exchanged at the settlement date

·                at settlement date, results in:

o      the Custodian receiving the 'buy' foreign currency from the relevant counter party and delivering the 'sell' foreign currency. That is, it is cash settleable

o        no additional payments being made in addition to the exchange of the foreign currencies

·                is recorded in a single Society for Worldwide Interbank Financial Telecommunication (SWIFT) MT300/MT304 message.

13.             Commercially, each CCHT is considered a single transaction where the Custodian will receive the 'buy' foreign currency and deliver the 'sell' foreign currency as consideration.

Custodian's Accounting Platform

14.             The Custodian's Accounting Platform, records each CCHT based on the SWIFT message received from the Investment Manager. In particular, it records:

·                trade date

·                currency code and foreign currency amount bought

·                currency code and foreign currency amount sold

·                settlement date.

15.             The Custodian's Accounting Platform will, for each CCHT, perform the following:

·                for each foreign currency, calculate the amounts receivable and amounts payable referable to the base currency of the taxpayer using the exchange rate as of the trade date of the transaction. That is, it creates two legs for the transaction with each leg separately recorded and reported in the base currency

·                revalue, on a daily basis, the amounts receivable and payable to the spot exchange rate

·                on the settlement date, close the amount receivable and payable for the transaction against cash.

Custodian's FX report

16.             The Custodian provides an FX report to the Fund.

17.             The sole purpose of the FX report is to assist the Fund in determining its entitlement to the Foreign Income Tax Offset (FITO) under section 770-75.

18.             Relevantly, the FX report:

·                 lists each CCHT for the applicable income year

·                translates all foreign currency amounts into AUD (in accordance with Subdivision 960-C)

·                categorises each CCHT, as giving rise to either a domestic or foreign sourced gain or a domestic or foreign sourced loss (based on the instruction received from the relevant Investment Manager)

·                calculates the outcome for each CCHT in accordance with the balancing adjustment method in Subdivision 230-G.

19.             In respect of each leg of a CCHT, the gross gain or loss resulting from the currency exchange rate fluctuations is netted to provide the overall net gain or loss for the transaction.

Elections for taxation purposes

20.             The Fund is subject to the Taxation of Financial Arrangements (TOFA) regime in Division 230 and has not made an election for any of the elective timing methods contained in Subdivisions 230-C, 230-D, 230-E or 230-F to apply.

21.             The Fund has not chosen to apply the accruals method to the overall gain or loss pursuant to subsection 230-100(2).

Assumption

22.             The CCHT is entered into by an Investment Manager to solely offset all, or part, of any foreign currency fluctuation risk attached to the value of an underlying portfolio of assets.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subparagraph 230-5(2)(a)(ii)

Income Tax Assessment Act 1997 Subsection 230-15(1)

Income Tax Assessment Act 1997 Subsection 230-20(4)

Income Tax Assessment Act 1997 Subsection 230-40(2)

Income Tax Assessment Act 1997 Subsection 230-40(3)

Income Tax Assessment Act 1997 Paragraph 230-45(1)(c)

Income Tax Assessment Act 1997 Paragraph 230-45(2)(a)

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

Income Tax Assessment Act 1997 Subsection 230-100(2)

Income Tax Assessment Act 1997 Paragraph 230-435(1)(b)

Income Tax Assessment Act 1997 Subsection 230-445(1)

Income Tax Assessment Act 1997 Paragraph 295-85(2)(aa)

Income Tax Assessment Act 1997 Paragraph 295-85(3)(a)

Income Tax Assessment Act 1997 Subsection 295-85(4)

Income Tax Assessment Act 1997 Subsection 770-75(2)

Income Tax Assessment Act 1997 Subsection 770-75(4)

Income Tax Assessment Act 1997 Paragraph 770-75(4)(a)

Income Tax Assessment Act 1997 Section 974-160

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Question 1

Is the 'Net gain' resulting from a 'Cross currency hedging transaction' (CCHT) assessable income for the Fund under subsection 230-15(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

Yes. The 'Net gain' resulting from a CCHT is assessable income for the Fund under subsection 230-15(1) of the ITAA 1997.

Detailed reasoning

Capital gains tax

Division 295 contains the provisions relating to the taxation of complying superannuation funds.

Section 295-85 makes capital gains tax (CGT) the primary code for calculating gains or losses resulting from a CGT event happening to a CGT asset of a complying superannuation fund.

Relevantly, paragraph 295-85(2)(aa) states that section 230-15 (about financial arrangements) does not apply to a CGT event happening to a CGT asset of a complying superannuation fund.

However, paragraph 295-85(3)(a) provides an exception to the application of subsection 295-85(2) when a capital gain or loss from a CGT event is attributable to currency exchange rate fluctuations.

As stated in the Facts and Assumptions, a CCHT is entered into by an Investment Manager to offset all, or part, of any foreign currency fluctuation risk attached to the value of an underlying portfolio of assets. The gain or loss resulting from a CCHT is attributable to the currency exchange rate fluctuations of the transaction.

Therefore, a capital gain or loss resulting from a CCHT falls within the scope of paragraph 295-85(3)(a) such that the modification in paragraph 295-85(2)(aa) does not apply to a gain or loss resulting from a CCHT.

Accordingly, section 230-15 (about financial arrangements) may apply to a gain or loss resulting from a CCHT.

Taxation of Financial Arrangements (TOFA)

Division 230 deals with the tax treatment of gains and losses from certain financial arrangements.

The Fund is subject to the TOFA regime under subparagraph 230-5(2)(a)(ii).

As such Division 230 may apply to the Fund's financial arrangements.

Where Division 230 applies to a financial arrangement, a gain from that financial arrangement is included in assessable income under subsection 230-15(1).

If a gain from a financial arrangement is included in assessable income under subsection 230-15(1), subsection 230-20(4) prevents that gain (to any extent) being included in assessable income under any other provision.

Financial arrangement

Subsection 230-45(1) states that you have a 'financial arrangement' if you have an arrangement that is:

·                a cash settable legal or equitable right, to receive a financial benefit, or

·                a cash settable legal or equitable obligation to provide a financial benefit, or

·                a combination of one or more such rights and/or one or more such obligations.

Subsection 995-1(1) defines an 'arrangement' as any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

Under subsection 995-1(1) 'financial benefit' has the meaning given by

section 974-160 which defines a 'financial benefit' as anything having economic value and includes property and services.

Under paragraph 230-45(2)(a) a right to receive or an obligation to provide a financial benefit will be cash settable if the benefit is money or money equivalent.

As stated in the Facts, under a CCHT one foreign currency is exchanged for a different foreign currency. On the settlement date for a CCHT, the Fund's Custodian receives foreign currency from the relevant counter party and delivers (provides) a different foreign currency in return.

As such, a CCHT satisfies the definition of a financial arrangement under paragraph 230-45(1)(c). However, whether rights and obligations should be grouped together under one arrangement or be separated and treated as different arrangements must also be determined.

Single financial arrangement

Subsection 230-55(4) states that whether a number of rights and/or obligations are themselves an arrangement or are 2 or more separate arrangements is a question of fact and degree that you determine having regard to the following:

·                the nature of the rights/obligations

·                their terms and conditions (including those relating to payment or other consideration)

·                the circumstances surrounding their creation and their proposed exercise or performance (including what can reasonably be seen as the purposes of one or more of the entities involved)

·                whether they can be dealt with separately or must be dealt with together

·                normal commercial understandings and practices in relation to them (including whether they are regarded commercially as separate things or as a group or series the forms a whole)

·                the objects of Division 230.

As stated previously, under a CCHT, on the settlement date one foreign currency is exchanged for a different foreign currency, with no additional payments made.

Further, a CCHT is:

·                entered into by an Investment Manager to solely offset all, or part, of any foreign currency fluctuation risk attached to the value of an underlying portfolio of assets

·                recorded in a single Society for Worldwide Interbank Financial Telecommunication MT300/MT304 message, and

·                commercially considered to be a single transaction where the Custodian will receive the 'buy' foreign currency and deliver the 'sell' foreign currency as consideration.

On this basis, each CCHT is a single financial arrangement for the purposes of Division 230.

Methods for taking gain or loss into account for a financial arrangement

The Fund has not made an election to apply any of the elective timing methods contained in Subdivisions 230-C, 230-D, 230-E or 230-F, and has not chosen to apply the accruals method in Subdivision 230-B (pursuant to subsection 230-100(2)).

As such, a gain or a loss resulting from a CCHT may be calculated under the realisation method provided for in Subdivision 230-B or the balancing adjustment provided for in Subdivision 230-G.

Subsection 230-40(2) provides that a gain or loss is not taken into account under Subdivision 230-B to the extent it is taken into account under the balancing adjustment method provided in Subdivision 230-G.

Relevantly, paragraph 230-435(1)(b) provides a balancing adjustment is made under Subdivision 230-G if all of your rights and/or obligations under a financial arrangement cease.

Under the CCHT, all the rights and obligations cease on the settlement date, therefore, paragraph 230-435(1)(b) applies and the following method statement contained in subsection 230-445(1) (method statement) is used to calculate the applicable gain or loss for the purposes of Subdivision 230-G and for Division 230:

·                Step 1 - total all of the financial benefits you have received under the financial arrangement.

·                Step 2 - total all of the financial benefits you provide under the financial arrangement.

·                Step 3 - compare the amount obtained under Step 1 of the method statement (Step 1 amount) with the amount obtained under step 2 of the method statement (Step 2 amount).

Relevantly, if the Step 1 amount exceeds the Step 2 amount, an amount equivalent to the excess is taken, as a balancing adjustment, to be a gain you make from the financial arrangement for the purposes of Division 230.

The Step 1 amount for a CCHT is the foreign currency amount the Fund's Custodian receives, and the Step 2 amount for a CCHT would be the amount of the different foreign currency that the Fund's Custodian delivers (provides).

In respect of each leg of a CCHT (amount of foreign currency received and amount of foreign currency provided), the gross gain or loss resulting from the currency exchange rate fluctuations is netted to provide the overall net gain or loss for the transaction.

As such, when each leg of a CCHT is netted and there is an overall net gain for the transaction (the 'Net gain'), that amount is taken, as a balancing adjustment, and is the gain the Fund makes from the CCHT for the purposes of Division 230.

As stated in the Facts, for each CCHT, all foreign currency amounts are translated into the Australian dollar in accordance with Subdivision 960-C.

Whilst Subdivision 230-H outlines specific exceptions of when Division 230 will not apply to a gain or loss from a financial arrangement, none of them are relevant in this case.

As such, the gain resulting from a CCHT, as calculated under Subdivision 230-G is assessable income under subsection 230-15(1).

Question 2

If the answer to Question 1 is yes, does paragraph 770-75(4)(a) of the ITAA 1997 apply to disregard the 'Net gain' resulting from a CCHT, to the extent it is foreign sourced, for the purposes of calculating the foreign income tax offset limit under subsection 770-75(2) of the ITAA 1997?

Summary

Yes. Paragraph 770-75(4)(a) of the ITAA 1997 applies to disregard the 'Net gain' resulting from a CCHT, to the extent it is foreign sourced, for the purposes of calculating the foreign income tax offset limit under subsection 770-75(2) of the ITAA 1997.

Detailed reasoning

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified.

Section 770-75 imposes a limit on the foreign income tax offset (FITO).

Under subsection 770-75(2) your offset limit is the greater of:

a)    $1,000; and

b)    this amount:

                      i.        the amount of income tax payable by you for the income year; less

                     ii.        the amount of income tax that would be payable by you for the income year if the assumptions in subsection 770-75(4) were made.

Relevantly, paragraph 770-75(4)(a) requires you to assume that your assessable income did not include:

           i.        so much of any amount included in your assessable income as represents an amount in respect of which you paid foreign income tax that counts towards the tax offset for the year; and

          ii.        any other amounts of ordinary income or statutory income from a source other than an Australian source.

In respect to a financial arrangement subject to TOFA, paragraph 3.20 of the Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 explains that the concept of a gain or loss connotes the appropriate offsetting of the cost (broadly, financial benefits provided under the financial arrangement) against proceeds (broadly, financial benefits received under the financial arrangement). That is a gain or loss on a financial arrangement is a net concept.

As explained in the detailed reasoning at Question 1, the Net gain resulting from a CCHT is a balancing adjustment under Subdivision 230-G (and not the elements in Step 1 or Step 2 of the method statement), and is the amount of assessable income for the Fund under subsection 230-15(1).

As such, it is only the 'Net gain' resulting from a CCHT that is taken into account for the purpose of paragraph 770-75(4)(a).

As such, paragraph 770-75(4)(a) applies to disregard a foreign source 'Net gain' resulting from a CCHT for the purposes of calculating the FITO limit under subsection 770-75(2).

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