House of Representatives

New Business Tax System (Taxation of Financial Arrangements) Bill (No. 1) 2003

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 3 - Translation of amounts into Australian or functional currency

Outline of chapter

3.1 This chapter explains how amounts which are expressed in a foreign currency are translated into Australian currency, or an applicable functional currency, for the purposes of the ITAA 1936 and the ITAA 1997.

3.2 The rules are contained in Subdivisions 960-C and 960-D.

Context of reform

3.3 An income tax that determines liability by reference to the sum of a number of amounts requires those amounts to be determined by reference to a constant unit of account. For Australian income tax purposes, that unit of account is A$. Accordingly, where a transaction (or, as explained below, the net result of a group of transactions) is denominated in a foreign currency, its economic consequences must be translated into an equivalent amount of A$ for the purposes of determining Australian income tax liability.

3.4 The current income tax law contains a number of provisions which require foreign currency amounts to be expressed in Australian currency. However, these rules are of an ad hoc nature, are found in different places in the law and are incomplete in a number of respects.

3.5 The amendments introduce a core translation principle into the income tax law. That principle applies not only to assessable income and allowable deductions, but to all amounts which are relevant to calculating an entity's income tax liability.

3.6 In conjunction with the realisation framework for foreign currency gains and losses (explained in Chapter 2), the translation rules ensure that foreign currency gains and losses are generally recognised by the tax system when they have been realised. This is the case even if the monetary elements of a foreign currency denominated transaction are not exchanged for A$.

Summary of new law

3.7 The new law clarifies that Australian income tax liability is determined by measuring amounts in A$, even when they are denominated in a foreign currency. In some cases, an intermediate step may be carried out by measuring certain amounts in a foreign currency; however, the sum of those amounts is to be converted to A$ in ultimately determining liability to Australian income tax.

Translation of amounts into Australian currency

3.8 The core translation rule provides that, for the purposes of the ITAA 1936 and the ITAA 1997, an amount of foreign currency is to be expressed in Australian currency.

3.9 The rule applies to amounts generally, and is intended to be interpreted broadly. Examples of an 'amount' include:

·
an amount of ordinary income;
·
an amount of an expense;
·
an amount of an obligation;
·
an amount of a liability;
·
an amount of a receipt;
·
an amount of a payment;
·
an amount of consideration; and
·
a value.

3.10 A number of special translation rules specify the exchange rate to be used for particular amounts that are relevant to an entity's income tax liability. Specifically:

·
amounts of obligations are translated at the exchange rate prevailing at the time the consideration received for them is recognised for tax purposes;
·
the cost of depreciating assets is translated at the exchange rate prevailing upon beginning to hold the asset, or satisfying the liability to pay for it, whichever occurs first;
·
amounts relevant to transactions or events to which the CGT provisions apply are to be translated at the exchange rate prevailing at the time of the transaction or event;
·
ordinary income is to be translated at the exchange rate prevailing at the time of derivation or receipt, whichever occurs first;
·
non-CGT statutory income is translated at the exchange rate prevailing at the time the amount must first be returned as income, or receipt, whichever occurs first;
·
deductible amounts not falling within Division 40 of the ITAA 1997 must be translated at the exchange rate prevailing at the time the amount becomes deductible, or the time of payment, whichever occurs first; and
·
receipts or payments must be translated at the exchange rate prevailing at the time of the receipt or payment.

Translation of amounts into an applicable functional currency

3.11 Some entities or parts of entities are able to choose to account for their activities in a currency other than A$ for income tax purposes (as an intermediate step prior to translating a net amount from those activities into A$). In particular, a choice may be made in respect of the following entities or parts of an entity:

·
residents who are required to prepare financial reports under section 292 of the Corporations Act 2001;
·
residents carrying on a business through an overseas PE;
·
non-residents carrying on a business through an Australian PE;
·
OBUs;
·
attributable taxpayers of a CFC; and
·
transferor trusts.

3.12 The functional currency rules allow those entities which make a valid choice to account for individual transactions using a unit of account other than A$. However, the net amount from those transactions (generally 'taxable income') must be converted into A$.

Comparison of key features of new law and current law
New law Current law
As a general principle (to which limited exceptions apply), all amounts which are relevant to the calculation of Australian tax liability are to be translated to A$. There are provisions which convert the following foreign currency denominated amounts into A$:

·
amounts of income and allowable deductions; and
·
the foreign currency components of transactions to which the CGT provisions apply.

The requirement to convert other amounts (e.g. the 'cost' of a depreciating asset) may be implied.

Some entities or parts of entities are entitled to account for their transactions in a foreign currency (called an 'applicable functional currency'), with only the net result from those transactions having to be translated to A$. The law is unclear about the extent to which entities can account for their transactions in a foreign currency.

Detailed explanation of new law

3.13 The translation provisions consist of 2 elements:

·
the core translation rule; and
·
the functional currency rules.

Translation of amounts into Australian currency

3.14 Australian income tax liability is calculated in terms of Australian currency. In order for foreign currency amounts to be appropriately taken into account in determining Australian income tax liability, there is a need for a rule or rules which translate these foreign currency denominated amounts into A$.

What does translation of amounts mean?

3.15 The core translation rule provides that, for the purposes of the ITAA 1936 and the ITAA 1997, an amount of foreign currency is to be translated into, or expressed in, Australian currency [Schedule 4, item 59, subsection 960-50(1)]. While this rule is specifically inserted into the ITAA 1997, it is incorporated into the ITAA 1936. This is by virtue of subsection 995-1(1), under which a reference to 'this Act' includes a reference to the ITAA 1936. Foreign currency is a currency other than Australian currency [Schedule 4, item 65, definition of 'foreign currency' in subsection 995-1(1)].

3.16 The rule applies to amounts generally, and is intended to be interpreted broadly. Examples of an 'amount' include:

·
an amount of ordinary income;
·
an amount of an expense;
·
an amount of an obligation;
·
an amount of a liability;
·
an amount of a receipt;
·
an amount of a payment;
·
an amount of consideration; and
·
a value.

[Schedule 4, item 59, subsection 960-50(2)]

3.17 The term 'amount' is used in a quantitative rather than qualitative sense. That is, it contemplates a numerical unit of account but does not deem an asset which is factually foreign currency to be Australian currency.

3.18 Because the translation rule applies to amounts generally, its relevance extends beyond income and deductions. For example, it will apply to determine the A$ value of an asset's foreign currency denominated cost or disposal proceeds.

Example 3.1: Foreign currency denominated cost expressed in A$ In year 1, Rainier Pty Ltd (Rainier) purchases an item of plant from the USA for US$100,000. At that time, A$1 is equivalent to US$0.50. Rainier becomes the legal owner of the plant in year 1, but does not pay for it until year 2.Under paragraph 40-185(1)(b) of the ITAA 1997, item 2 in the table, 'cost' is determined by reference to an 'amount'. Applying the translation rule to that amount, the cost of the plant for the purposes of Division 40 would be A$200,000 in year 1.

3.19 The translation rule also applies to 'values' [Schedule 4, item 59, paragraph 960-50(2)(h)]. The term 'value' carries its ordinary meaning. Broadly, it refers to the material or monetary worth of a thing - the amount at which such worth may be estimated in terms of a medium of exchange.

Amounts that are elements in the calculation of other amounts

3.20 In some cases an amount which is taken into account for tax purposes, for example an amount of income or a deduction is the sum or the result of 2 or more other amounts. An example is an amount included in assessable income under section 26BB of the ITAA 1936 or a deduction under section 70B of the ITAA 1936. Any amounts which are elements in the calculation of another amount are to be translated prior to calculating the other amount. [Schedule 4, item 59, subsection 960-50(4)]

3.21 However, in calculating a special accrual amount, amounts which are taken into account in the calculation are not translated under section 960-50 [Schedule 4, item 59, subsection 960-50(5)]. Only the result, that is the special accrual amount, is translated. Special accrual amounts are amounts that are included in assessable income or allowed as a deduction under provisions relating to:

·
luxury car leasing (Division 42A in Schedule 2E of the ITAA 1936);
·
certain arrangements treated as a sale and loan (Division 240 of the ITAA 1997);
·
arrangements for the use of property (Division 16D of Part III of the ITAA 1936); and
·
the accruals assessability and deductibility of certain security payments (Division 16E of Part III of the ITAA 1936).

[Schedule 4, item 73, definition of 'special accrual amount' in subsection 995-1(1)]

Special translation rules

3.22 A number of special translation rules specify the exchange rate to be used for particular amounts that are relevant to an entity's income tax liability. These rules are subject to modification by way of regulation [Schedule 4, item 59, subsections 960-50(7) and (8)]. The regulations might specify, for example, that an entity can use an 'average', rather than 'spot', rate for a particular class of transactions.

Forex realisation event 4

3.23 A special translation rule applies where forex realisation event 4 happens upon ceasing to have an obligation to pay foreign currency (other than an obligation that is an element in the calculation of a net amount which is included in assessable income or allowable as a deduction). The amount of the obligation is translated at the exchange rate prevailing at the tax recognition time [Schedule 4, item 59, subsection 960-50(6), item 1 in the table]. Forex realisation event 4 is explained in Chapter 2 (see paragraphs 2.53 to 2.79).

Cost of a depreciating asset

3.24 A special translation rule also applies where the cost of a depreciating asset is determined before or after an obligation to pay for it has been satisfied. Where holding precedes satisfaction of the obligation, the cost is translated at the exchange rate applicable at the time when holding begins. If satisfaction precedes holding, however, the cost is translated at the date of satisfaction [Schedule 4, item 59, subsection 960-50(6), item 2 in the table]. An entity 'holds' a depreciating asset where it satisfies one of the items in section 40-40 of the ITAA 1997.

Example 3.2: Applying the translation rule to the cost of a depreciating asset On 30 June, year 1, Seahawks Pty Ltd (Seahawks) purchases an item of plant from France for € 10,000. At that time, A$1 is equivalent to € 0.56. Although Seahawks becomes the legal owner of the plant immediately, it does not pay for the plant until year 2. When Seahawks pays, A$1 is equivalent to € 0.54.Applying the translation rule for depreciating assets, together with subsection 40-185(1), item 2 in the table, the cost of the plant is A$17,857.14. That is, the cost is worked out on the basis of an exchange rate of A$1.00 : € 0.56.

Trading stock

3.25 Trading stock on hand at the end of an income year, and which is valued at cost, is translated at the exchange rate prevailing at the time when it became on hand [Schedule 4, item 59, subsection 960-50(6), item 3 in the table]. Trading stock which is valued at market selling price or replacement value is translated at the exchange rate prevailing at the end of the income year [Schedule 4, item 59, subsection 960-50(6), item 4 in the table].

Transaction or event to which the CGT provisions apply

3.26 Where a transaction or event involves an amount of money or the market value of other property, and it is taken into account under Part 3-1 or 3-3 of the ITAA 1997, the amount or value is translated to A$ at the exchange rate prevailing at the time of the transaction or event [Schedule 4, item 59, subsection 960-50(6), item 5 in the table]. This rule replicates the effect of section 103-20, which applies to CGT assets. That provision is one of the ad hoc conversion rules which the core translation rule replaces.

Ordinary income

3.27 Ordinary income is translated at the exchange rate prevailing at the time of derivation, or receipt of the consideration to which that derivation relates. [Schedule 4, item 59, subsection 960-50(6), item 6 in the table]

3.28 Where derivation precedes receipt, the time of derivation is the relevant translation time.

Example 3.3: Translation of ordinary income - derivation before receipt Mavis sells opals to foreign retailers. Sales are usually denominated in foreign currencies and payment due within 90 days.On 1 June, year 1, Mavis sells a number of opals to a retailer in Germany for € 6,000. At that time the exchange rate is A$1.00: € 0.67. Mavis receives payment on 1 July, year 2, at which time the exchange rate is A$1.00: € 0.70.As Mavis accounts for her income on an earnings basis, she derives the income of € 6,000 in year 1. As the income is derived prior to payment being received, Mavis is required to translate the foreign currency denominated income to Australian dollars at the exchange rate prevailing at the time that the income is derived.Mavis' income from the sale of the opals is A$8,955, that is, € 6,000 translated to Australian dollars at the exchange rate of A$1.00 : € 0.67.Mavis' receipt in respect of the opals sale is A$8571, that is, € 6000 translated to Australian dollars at the exchange rate of A$1.00 : € 0.70. This is the amount taken into account by item 6 in the table in subsection 960-50(6) in determining whether there is a forex realisation gain or loss (see Chapter 2). In this case, the change in the exchange rate between the time of derivation of the income and the time of receipt will result in a forex realisation loss of A$384 (i.e. A$8,955 - A$8,571).

3.29 On the other hand, where derivation occurs after receipt, the time of receipt is the relevant translation time.

Example 3.4: Translation of ordinary income - derivation after receipt Chan Self Defence Academy Pty Ltd (Chan) teaches self-defence to international students. Students are able to pay for classes in a number of foreign currencies.On 27 July Bruce pays Chan ¥ 6,000 for 50 weekly classes which can be taken over the next 12 months. At that time the exchange rate is A$1.00: ¥ 63.00.As Chan accounts for its income on an accruals basis, Chan will not derive the income until the classes are taken by Bruce. [F11] However, as Chan receives payment before the time of derivation the ¥ 6,000 is translated to Australian dollars at the exchange rate prevailing at the time the ¥ is received.The Australian dollar amount of the income is:

( ¥ 6,000/63.00) = A$95.24

Non-CGT statutory income

3.30 Statutory income arising outside of the CGT provisions is translated at the exchange rate prevailing at the time the amount must first be returned as income or at the time of receipt of the consideration to which that income relates, whichever occurs first. [Schedule 4, item 59, subsection 960-50(6), item 7 in the table]

Deductible amounts

3.31 Deductible amounts not falling within Division 40 must be translated at the exchange rate prevailing at the time the amount becomes deductible, or at the time of payment, whichever occurs first. [Schedule 4, item 59, subsection 960-50(6), item 8 in the table]

Production expenditure on a film

3.32 Amounts taken into account in quantifying a company's production expenditure or qualifying Australian production expenditure on a film for the purposes of Division 376 are translated at the average exchange rate between the time that photography starts or the production of animated images commences and the time when the film is completed. [Schedule 4, item 59, subsection 960-50(6), item 9 in the table]

Amounts withheld

3.33 An amount that is required to be withheld from a payment by Division 12 of Part 2.5 in Schedule 1 to the TAA 1953 is translated at the exchange rate at the time when the amount is required to be withheld. [Schedule 4, item 59, subsection 960-50(6), item 10 in the table]

Receipts or payments

3.34 Receipts and payments not covered by any other item in the table are translated at the exchange rate prevailing at the time of the receipt or payment. [Schedule 4, item 59, subsection 960-50(6), item 11 in the table]

Exclusions from translation rule

3.35 The core translation rule does not affect the operation of the following provisions:

·
section 775-210 (notional loans under facility agreements); [F12]
·
Subdivision 960-D (functional currency); [F13] and
·
subsection 974-35(6) (valuation of financial benefits for the purposes of the debt/equity provisions).

[Schedule 4, item 59, subsection 960-50(10)]

3.36 The core translation rule does not apply in determining the taxable income, or tax loss, of an ADI or a non-ADI financial institution. [Schedule 4, item 59, subsection 960-55(3)]

Using a functional currency

3.37 As explained in paragraph 3.3, calculating income tax liability in respect of the sum of a number of amounts requires those amounts to be measured in a constant unit of account, that is, in the same currency. As also explained above, Australian income tax liability is calculated in terms of Australian currency; a translation rule is therefore needed to deal with amounts of foreign currency.

3.38 To achieve this, however, it is not necessary that each transaction be translated to A$. One way of obtaining an Australian dollar amount from which to determine income tax liability is to account for individual transactions on the basis of a foreign currency, but translate the net amount attributable to those transactions into A$. Such a translation process is depicted in the following diagram.

Diagram 3.1:  Translation from transactional currency, to functional currency, to Australian dollars

3.39 This approach involves 2 translations: Translation 1 , which ensures that an entity uses a consistent unit of measurement when accounting at a transactional level, and Translation 2 , which translates the net result from the particular transactions for a particular period, into A$.

3.40 What is the appropriate unit of measurement under this approach? This is answered by the 'functional currency' concept.

Why have a functional currency option?

3.41 Some entities are subject to Australian income tax, but nonetheless conduct a significant part of their activities in a foreign currency. For these entities, there may be compelling arguments for allowing transactions to be accounted for in a currency other than A$. Use of a non-Australian functional currency may facilitate significant compliance cost savings, whilst not producing any undue distortion to the entity's ultimate A$ income tax liability.

What entities can choose to use a functional currency, and how does the choice apply?

3.42 The functional currency provisions are a compliance cost saving measure. They constitute an exception to the core translation principle in section 960-50. Accordingly, access to a functional currency for tax purposes is limited to those entities or parts of entities which are expected to have substantial international operations.

3.43 The effect of the choice depends upon the type of entity or part of an entity in respect of which the choice is made (as well as how its income tax position is worked out). In particular, a choice can only be made in respect of the following entities or parts of entities:

·
residents which are required to prepare financial reports under section 292 of the Corporations Act 2001;
·
residents carrying on a business through an overseas PE;
·
non-residents carrying on a business through an Australian PE;
·
OBUs;
·
attributable taxpayers of a CFC; and
·
transferor trusts.

[Schedule 4, item 59, subsection 960-60(1)]

Residents who prepare financial reports under the Corporations Act 2001

3.44 A resident that is required to prepare financial reports under section 292 of the Corporations Act 2001 can use the applicable functional currency to work out its taxable income. Such an election will apply to the calculation of all the amounts included in the entity's taxable income, unless they make separate elections in respect of any overseas PE, OBU, the attributable income from a CFC, or transferor trust (see paragraphs 3.46 to 3.52). [Schedule 4, item 59, subsection 960-60(1), item 1 in the table]

3.45 The choice has effect from the commencement of the year of income, or from the time the resident came into existence, if the choice is made within 90 days of the commencement of the income year or of the time the resident came into existence. Otherwise the choice has effect from the first income year following the year in which the choice was made. [Schedule 4, item 59, subsection 960-60(1), item 1 in the table, and subsection 960-65, item 1 in the table]

Residents carrying on a business through an overseas PE

3.46 Residents carrying on business through an overseas PE can use the applicable functional currency to work out the taxable income derived from that PE. [Schedule 4, item 59, subsection 960-60(1), item 2 in the table]

3.47 The choice has effect from the commencement of the year of income, or from the time the PE came into existence, if the choice is made within 90 days of the commencement of the income year or of the time the PE came into existence. Otherwise the choice has effect from the first income year following the year in which the choice was made. [Schedule 4, item 59, subsection 960-60(1), item 2 in the table, and section 960-65, item 2 in the table]

Non-residents carrying on a business through an Australian PE

3.48 Conversely, non-residents carrying on business through an Australian PE can also use the applicable functional currency [Schedule 4, item 59, subsection 960-60(1), item 2 in the table]. The choice has effect from the commencement of the year of income, or from the time the PE came into existence, if the choice is made within 90 days of the commencement of the income year or of the time the PE came into existence. Otherwise the choice has effect from the first income year following the year in which the choice was made. [Schedule 4, item 59, subsection 960-60(1), item 2 in the table, and section 960-65, item 2 in the table]

Offshore banking units

3.49 An OBU can work out its total assessable OB income and its total allowable OB deductions using the applicable functional currency. The choice has effect from the commencement of the year of income, or from the time the OBU came into existence, if the choice is made within 90 days of the commencement of the income year or of the time the OBU came into existence. Otherwise the choice has effect from the first income year following the year in which the choice was made [Schedule 4, item 59, subsection 960-60(1) item 3 in the table, and section 960-65, item 3 in the table]. The term 'offshore banking unit' is defined in section 128AE of the ITAA 1936 [Schedule 4, item 70, the definition of 'offshore banking unit' in subsection 995-1(1)].

Attributable taxpayers of a controlled foreign company

3.50 An attributable taxpayer of a CFC can work out the CFC's total attributable income using the applicable functional currency [Schedule 4, item 59, subsection 960-60(1), item 4 in the table]. The choice has effect from the commencement of the CFC statutory accounting period, or from the time the CFC came into existence, if the choice is made within 90 days of the commencement of the CFC statutory accounting period or of the time the CFC came into existence. Otherwise the choice has effect from the start of the first CFC statutory accounting period following the one in which the choice was made [Schedule 4, item 59, subsection 960-60(1), item 4 in the table, and section 960-65, item 4 in the table]. A CFC may have a number of attributable taxpayers, each of which may make a choice.

Transferor trusts

3.51 Transferor trusts can work out their attributable income using the applicable functional currency [Schedule 4, item 59, subsection 960-60(1), item 5 in the table]. The choice has effect from the commencement of the income year in which it was made if the choice was made within 90 days of commencement of that income year. Otherwise, the choice has effect from the commencement of the following income year [Schedule 4, item 59, subsection 960-60(1), item 5 in the table and section 960-65, item 5 in the table]. 'Attributable income' is defined in Division 6AAA of Part III of the ITAA 1936.

3.52 A transferor trust exists where, having regard to all relevant circumstances, it would be reasonable to conclude that another entity is, or is likely to be, an attributable taxpayer in relation to the trust under Division 6AAA of Part III of the ITAA 1936. [Schedule 4, item 59, section 960-75 and item 74, definition of 'transferor trust' in subsection 995-1(1)]

How is the choice made?

3.53 The choice must be made in writing [Schedule 4, item 59, subsection 960-60(2)]. The choice continues until a withdrawal takes effect (see paragraphs 3.85 to 3.87), or in the case of a resident taxpayer who is required to prepare financial reports under section 292 of the Corporations Act 2001, until the first year after the requirement to prepare financial reports ceases [Schedule 4, item 59, subsection 960-60(3) and (4)].

What is the applicable functional currency?

3.54 The applicable functional currency will depend on the factual circumstances surrounding the entity's operations. Broadly, an entity's applicable functional currency is the sole or predominant currency in which its accounts are kept at the time when the choice was made [Schedule 4, item 59, section 960-70 and item 60, definition of 'applicable functional currency' in subsection 995-1(1)]. This aligns the commercial rationale for accounting in a foreign currency with the use of that currency for income tax purposes.

Residents who prepare financial reports under the Corporations Act 2001

3.55 For Australian residents required to prepare financial reports under section 292 of the Corporations Act 2001 , the applicable functional currency for the income year and each later year for which the choice is in effect, is the sole or predominant foreign currency in which the books of account are kept. [Schedule 4, item 59, subsection 960-70(1)]

Permanent establishments, offshore banking units or transferor trusts

3.56 For PEs, OBUs or transferor trusts, the applicable functional currency for the income year and each later year for which the choice is in effect, is the sole or predominant foreign currency in which, at the time of the choice, the PE, OBU, or transferor trust kept its accounts. [Schedule 4, item 59, subsection 960-70(2)]

Controlled foreign companies

3.57 For choices made in relation to a CFC, the applicable functional currency for the statutory accounting period and each later period for which the choice is in effect, is the sole or predominant foreign currency in which, at the time of the choice, the CFC kept its accounts. [Schedule 4, item 59, subsection 960-70(3)]

3.58 'Statutory accounting period' is defined in section 319 of the ITAA 1936. Generally, it is each period of 12 months finishing at the end of 30 June.

What are accounts?

3.59 For all entities, the term 'accounts' denotes ledgers, journals, statements of financial performance, profit and loss accounts, balance sheets and statements of financial position and includes statements, reports and notes attached to, or intended to be read, with such items [Schedule 4, item 59, subsection 960-70(4)]. These terms are intended to be interpreted broadly and in light of their ordinary commercial connotations.

How are amounts translated using an applicable functional currency?

3.60 Again, the translation rules depend upon the type of entity or part of entity concerned and how its income tax position is worked out. This reflects the different methodologies used by the income tax law to determine the income tax liability of these entities or parts of entities.

3.61 Broadly, however, each of the translation rules performs the following functions:

·
translates all amounts to the applicable functional currency;
·
alters the normal foreign currency rules so that the functional currency is no longer treated as 'foreign currency' whereas Australian currency is; and
·
translates the final elements of a tax liability calculation into A$.

Residents who prepare financial reports under the Corporations Act 2001

3.62 Residents convert amounts relevant to their tax liability using the following methodology:

·
amounts not expressed in the applicable functional currency are converted to that functional currency; and
·
the taxable income is translated to Australian dollars.

[Schedule 4, item 59, subsection 960-80(1), item 1 in the table]

3.63 A further consequence of the translation rule applying is that for all tax purposes:

·
the applicable functional currency is taken not to be foreign currency; and
·
Australian currency is taken to be a foreign currency.

[Schedule 4, item 59, subsection 960-80(1), item 1, column 3, subparagraphs (a)(iii) and (iv) in the table]

Residents with an overseas PE, or non-residents with an Australian PE

3.64 Residents with an overseas PE, or non-residents with an Australian PE, translate amounts relevant to the activity or business of the PE using the following methodology:

·
amounts not expressed in the applicable functional currency are translated to that functional currency; and
·
the taxable income derived from the activity or business of the PE is translated into Australian currency.

[Schedule 4, item 59, subsection 960-80(1), item 2 in the table]

3.65 The phrase 'taxable income derived from [an] activity or business' is used in order to correspond to subsection 3(2) of the International Tax Agreements Act 1953.

3.66 A further consequence of the translation rule applying is that:

·
the applicable functional currency is taken not to be foreign currency; and
·
Australian currency is taken to be a foreign currency.

[Schedule 4, item 59, subsection 960-80(1), item 2, column 3, subparagraphs (a)(iii) and (iv) in the table]

Example 3.5: Consequences of a functional currency election An Australian branch of USA company Snoqualmie Inc (Snoqualmie) makes a valid functional currency election under which its applicable functional currency is US$.In year 1, Snoqualmie contracts to purchase a depreciating asset from an Australian entity for A$10,000. At the time, A$1.00 = US$0.50. Assuming Snoqualmie holds the asset from the date of contract, its cost will be US$5,000.In year 2, 13 months after first holding the asset, Snoqualmie pays for the asset. By this time, A$1.00 = US$0.55. As a result, the A$10,000 Snoqualmie pays is equivalent to US$5,500.For Snoqualmie's purposes, US$ is not foreign currency and A$ is. Therefore, Snoqualmie makes a forex realisation loss of US$500 under forex realisation event 3. This loss will be taken into account in calculating Snoqualmie's Australian taxable income. That taxable income will be calculated in US$ and converted into A$.

Offshore banking units

3.67 OBUs convert amounts relevant to the OB activities using the following methodology:

·
amounts not expressed in the applicable functional currency are converted to that functional currency; and
·
the total assessable OB income and total allowable OB deductions are to be converted into Australian currency.

[Schedule 4, item 59, subsection 960-80(1), item 3 in the table]

3.68 'Assessable OB income' is defined in subsections 121EE(2) and (3A) of the ITAA 1936. 'Allowable OB deductions' is defined in subsection 121EF(2) of the ITAA 1936.

3.69 Again, the applicable functional currency is taken not to be foreign currency and Australian currency is taken to be a foreign currency. [Schedule 4, item 59, subsection 960-80(1), item 3, column 3, subparagraphs (a)(iii) and (iv) in the table]

Attributable taxpayers of a controlled foreign company

3.70 Attributable taxpayers of a CFC convert amounts relevant to attributable income of the CFC using the following methodology:

·
amounts not expressed in the applicable functional currency are converted to that functional currency; and
·
the attributable income is converted to Australian currency.

[Schedule 4, item 59, subsection 960-80(1), item 4 in the table]

3.71 'Attributable income' has the meaning given by Division 7 of Part X of the ITAA 1936.

3.72 Again, the applicable functional currency is taken not to be foreign currency and Australian currency is taken to be a foreign currency. [Schedule 4, item 59, subsection 960-80(1), item 4, column 3, subparagraphs (a)(iii) and (iv) in the table]

Transferor trusts

3.73 Transferor trusts convert amounts using the following methodology:

·
amounts not expressed in the applicable functional currency are converted to that functional currency; and
·
the attributable income is converted to Australian currency.

[Schedule 4, item 59, subsection 960-80(1), item 5 in the table]

3.74 'Attributable income' has the meaning given by Division 7 of Part X of the ITAA 1936.

3.75 Again, the applicable functional currency is taken not to be foreign currency and Australian currency is taken to be a foreign currency. [Schedule 4, item 59, subsection 960-80(1), item 5, column 3, subparagraphs (a)(iii) and (iv) in the table]

What does translation of 'amounts' mean?

3.76 The functional currency translation rules all provide for the translation of 'an amount' into the applicable functional currency.

3.77 The rule applies to amounts generally, and is intended to be interpreted broadly. It does not matter whether the amounts are on revenue or capital account [Schedule 4, item 59, subsection 960-80(3)]. Examples of an 'amount' include:

·
an amount of ordinary income;
·
an amount of an expense;
·
an amount of an obligation;
·
an amount of a liability;
·
an amount of a receipt;
·
an amount of a payment;
·
an amount of consideration;
·
a value; and
·
a monetary limit or other amount set out in the ITAA 1936, the ITAA 1997 or any other Commonwealth law.

[Schedule 4, item 59, subsection 960-80(2)]

Example 3.6: Application of the translation rule to a monetary limit Exact Ltd (Exact), an OBU, has elected to use a functional currency, and its applicable functional currency is US$. In year 1, Exact purchases a car for US$40,000. At the time, the price is equivalent to A$72,700.If the car limit under section 40-230 of the ITAA 1997 was A$60,000 in year 1, Exact would apply that provision by converting the limit to US$33,012. The first element of the (US$) cost of a car is therefore reduced to that amount.

3.78 In translating an amount to the applicable functional currency or A$, the regulations (if any) must be complied with [Schedule 4, item 59, subsection 960-80(7)]. Regulations can make provision in relation to any matter by applying, adopting, or incorporating matter contained within the accounting standards (as defined in the Corporations Act 2001 ) [Schedule 4, item 59, subsection 960-80(8)].

How are events happening before a functional currency choice treated?

3.79 The need for a constant unit of account, combined with the ability to choose an applicable functional currency, raises the question of how to address events which straddle the time of choice. For example, an entity which has chosen to use a functional currency may sell an asset acquired prior to the choice, the cost of which was originally accounted for in A$. A special translation rule deals with these cases. [Schedule 4, item 59, section 960-85]

When does the special rule apply?

3.80 The special rule applies where:

·
an entity makes a choice and is consequently required to convert an amount to the applicable functional currency [Schedule 4, item 59, paragraph 960-85(1)(a)]; and
·
the amount is attributable to an event that happened, or a state of affairs that arose before the current choice took effect [Schedule 4, item 59, paragraph 960-85(1)(b)].

What are the consequences of the special rule applying?

3.81 Where no previous choice was in effect at the event time, a 2-stage translation applies, that is, a conversion:

·
to Australian currency at the rate prevailing at the event time; and
·
a translation of the A$ amount to the applicable functional currency at the rate prevailing at the time the choice took effect.

[Schedule 4, item 59, section 960-85, item 1 in the table]

3.82 Where a previous choice has been made, the same process applies, except the previously applicable functional currency is substituted for Australian currency. [Schedule 4, item 59, section 960-85, item 2 in the table]

3.83 An example of where the translation of an amount which is attributable to an event that happened, or a state of affairs that arose before the current choice took effect, is where a taxpayer purchased a capital asset prior to the choice and sold the asset after making the choice.

3.84 The 2-stage translation process ensures that any unrealised gain or loss at the time of the election is made, does not escape taxation simply because the election is made. Such an unrealised gain or loss is not brought to account at the time of the choice taking effect but will be brought to account when the asset is ultimately realised. The unrealised gain or loss could be either increased or reduced prior to realisation because of changes in value occurring after the time that the choice takes effect.

Example 3.7: Sale of assets acquired prior to a functional currency choice Airotciv Inc (Airotciv), a non-resident corporation operates through a PE in Australia. Airotciv transacts predominantly in ¥ and in the year ended 30 June year 1 it elects to use ¥ as its functional currency. The election will apply for the year commencing 1 July year 2.In the year ended 30 June year 3, Airotciv sells a tourist resort for ¥ 600 million, which it had purchased prior to year 1 for ¥ 500 million.As Airotciv's functional currency is ¥ the capital gain or capital loss will be calculated in ¥ . However, as ¥ was not the functional currency at the time the asset was acquired, the ¥ cost is converted to A$ at the exchange rate prevailing at the time the cost was incurred. The A$ amount is then converted to ¥ at the exchange rate prevailing at the time the choice to use ¥ as the functional currency took effect.Assume that the exchange rates were:

At the time of purchase of the asset: A$1.00: ¥ 68.50;
At the time the choice took effect: A$1.00: ¥ 62.00.
The cost base for the purposes of calculating the capital gain or loss on the disposal of the asset is:

( ¥ 500,000,000 / 68.50) * 62.00
= $A7,299,270 * 62.00
= ¥ 452,554,744

The capital gain, calculated in Airotciv's functional currency, is:
Sale proceeds: ¥ 600,000,000
Less: Cost base ¥ 452,554,744
Gain ¥ 147,445,256

When is a choice withdrawn?

3.85 A choice can be withdrawn if the applicable foreign currency has ceased to be the sole or predominant currency in which the entity or part thereof keeps its books of account. For entities other than attributable taxpayers, the withdrawal of a choice has effect from immediately after the end of the year of withdrawal [Schedule 4, item 59, subsection 960-90(1), items 1, 2, 3 and 5 in the table]. Equivalently, an attributable taxpayer's withdrawal has effect from immediately after the end of the statutory accounting period in which withdrawal occurs [Schedule 4, item 59, subsection 960-90(1), item 4 in the table].

3.86 A taxpayer is not compelled to withdraw a choice and the choice can only be withdrawn if the applicable foreign currency has ceased to be the sole or predominant currency in which the entity or thereof keeps its books of account.

3.87 A choice must be withdrawn in writing [Schedule 4, item 59, subsection 960-90(2)]. Withdrawal of a choice does not prevent an entity from making a new choice [Schedule 4, item 59, subsection 960-90(3)]. If a new choice is not made after withdrawing an earlier choice, the entity or part of the entity will be required to use A$ for the purposes of calculating the income tax liability.

Choices made for the sole or dominant purpose of obtaining a tax benefit

3.88 Where the choice to use a functional currency is made with the sole or dominant purpose of obtaining a tax benefit, the choice, or a scheme of which the choice is part, may be subject to the operation of Part IVA of the ITAA 1936, despite subsection 170C(2) (see also paragraph 3.96). For example, the tax benefit arising from a scheme could be increased because a functional currency election has been made.

Application and transitional provisions

3.89 The core translation rule applies to a transaction or event that involves an amount of foreign currency and occurs after the commencement date. However, the rule does not apply to a transaction or event involving an amount covered by subsections 775-110(1), (2) and (4) of the ITAA 1997. [Schedule 4, item 59, section 960-55]

3.90 Sections 20, 102AAX and 391 of the ITAA 1936 and section 103-20 of the ITAA 1997 continue to apply in relation to a transaction or event to which section 960-50 does not apply. [Schedule 4, item 78]

3.91 Sections 102AAW and 389 of the ITAA 1936 continue to apply in relation to section 20 of the ITAA 1936. [Schedule 4, item 79]

Consequential amendments

3.92 Section 20 of the ITAA 1936 is repealed to reflect the introduction of the core translation rule in section 960-50. [Schedule 4, item 21]

3.93 The reference to 'section 20' in subsection 102AAW(1) of the ITAA 1936 is removed to reflect the former provision's repeal. [Schedule 4, item 23]

3.94 Section 102AAX of the ITAA 1936 is repealed to reflect the introduction of the core translation rule in section 960-50. [Schedule 4, item 24]

3.95 Subsection 170(10) of the ITAA 1936 is amended to exclude references to subsections 82Z(3) and (4). [Schedule 4, item 25]

3.96 Subparagraphs 177C(2)(a)(i), (b)(i) and (c)(i) of the ITAA 1936 are amended in order to add a further exception to the tax benefit exclusion rule relating to functional currency elections. [Schedule 4, items 26 to 28]

3.97 The reference to 'section 20' in paragraph 389(a) of the ITAA 1936, is removed to reflect the former provision's repeal. [Schedule 4, item 29]

3.98 Section 391 of the ITAA 1936 is repealed to reflect the introduction of the core translation rule in section 960-50. [Schedule 4, item 30]

3.99 Sections 103-20 and 376-60 of the ITAA 1997 are repealed to reflect the insertion of Subdivisions 960-C and 960-D. [Schedule 4, items 48 and 57]

3.100 Sections 12-15 and 425-30 of Schedule 1 of the TAA 1953 are repealed to reflect the insertion of Subdivision 960-C into the ITAA 1997. [Schedule 4, items 75 and 76]

3.101 However, sections 20, 102AAX and 391 of the ITAA 1936, sections 103-20 and 376-60 of the ITAA 1997 and sections 12-15 and 425-30 in Schedule 1 of the TAA 1953 continue to apply in relation to amounts to which section 960-50 does not apply. [Schedule 4, items 78 and 79]


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