Edited version of private ruling

Authorisation Number: 1011419555246

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Ruling

Subject: Division 775 - Foreign exchange gains & losses

Question

Are the foreign exchange realisation gains and losses made on repayment or conversion of your foreign currency loans for your investment properties in Australia, assessable and deductible to you as a foreign resident of Australia?

Answer

Yes.

This ruling applies for the following period/s:

Year ended 30 June 2009

The scheme commences on:

1 July 2008

Relevant facts and circumstances

You are a foreign resident.

You owned investment properties that were located in Australia.

These rental properties were purchased with bank (Bank X) loans.

They were purchased with a multi-currency loan. The loans were all established in AUD and immediately transferred to country X dollars.

As a result of the drop of the AUD from the original loan establishment dates, the loan to value (equity) ratio increased. The equity reduced only as a result of currency movements.

This triggered Bank X to request that you convert all country X dollar loans to AUD loans.

This resulted in the AUD value of the loan increasing by a significant amount of money. This was calculated by deducting:

The AUD value of the loan when the country X dollar loans were first established, from the new AUD loan value when the loans were converted back to AUD (from country X dollars).

Later, you converted these AUD loans back to country X dollars.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 775

Income Tax Assessment Act 1997 Subsection 775-55(1)

Income Tax Assessment Act 1997 Paragraph 775-55(1)(a)

Income Tax Assessment Act 1997 Subparagraph 775-55(1)(b)(ix)

Income Tax Assessment Act 1997 Subsection 775-55(2)

Income Tax Assessment Act 1997 Subsection 775-55(3)

Income Tax Assessment Act 1997 Subsection 775-55(5)

Income Tax Assessment Act 1997 Subsection 960-50(6)

Income Tax Assessment Act 1997 Section 775-95

Income Tax Assessment Act 1997 Subsection 775-55(7)

Income Tax Assessment Act 1997 Section 775-105

Reasons for decision

Forex gains or losses from 1 July 2003 are covered by Division 775 of the Income Tax Assessment Act 1997 (ITAA 1997).

The general principle is that foreign currency gains or losses have a revenue character rather than a capital nature. Foreign currency gains or losses are assessable or deductible when they are realised. They are realised when a Forex realisation event (FRE) happens.

FRE 4 occurs when a taxpayer ceases to have an obligation, or part of an obligation, to pay foreign currency; that is, when borrowings are repaid.

Since a taxpayer's obligation to repay foreign currency was incurred in return for receiving an amount of foreign currency, forex realisation event 4 (FRE 4) will happen each time the taxpayer repays some or all of the borrowings (paragraph 775-55(1)(a) and subparagraph 775-55(1)(b)(ix) applies of the ITAA 1997). FRE 4 will happen at the time of each repayment or when the foreign currency loan is converted to A$, pursuant to subsection 775-55(2) of the ITAA 1997.

Whether a FRE 4 arising on a repayment by the taxpayer, of some or all of the borrowings, gives rise to a forex realisation gain (under subsection 775-55(3) of the ITAA 1997) or a forex realisation loss (under subsection 775-55(5)), requires a comparison to be made between:

(a) the amount the taxpayer repays, translated into Australian currency at the exchange rate applicable at the time of repayment (pursuant to subsection 960-50(6) item 11 of the ITAA 1997), and

(b) the amount of that part of the borrowings repaid, translated into Australian currency at the exchange rate applicable at the time when the foreign currency borrowed was received by the taxpayer (pursuant to section 775-95, subsection 775-55(7) item 8(a) and subsection 960-50(6) item 11 of the ITAA 1997).

Where the amount in paragraph (a) above is smaller than the amount in paragraph (b) above, so much of that shortfall that is attributable to a currency exchange rate effect (as defined in section 775-105 of the ITAA 1997), is a forex realisation gain of the taxpayer (pursuant to subsection 775-55(3) of the ITAA 1997). Conversely, if the amount in (a) is bigger than the amount in (b) so much of the excess attributable to the exchange rate effect is a forex realisation loss of the taxpayer (pursuant to subsection 775-55(5) of the ITAA 1997).

On the relevant date, you converted all your country X dollar loans to AUD loans.

When you converted the country X dollar loans into AUD loans, you ceased to have an obligation or part of an obligation to pay foreign currency and FRE4 occurred.

To determine the link or nexus between forex realisation losses or gains that arise on a complete or partial repayment of the foreign currency loan borrowings, it is necessary to consider the purpose for, or use to which, you put those borrowings, that is, whether they are 'made in gaining or producing assessable income'. This is because you only incurred the obligation in relation to which the forex realisation losses or gains arose (the obligation to repay the borrowings) in return for receiving the amount of those borrowings.

Since the loans were in respect of the properties that were used for income producing purposes, the forex gains or losses that arose when you ceased to have an obligation or part of an obligation to pay foreign currency, are outgoings incurred in gaining or producing assessable income.

Therefore, as the properties were owned by you, you are entitled to the forex realisation gains or losses made in respect of the loans for the investment properties in Australia. They are assessable or deductible to you pursuant to section 775-55 of the ITAA 1997.

Please note:

The FOREX 4 gains or losses are calculated by comparing:

- the amount the taxpayer repays, translated into Australian currency at the exchange rate applicable at the time of repayment or conversion (pursuant to subsection 960-50(6) item 11 of the ITAA 1997), and

- the amount of that part of the borrowings repaid, translated into Australian currency at the exchange rate applicable at the time when the foreign currency borrowed was received by the taxpayer (pursuant to section 775-95, subsection 775-55(7) item 8(a) and subsection 960-50(6) item 11 of the ITAA 1997).