Edited version of private ruling

Authorisation Number: 1011615305920

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Ruling

Subject: Foreign exchange

1. Are the foreign exchange gains and losses made from your foreign currency bank accounts opened between date A and date B disregarded under the Division 775 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes.

2. Are the foreign exchange gains or losses made on withdrawals from your foreign currency bank accounts subject to the capital gains tax (CGT) provisions?

Yes.

This ruling applies for the following period:

Income year ending 30 June 2011

Relevant facts and circumstances

You hold a couple of foreign currency bank accounts opened between date A and date B.

These accounts were established when you were working overseas and when you were a foreign resident of Australia for income tax purposes.

When you were working overseas you were paid in foreign currency and you paid foreign tax on this income.

You are now an Australian resident and you have left the work force and wish to access these accounts. You wish to convert them to Australian dollars and use the funds to contribute to your retirement.

You have not made a transitional election under section 775-150 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 775-45(1)

Income Tax Assessment Act 1997 Subsection 775-45(2)

Income Tax Assessment Act 1997 subparagraph 775-45(1)(b)(iii)

Income Tax Assessment Act 1997 Subsection 775-45(3)

Income Tax Assessment Act 1997 Subsection 775-45(5)

Income Tax Assessment Act 1997 Subparagraph 775-165(2)(a)(ii)

Income Tax Assessment Act 1936 subsection 82V(1)

Income Tax Assessment Act 1997 Section 108-5

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

Income Tax Assessment Act 1997 Section 855-15

Income Tax Assessment Act 1997 Section 104-165

Income Tax Assessment Act 1997 Section 855-45

Income Tax Assessment Act 1997 Section 855-

Reasons for decision

Foreign exchange (Forex) gains and losses under the forex provisions

A forex realisation gain or loss is made when a forex realisation event happens. Subsection 775-45(1) of the ITAA 1997 provides that forex realisation event 2 (FRE 2) happens if an entity ceases to have a right, or part of a right, to receive foreign currency which is created or acquired in return for paying an amount of Australian currency or foreign currency. Subsection 775-45(2) of the ITAA 1997 provides that the time of FRE 2 is when the right or part of the right ceases.

The relationship between banker and customer in respect of a bank account is that of debtor and creditor: Foley v. Hill and Ors (1848) 2 HL Cas 28; All ER Rep 16. Thus, when a customer deposits money into a bank account the customer acquires contractual rights as a creditor of the bank. Similarly, when an amount is withdrawn from a bank account some or all of these previously acquired rights are extinguished or satisfied.

This does not mean that each deposit made by a customer represents a new contract. Rather, the nature of the contractual relationship remains constant. That is, there is a single chose in action in respect of the customer's right to be repaid the amount previously deposited: Hart (Inspector of Taxes) v. Sangster 1 Ch 329; [1957] 2 All ER 208; [1984] AC 580.

A taxpayer therefore has the right to receive the balance standing to the credit of their foreign account (a right to receive a certain amount of foreign currency). This right to receive foreign currency is a relevant right within the terms of subparagraph 775-45(1)(b)(iii) of the ITAA 1997.

A part of this right will cease if you direct that money be withdrawn or transferred out of the foreign account. Upon this right, or part of this right ceasing, a forex realisation event 2 will happen (pursuant to 775-45(1) of the ITAA 1997).

A forex realisation gain or loss may be made as a result of a forex realisation event 2 happening on a withdrawal transfer or payment out of the foreign account (pursuant to subsections 775-45(3) and (5) of the ITAA 1997).

However, subparagraph 775-165(2)(a)(ii) of the ITAA 1997 operates to disregard forex gains or losses made as a result of forex realisation event 1, 2 or 5 happening to rights or parts of rights that:

arose under an eligible contract (within the meaning of the former Division 3B of Part III of the Income Tax Assessment Act 1936 (ITAA 1936)) that was entered into before the applicable commencement date,

where the taxpayer has not made a transitional election under section 775-150 of the ITAA 1997.

Under Division 3B of Part III of the ITAA 1936, an eligible contract is defined by subsection 82V(1) of the ITAA 1936 as a contract entered into by the taxpayer on or after the commencing day, other than a hedging contract.

Subsection 82V(1) of the ITAA 1936 also provides that 'commencing day' means 19 February 1986.

As your foreign account was opened after 19 February 1986, it is an eligible contract within the meaning of Division 3B of Part III of the ITAA 1936.

Whether or not the your right to be paid the amount standing to the credit of your foreign account 'arose under' the eligible contract, will depend on the meaning given to the phrase in the context of section 775-165 of the ITAA 1997.

In N. Joachimson v. Swiss Bank Corporation [1921] All ER 92; [1921] 3 KB 110 Atkin LJ (at All ER 100; KB 127) noted that there is only one contract between the bank and its customer. While the making of deposits with a bank may create a credit balance, the banking contract confers on the customer the right to be repaid that balance. Accordingly, rights conferred by the terms of the taxpayer's eligible contract (their foreign account) properly arise 'under' that contract.

The rights arising upon the making of a deposit into the foreign account will have arisen under the contract, which is an eligible contract. As the account is an eligible contract entered into before date B and you have not made a transitional election, any forex realisation gains or losses made by you as a result of forex realisation event 2 happening upon a withdrawal, transfer or payment out of the account will be disregarded under the forex provisions (see subsection 775-165(2) of the ITAA 1997).

Therefore, the forex gains or losses made from withdrawals from your foreign currency bank accounts opened between date A and date B are disregarded under the forex provisions in Division 775 of the ITAA 1997. However, gains or losses may still be taken into account under other provisions of the ITAA 1936 or the ITAA 1997 as a result of a withdrawal from such a foreign account.

Gains or losses under the CGT provisions

Under section 108-5 of the ITAA 1997, foreign currency is a CGT asset. However, bank accounts denominated in a foreign currency are not foreign currency but rather a chose in action, or more specifically a debt (or debts), denominated in a foreign currency.

The depositing of foreign currency into a bank account results in the acquisition of a debt by the depositor, the debt being a chose in action and a CGT asset. The chose in action is the ability to require payment of the account balance, or part of it, on demand (Joachimson v. Swiss Bank Corporation [1921] 3 KB 110 at 127).

A bank account is a single asset, the one debt and chose in action. That is, a single debt existing between the customer and the banker in their respective capacities as creditor and debtor (Foley v. Hill [1843-1860] All ER 16).

As the bank account is one asset, each deposit adds to its cost base and reduced cost base and each withdrawal constitutes a part ending or part satisfaction of the debt asset. Each withdrawal will constitute CGT event C2 happening to the relevant 'part' of the asset (the amount withdrawn).

Item 5 of the table in subsection 960-50(6) of the ITAA 1997 requires a 'transaction or event' involving money or property denominated in foreign currency to be converted to AUD at the time of the 'transaction or event'.

Therefore, each deposit and withdrawal must be converted to AUD to work out the relevant cost base and capital proceeds of the debt asset.

On this basis, foreign exchange gains or losses will be brought to account at the time of a withdrawal depending on the movement of the foreign currency as against the Australian dollars under the CGT provisions.

However, from 12 December 2006 a foreign resident is only subject to CGT for CGT event that happen to taxable Australian property. The term 'taxable Australian property' is defined in section 855-15 of the ITAA 1997 to include:

· taxable Australian real property

· an indirect interest in Australian real property

· a business asset of a permanent establishment in Australia

· an option or right to acquire any of the CGT assets in items 1 to 3 listed above, or

· a CGT asset that is deemed to be Australian taxable property where a taxpayer on ceasing to be an Australian resident, makes an election under section 104-165 of the ITAA 1997.

Your foreign currency bank accounts are not taxable Australian property as defined.

When an individual becomes an Australian resident, then for each CGT asset that is not a taxable Australian property (or for CGT events before 12 December 2006 that does not have the necessary connection with Australia):

(a) the asset is taken to be acquired by the individual, company or trustee (as the case may be) at the time of becoming resident, and

(b) the first element of the cost base and reduced cost base of the asset is its market value at that time (sections 855-45, 855-50 of the ITAA 1997).

An Australian resident is assessable on the capital gains or losses made from CGT events that happen on his or her worldwide assets.

Therefore, when you became an Australian resident you are deemed to have acquired the foreign currency bank accounts at their market value at the time you became an Australian resident. This will form the first element of your cost base when calculating your CGT. Gains or losses made from withdrawals made from the foreign currency bank accounts constitute a CGT event C2 happening to relevant part of the CGT asset. A capital gain or capital loss is calculated by deducting the cost base from the capital proceeds. The capital proceeds are the amount in Australian dollars that you received upon the exchange of your foreign currency.

Consequently, the gains or losses made on converting to Australian dollars upon withdrawals from the foreign currency bank accounts are subject to CGT.