Edited version of private ruling

Authorisation Number: 1011653795106

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Ruling

Subject: Foreign Exchange Loss

Question

Is the loss that has been incurred by the estate of the deceased (the estate), a loss to which Division 775 of the Income Tax Assessment Act 1997 (ITAA 1997) applies?

Answer

No. The loss that has been incurred by the estate is not a loss to which Division 775 of the ITAA 1997 applies.

This ruling applies for the following period:

1 July 2009 to 30 June 2010

Relevant facts and circumstances

The deceased who passed away in foreign Country X was not a resident of Australia for income tax purposes.

The executors of the deceased estate are residents of Australia. The estate is a tax resident of Australia.

On the date of death, the deceased held bank accounts and securities in a foreign bank in Country X.

Following the date of death, a grant of probate resulting from the presentation of a fraudulent Will was issued in Country X in favour of a third party.

All accounts held at the foreign bank in Country X were closed following the transfer of the funds to the third party.

Following protracted litigation, a court in Country X ordered that the remaining funds which had been obtained fraudulently be returned to the estate.

The amount returned to the estate was deposited to an account held in trust by a legal firm which acted for the executors, in Country X.

A grant of probate in favour of the executors was subsequently made in Australia.

During the time that the trust account was held in trust by the legal firm in Country X, several amounts were withdrawn from the trust bank account to pay for various expenses, culminating in the closure of the trust account. On the closure of the trust account, an amount of foreign currency was returned to the executors in Australia.

No elections had been made in relation to any of the bank accounts under Division 775 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 Division 775

Income Tax Assessment Act 1997 section 775-5

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

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

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Detailed reasoning

Section 775-5 of the ITAA 1997 is a guide to Division 775 of the ITAA 1997. It provides that a taxpayer's assessable income includes a forex realisation gain resulting from a forex realisation event and that the taxpayer can deduct a forex realisation loss resulting from a forex realisation event.

Section 775-5 of the ITAA 1997 lists five main types of forex realisation events.

Subsection 775-45(1) of the ITAA 1997 states that forex realisation event 2 (FRE 2) happens if the following three conditions are satisfied:

(a)  you cease to have a right, or a part of a right, to receive foreign currency; and

(b) the right, or the part of the right, is one of the following:

(i)  a right, or a part of a right, to receive, or that represents, ordinary income or statutory income (other than statutory income that is assessable under this Division or Division 102);

(ii)  a right, or a part of a right, created or acquired in return for your ceasing to hold a depreciating asset;

(iii) a right, or a part of a right, created or acquired in return for your paying, or agreeing to pay, an amount of Australian currency or foreign currency;

(iv) a right, or a part of a right, created or acquired in return for the occurrence of a realisation event in relation to a CGT asset you own, and none of subparagraphs (i), (ii) and (iii) applies; and

(c)  you did not cease to have the right, or the part of the right, because you disposed of the right or the part of the right (within the meaning of section 775-40).

The events arising in the time period starting from the date of death and ending on the withdrawal of the funds on the closure of the trust account must be analysed separately and can be broken down into the following events:

· date of death.

· grant of probate under fraudulent Will.

· funds withdrawn under a fraudulent Will.

· the remaining funds were deposited into the trust bank account of the legal firm which acted for the executors in Country X.

· the trust account was closed and the funds were paid to the executors.

a) Date of death

On the date of death, the property of the deceased passes to the estate, legal control of which is exercised by the executors.

When the property passes to the executors on the date of death, the executors have a fiduciary duty in favour of the beneficiaries. At this stage however, the beneficiaries have no legal interest in the assets of the estate other than an equitable right to see the estate is properly administered. Even though they may have an indefeasible interest in the assets of the estate, those interests cannot crystallise until probate has been granted.

b) Fraudulent Grant of Probate

Probate is the legal proving of the Will and provides the executors with the authority to deal with the estate.

The granting of probate does not, however, result in any foreign exchange gain or loss. It is merely a court order pursuant to which the assets of the estate can be dealt with according to the Will.

c) Funds withdrawn under a fraudulent Will

FRE 2 applies when there is a cessation of a right (or part of a right) to receive foreign currency and that right is one that is listed in paragraph 775-45(1)(b) of the ITAA 1997.

Upon the death of the deceased, the executors, both of whom are residents of Australia, thereby had the right to receive foreign currency in the deceased overseas bank accounts in their capacity as the executors.

When the funds were withdrawn pursuant to the fraudulent grant of probate, the executors ceased to have the right to receive foreign currency.

However, the cessation of the executor's right to receive foreign currency does not trigger FRE 2 as the condition in paragraph 775-45(1)(b) of the ITAA 1997 is not satisfied. The cessation of the right to receive foreign currency in the bank accounts does not represent ordinary income or statutory income. It is also not a right acquired in return for any of the events listed in sub-paragraphs 775-45(1)(b)(ii) to 775-45(1)(b)(iv). Instead, the executor's right to receive foreign currency arose as a result of the death of the deceased and the appointment of the executors of the deceased estate.

Accordingly, when the foreign currencies were withdrawn from the foreign bank accounts of the deceased under the fraudulent Will, FRE 2 does not arise for the estate.

d) Funds deposited into the trust account

The issue to address is whether, when funds were deposited into the trust account, any foreign exchange gains or losses are brought within Division 775 of the ITAA 1997.

Forex realisation event 1 (FRE 1) arises if CGT event A1 happens in relation to the foreign currency, namely the disposal of foreign currency. For there to be a disposal of an asset, there must be a change in ownership of the CGT asset from one entity to another. However, a change in ownership does not occur because there is a change in the legal but not the beneficial owner. Nor does it occur merely because there is change of trustee (subsection 104-10(2) of the ITAA 1997).

The fraudulent withdrawal of foreign currency from the bank accounts of the deceased creates a constructive trust over the foreign currency for the benefit of the estate.

Subsequent to the monies being deposited into trust account held with the legal firm, there is merely a change in trustee, as the estate continues to be beneficially entitled to the foreign currency.

Accordingly, there is no disposal of foreign currency and as a consequence, FRE 1 does not happen when the foreign currencies were deposited into the trust bank account.

e) Funds withdrawn from trust account

During the time that the trust account was held in trust by the legal firm, several amounts were withdrawn from the trust bank account to pay for various expenses, culminating in the closure of the bank account.

The issue is whether the foreign exchange gains or losses arising under each of these withdrawals fall within FRE 2.

A requirement for FRE 2 to happen is the cessation of a right to receive foreign currency.

he rights of a beneficiary in a trust is a right in personam and not one in rem (see Glenn and Ors v. Commissioner of Land Tax (Cth) 20 CLR 490 at 503, 504 per Isaacs J). Accordingly, the right attaches to the specified person and is based on personal relations, as opposed to a right being based on property ownership.

As the foreign currencies were held in the trust bank account, the estate does not gain a right to receive foreign currency when those funds are deposited into the trust bank account.

Accordingly, there is no cessation of a right to receive foreign currency when the funds are used to pay for expenses incurred on behalf of the estate.

Nor does a foreign exchange again or loss arise when the balance of the monies owing are paid to the estate by the solicitor. Accordingly, FRE 2 does not happen on each withdrawal of funds from the trust bank account.

Conclusion

As the events leading up to the closure of the trust account do not trigger any of the forex realisation events, any foreign exchange losses do not fall within Division 775 of the ITAA 1997.

Other Matters for your consideration

As the foreign exchange losses do not fall within Division 775 of the ITAA 1997, these losses are to be considered under the Capital Gains Tax (CGT) provisions contained in Parts 3-1 and 3-3 of the ITAA 1997.