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Ruling

Subject: Determining the sole or predominant currency pursuant to Subdivision 960-D of the Income Tax Assessment Act 1997

Issue 1

Question 1

Will the Australian dollar be the sole or predominant currency in which the taxpayer keeps its accounts, for the purposes of subdivision 960-D of the Income Tax Assessment Act 1997 (ITAA 1997) on and from the commencement of its 2010-11 income year?

Answer:

Yes.

Question 2

Will the United States dollar cease to be the sole or predominant currency in which the taxpayer keeps its accounts, for the purposes of subdivision 960-D of the ITAA 1997 immediately after the end of its 2009-10 income year?

Answer:

Yes.

This ruling applies for the following periods:

2009-10 income year

2010-11 income year

The scheme commenced on:

2009-10 income year

Relevant facts and circumstances

The taxpayer is the provisional head company of a multiple entry consolidated group (the MEC group). The MEC group formed when the eligible tier one companies of a foreign resident chose to form the MEC group with effect from a particular date.

The taxpayer is an Australian resident company that is required to prepare financial reports under section 292 of the Corporations Act 2001. The taxpayer has, for income tax purposes, a substituted accounting period.

At the date on which the MEC group was formed the taxpayer's sole or predominant currency in which it kept its accounts was the United States dollar (USD). That is, the 'functional currency' for accounting purposes was the USD.

The taxpayer made a choice under item 1 of the table in subsection 960-60(1) of the ITAA 1997 to use the USD as its 'applicable functional currency' for taxation purposes from the date on which the MEC group was formed.

The MEC group was acquired by Entity B. This occurred when the foreign resident was acquired by Entity B. Entity B became the top company of the MEC group, with the taxpayer remaining as the provisional head company.

Entity B has an accounting policy that its group members use their local currency for accounting purposes. The accounting functional currency of Entity B is the Australian dollar (AUD).

To be consistent with the accounting policy of Entity B the Directors of the MEC group are of the view that the MEC group should also use the AUD as its functional currency for accounting purposes.

Assumption

The AUD will become the functional currency of the MEC group under Australian Accounting Standards Board (AASB) Accounting Standard AASB 121, such that foreign currency translations shall be recorded, on initial recognition, in AUD (in accordance with paragraph 21 of AASB 121) from no later than the commencement of the taxpayer's 2010-11 income year.

Relevant legislative provisions

Income Tax Assessment Act 1997

section 701-1

Subdivision 960-D

section 960-59

section 960-60

subsection 960-60(1)

section 960-70

subsection 960-70(1)

subsection 960-70(4)

section 960-90

subsection 960-90(1)

Income Tax Assessment Act 1936

subsection 391(2)

Corporations Act 2001

section 292

Reason for Decision

Question 1

Summary

The taxpayer will, for the purposes of subdivision 960-D of the ITAA 1997, keep its accounts solely or predominantly in AUD on and from the commencement of its 2010-11 income year.

Detailed reasoning

Section 960-59 of the ITAA 1997 states that the object of Subdivision 960-D of the ITAA 1997, dealing with functional currency, is for the purposes of reducing compliance costs and reflecting commercial practice. It allows certain entities whose accounts are kept solely or predominantly in a particular foreign currency to calculate their net incomes by reference to the functional currency.

Under item 1 of the table in subsection 960-60(1) of the ITAA 1997, an Australian resident that is required to prepare financial reports under section 292 of the Corporations Act 2001 may choose to use the 'applicable functional currency'.

For an Australian resident making a choice under item 1 of the table in subsection 960-60(1) of the ITAA 1997, the 'applicable functional currency' is defined in subsection 960-70(1) of the ITAA 1997 to be the sole or predominant foreign currency in which they kept their 'accounts' at the time they made the choice.

Currency in accounts

Subsection 960-70(4) of the ITAA 1997 defines 'accounts' to mean:

a) ledgers; and

b) journals; and

c) statements of financial performance; and

d) profit and loss accounts; and

e) balance-sheets; and

f) statements of financial position;

and includes statements, reports and notes attached to, or intended to be read with, any of the foregoing.

Item 1 of the table in subsection 960-90(1) of the ITAA 1997 has the effect that, if you have previously made a choice under subsection 960-60(1), you may withdraw this choice if your 'applicable functional currency' has ceased to be the sole or predominant currency in which you keep your 'accounts' (within the meaning of section 960-70).

That is, the taxpayer may, having made a choice under subsection 960-60(1), withdraw this choice if the taxpayer's applicable functional currency, being the USD, has ceased to be the sole or predominant currency in which its accounts are kept.

Sole or predominant currency for tax purposes

The Explanatory Memorandum to the New Business Tax System (Taxation of Financial Arrangements) Bill (No.1) 2003 (the EM) supports the view that, fundamental to being able to choose to use the 'applicable functional currency', or to withdraw the choice to use the 'applicable functional currency', an entity must keep or cease to keep, as is applicable, their books of account solely or predominantly in the relevant foreign currency.

The EM states:

3.54 … Broadly, an entity's applicable functional currency is the sole or predominant currency in which its accounts are kept … This aligns the commercial rationale for accounting in a foreign currency with the use of that currency for income tax purposes. ...

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. …

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 … keeps its books of account."

For taxation purposes, the 'applicable functional currency' under subsection 960-70 of the ITAA 1997 is premised on that foreign currency being the sole or predominant foreign currency in which the entity's 'accounts' are kept.

For accounting purposes, the accounting standard AASB 121 The Effects of Changes in Foreign Exchange Rates, applies to annual reporting periods beginning on or after 1 January 2005. AASB 121 defines 'functional currency' as the currency of the primary economic environment in which the entity operates, which is normally the currency in which it primarily generates and expends cash (refer to paragraphs 8 and 9 of AASB 121). An entity does not have a free choice as to whether to use functional currency for accounting purposes.

Paragraphs 17 and 21 of AASB 121 require that:

17 In preparing financial statements, each entity - whether a stand-alone entity, an entity with foreign operations (such as a parent) or a foreign operation (such as a subsidiary or branch) - determines its functional currency in accordance with paragraphs 9-14. The entity translates foreign currency items into its functional currency and reports the effects of such translation in accordance with paragraphs 20-37 and 50. …

21 A foreign currency transaction shall be recorded, on initial recognition in the functional currency, by applying to the foreign currency amount the spot exchange rate between the functional currency and the foreign currency at the date of the transaction.

In contrast to AASB 121, section 960-60 of the ITAA 1997 has the effect of giving an entity the choice as to whether or not to use a functional currency. Therefore, it is possible, that an entity may have a 'functional currency' for accounting purposes that is different to the entity's 'applicable functional currency' for taxation purposes.

Taxation Determination TD 2006/4 Income tax: can an Australian resident entity which keeps its 'accounts' predominantly in a foreign currency, choose to use that foreign currency as its 'applicable functional currency', where the entity is required to prepare financial statements in Australian dollars for statutory reporting purposes? discusses the interaction between 'functional currency' for accounting purposes, and the 'applicable functional currency' for taxation purposes.

Paragraph 15 of TD 2006/4 states:

… an entity may be required under Australian law to keep its accounts in a currency other than Australian currency. This is governed currently by whether or not it is required to comply with the relevant Accounting Standard.⁵ At the time of issue of this Determination, the relevant Accounting Standard was AASB 121.⁶ It is accepted in relation to a year of income that, where an eligible entity within the meaning of subsection 960-60(1) of the ITAA 1997) is required under AASB 121 to keep its accounts so that entries are made in a non-Australian currency (referred to in AASB 121 as the 'functional currency'⁷), then that currency will qualify as the entity's 'applicable functional currency' for the purposes of subsection 960-70(1) of the ITAA 1997. [Emphasis added].

In order for an Australian resident entity to withdraw their functional currency choice made under item 1 of the table in subsection 960-60(1) of the ITAA 1997, item 1 of the table in subsection 960-90(1) of the ITAA 1997 clearly requires that the 'applicable functional currency' has ceased to be the sole or predominant currency in which they keep their 'accounts' within the meaning of section 960-70 of the ITAA 1997.

Notwithstanding that the taxpayer's 'functional currency' for accounting purposes may change from the USD to the AUD, the taxpayer will only be able to withdraw its choice of the USD as its 'applicable functional currency' for taxation purposes if the requirements of section 960-90 of the ITAA 1997 are met. This will necessitate that the USD ceases to be the sole or predominant currency in which the taxpayer keeps its 'accounts' within the meaning of section 960-70 of the ITAA 1997.

Sole or predominant currency in a MEC group

Taxation Determination TD 2007/24 Income tax: is the 'applicable functional currency' for the head company of a consolidated group determined by looking at the 'accounts' of all the members of the consolidated group, for the purposes of item 1 of subsection 960-60(1) of the Income Tax Assessment Act 1997? discusses determining the sole or predominant currency when there are accounts of a head company, and accounts of members of a consolidated group.

Paragraphs 8 and 9 of TD 2007/24 state:

8. Accordingly the term 'you' in subsection 960-70(1) refers, in such a case, to the head company of the consolidated group; including as parts of that entity all of the subsidiary members for the relevant period. The term 'your accounts' in the subsection correspondingly refers to the 'accounts' of the head company and all of the subsidiary members for this period. ⁸ Note that only the 'accounts' of entities within a group consolidated for tax purposes are considered. Thus, in determining whether there is a predominant foreign currency for a consolidated group, no reliance is placed upon any consolidated group 'accounts' that do not relate solely to the tax consolidated group.

9. The 'applicable functional currency' of the head company of a multiple entry consolidated (MEC) group is determined in the same way as that set out above for the head company of a non-MEC consolidated group. The single entity rule in section 701-1 applies equally to both head companies (refer paragraph 15 of Taxation Ruling TR 2004/11).

Therefore, when examining the accounts of the taxpayer to determine the sole or predominant currency in the taxpayer's accounts you are required, given that the taxpayer is a provisional head company, to also examine the accounts of the entities within the MEC group.

Determining the taxpayer's sole or predominant currency on and from the commencement of its 2010-11 income year

The test of whether or not a particular foreign currency is the predominant one in which an entity keeps its 'accounts', is a quantitative one, as it involves an examination of those 'accounts' in terms of the unit of measurement used (see for example Federal Commissioner of Taxation v. FH Faulding & Co Ltd (1950) 83 CLR 594).

The Explanatory Memorandum to the Taxations Laws Amendment (Foreign Income) Bill 1990 (the FI EM) provided guidance for former subsection 391(2) of Part X of the Income Tax Assessment Act 1936 (ITAA 1936), which contained the following words:

a single or predominant currency in which eligible amounts… are expressed in the accounts…

In relation to subsection 391(2) of the ITAA 1936 the FI EM stated:

Whether or not there is a predominant foreign currency is not to be determined by the volume or size of the transactions. Rather, the test will turn on whether or not there is a particular foreign currency used for the basic record keeping of the CFC.

The same approach to interpreting the words 'predominant currency… expressed in the accounts' under former subsection 391(2) of the ITAA 1936 is considered appropriate in interpreting the words 'predominant foreign currency' in a taxpayer's 'accounts' under subsection 960-70(1) of the ITAA 1997.

The taxpayer made a functional currency choice, commencing in the income year the MEC Group was formed, to use the USD as the applicable functional currency of the MEC group for taxation purposes.

From the commencement of its 2010-11 income year, the taxpayer and subsidiaries in the MEC group will no longer record initial transactions in accounts in USD. This reflects the intention of the directors of the MEC group to record transactions in the MEC group's accounts on and from the commencement of its 2010-11 income year in AUD.

The currency recorded in the taxpayer's accounts will change from USD to AUD immediately after the end of its 2009-10 income year when the currency recorded in the provisional head company's accounts changes at year end.

This means that an examination of the accounts of the taxpayer and the accounts of the entities in the MEC group (as required by subsection 960-70(1) of the ITAA 1997), upon the commencement of its 2010-11 income year, will show that the sole or predominant currency in which the taxpayer and the subsidiaries in the MEC group keeps accounts is the AUD.

Question 2

Summary

The USD will cease to be the sole or predominant currency in which the taxpayer keeps its 'accounts', for the purposes of subdivision 906-D of the ITAA 1997 immediately after the end of its 2009-10 income year.

Detailed reasoning

On and from the commencement of its 2010-11 income year, the MEC group will no longer use the USD in its accounts. This reflects the intention of the directors of the MEC group to record transactions in the MEC group accounts from the commencement of its 2010-11 income year in AUD.

The currency recorded in the taxpayer's accounts will change from USD to AUD immediately after the end of its 2009-10 income year when the currency recorded in the provisional head company's accounts changes at year end.

This means that an examination of the accounts of the taxpayer and the accounts of the entities in the MEC group (as required by subsection 960-70(1) of the ITAA 1997), on the commencement of its 2010-11 income year, will show that the sole or predominant currency in which the taxpayer and the subsidiaries in the MEC group keeps accounts is the AUD.

The change to using the AUD in the taxpayer's accounts and the accounts of the subsidiaries in the MEC group, means that the sole and predominant currency in which these accounts are kept will cease to be the USD. This change occurs immediately after the end of the taxpayer's 2009-10 income year when the currency recorded in the accounts changes to the AUD.