Edited version of your private ruling

Authorisation Number: 1011936042731

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Ruling

Subject: Election of Applicable Functional Currency ('AFC')

Question 1

Does section 960-85 of the ITAA 1997 apply to the Company's principal amounts of foreign currency denominated liabilities and receivables at the effective time of the Company's 'functional currency' choice?

Answer

Yes. Section 960-85 of the ITAA 1997 can apply to the Company's foreign currency denominated liabilities and receivables at the effective time of the Company's 'functional currency' choice

Question 2

In respect of the Company's liabilities and receivables can subsection 775-15(1) and subsection 775-30(1) of the ITAA 1997 apply, respectively, to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997 on election of the applicable functional currency?

Answer

No. In respect of the Company's liabilities and receivables, subsections775-15(1) and 775-30(1) of the ITAA 1997 do not apply, respectively, to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997 on election of the applicable functional currency.

Question 3

In respect of the Company's liabilities and receivables, can sections 6-5 and 8-1 of the ITAA 1997 apply, respectively, to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997 on election of the applicable functional currency?

Answer

No. In respect of the Company's liabilities and receivables, sections 6-5 and 8-1 of the ITAA 1997 do not apply, respectively, to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997 on election of the applicable functional currency.

Question 4

Does subsection 775-15(1) and subsection 775-30(1) of the ITAA 1997 apply, respectively, to bring to account for income tax purposes any gains or losses on the repayment of the Company's liabilities and receivables?

Answer

No. Subsections 775-15(1) and 775-30(1) of the ITAA 1997 do not apply, respectively, to bring to account for income tax purposes any gains or losses on the ultimate repayment of the Company's liabilities and receivables.

Question 5

Do sections 6-5 and 8-1 of the ITAA 1997 apply, respectively, to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997, on the repayment of the Company's liabilities and receivables?

Answer

No. Sections 6-5 and 8-1 of the ITAA 1997 do not apply, respectively, to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997, upon the repayment in USD of the Company's receivables and liabilities.

Question 6

Does section 102-5 and section 102-10 of the ITAA 1997 apply on the ultimate repayment of the amounts borrowed and lent by the Company and to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997?

Answer

Sections 102-5 and 102-10 of the ITAA 1997 do not apply on the ultimate repayment of the Company's liabilities and to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997.

However, section 102-5 and section 102-10 of the ITAA 1997, as the case may be, applies on the ultimate repayment of the Company's receivables and to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997.

Question 7

Does section 960-85 of Subdivision 960-D of the ITAA 1997 apply on the repayment of the principal amount in respect of amounts borrowed and lent by the Company?

Answer

No. Section 960-85 of the ITAA 1997 has no application on the ultimate repayment of the principal amount in respect of amounts borrowed and lent by the Company.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Company X (' the Company') is is required to prepare financial reports under the Corporations Act 2001.

The Company raised funds in currency D to acquire Country D businesses.

As a result the Company has non-interest bearing currency D denominated liabilities.

Following the initial acquisition transactions the Company lent funds to its Country D subsidiaries to fund capital purchases and other projects in respect of their business.

The Company does not charge interest on the loans made to its Country D subsidiaries.

As a result the Company has currency D denominated receivables.

The Company has not actively traded and has only operated as a head investment entity.

The provision of finance is not in the ordinary course of business for the Company.

The Company keeps its accounts in currency D as its 'functional currency' for reporting purposes under Australian Accounting Standards Board (AASB) 121.

The Company keeps its basic reporting in currency D.

The Company intends to make an election to adopt currency D as its functional currency.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 960-D

Income Tax Assessment Act 1997 Section 960-60

Income Tax Assessment Act 1997 Subsection 960-60(1)

Income Tax Assessment Act 1997 Section 960-70

Income Tax Assessment Act 1997 Subsection 960-70 (1)

Income Tax Assessment Act 1997 Section 960-80

Income Tax Assessment Act 1997 Subsection 960-80(1)

Income Tax Assessment Act 1997 Section 960-85

Corporation Act 2001 Section 292

Income Tax Assessment Act 1997 Division 775

Income Tax Assessment Act 1997 Section 775-55

Income Tax Assessment Act 1997 Section 775-45

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

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

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-10

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-5

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 108-5 (2)

Income Tax Assessment Act 1997 Section 104-5

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 104-25(2)

Reasons for Decision

These reasons for decision accompany the Notice of private ruling for the Company.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Applicable Functional Currency choice

The functional currency provisions in Subdivision 960-D of the ITAA 1997, allow certain entities that keep their 'accounts' solely or predominantly in a particular foreign currency, to choose to work out their taxable income or tax loss in that foreign currency. This unit of foreign currency is called the 'applicable functional currency' (AFC).

Subdivision 960-D of the ITAA 1997 contains eligibility rules in sections 960-60 and 960-70 of the ITAA 1997 and translation rules in sections 960-80 and 960-85 of the ITAA 1997.

Eligibility Rules

The table in subsection 960-60(1) of the ITAA 1997 identifies the entities, or parts of entities, which may be eligible to choose to use the AFC, the purposes for which it can be used and when the choice takes effect.

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, is included in the list of entities eligible to make the choice of an AFC.

Relevantly, Section 292 of the Corporations Act 2001 provides that a financial report and directors' report must be prepared for each financial year by all public companies among other entities.

Subsection 960-70(1) of the ITAA 1997 provides that the AFC for entities that are required to prepare financial reports under section 292 of the Corporations Act 2001, is the sole or predominant foreign currency in which they kept their 'accounts' at the time when they made the AFC choice.

Taxation Determination TD 2006/4 (TD 2006/4) clarifies that 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 entity in question.

TD 2006/4 further provides 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'), then that currency will qualify as the entity's AFC for the purposes of subsection 960-70(1) of the ITAA 1997.

Where an eligible entity chooses a functional currency, the choice applies from the start of the first income year following the one in which the choice is made and continues until withdrawn.

Application of sections 960-60 and 960-70 of the ITAA 1997 to the Company

The Company is eligible to choose to use an AFC under section 960-60 as it is a public company that is required to prepare financial reports under section 292 of the Corporations Act 2001 for the purposes of item 1 of the table in subsection 960-60(1) of the ITAA 1997.

The Company is eligible to choose to use an AFC under section 960-70 despite the lack of significant volume of business transactions as the Company's basic record keeping involves the use of currency D. Additionally, the Company keeps its accounts in currency D as its 'functional currency' for reporting purposes under AASB 121.

The Company does not itself carry on business activities, it purely operates as an Australian head investment company for a number of subsidiary companies carrying on a business in Country D. The Company has raised funds for investment in the business of its Country D subsidiaries. In turn, the subsidiaries will pay dividends to the Company in the nature of non-assessable non- exempt dividends. Additionally, the subsidiaries will also make repayments to the Company towards funds loaned by the Company.

All of the above transactions which form the backbone of the Company's investment in Country D are denominated in currency D.

Translation rules

Subdivision 960-D of the ITAA 1997 contains translation rules in sections 960-80 and 960-85 of the ITAA 1997.

Taxation ruling TR 2007/5 (TR 2007/5) considers the operation of sections 960-80 and 960-85 in Subdivision 960-D of ITAA 1997. In particular, TR 2007/5 considers when an amount is 'not in the applicable functional currency', for the purposes of subsection 960-80(1) and section 960-85, as explained further.

Subsection 960-80(1) of the ITAA 1997 provides that, for the purpose of working out the relevant annual net amount, an 'amount' which is not in the 'applicable functional currency' is to be translated into that currency.

Essentially, the core translation rule in subsection 960-80(1) of the ITAA 1997 ensures that an entity's income tax relevant net amount (such as taxable income or a tax loss or 'attributable income') will be calculated using only 'applicable functional currency' denominated amounts.

Section 960-85 of the ITAA 1997applies where:

· an 'amount' is required to be translated to the 'applicable functional currency' under subsection 960-80(1); and

· the amount is 'attributable to' an 'event that happened, or a state of affairs' that arose at a time (the 'event time') before an 'applicable functional currency' choice took effect - therefore to a 'pre-choice' amount.

A two step translation rule in section 960-85 of the ITAA 1997 applies relevant 'pre-choice' amounts - that is those 'pre-choice' amounts that are directly relevant to determining an entity's tax relevant net amount, i.e. taxable income or tax loss and so need to be translated into the AFC.

When translating an amount from a foreign currency into an entity's AFC where no previous AFC choice was in effect at the 'event time', the two-stage translation process applies, as follows:

· there is firstly a translation of the relevant amount to Australian dollars at the rate prevailing at the 'event time'; and then,

· a translation of this Australian dollar amount to the 'applicable functional currency', at the rate prevailing at the time the choice took effect.

The practical impact of this is that it will bring to account any unrealised exchange gains or losses in relation to the amount, arising from fluctuations between Australian currency and the AFC, between the 'event time' and the time the choice to use the AFC takes effect.

Question 1

In the arrangements under consideration, the borrowings by the Company (liabilities) and loans made to its Country D subsidiaries (receivables) are denominated in currency D. All of the above transactions were completed prior to the intended choice by the Company that currency D will be its 'applicable functional currency' (AFC).

As the borrowings and monies lent are already denominated in currency D, which is intended to be the Company's AFC, the question to be answered is whether, notwithstanding this, there is an 'amount' required to be translated to the AFC for the purposes of section 960-85 of Subdivision 960-D of the ITAA 1997.

If there is no 'amount' requiring translation into the AFC, then the two step translation rule in section 960-85 of the ITAA 1997 will generally have no application.

However, TR 2007/5 provides at paragraphs 33 that, in the absence of a valid choice under subsection 960-60(1) of the ITAA 1997 to use an AFC, the appropriate currency required to be used for income tax purposes is Australian currency.

At paragraph 34, TR 2007/5 further provides that the amounts which are 'attributable to' a 'prior year event' in a year in which the use of the AFC did not apply, are amounts which are not in the AFC. This is so even where the amounts (or their elements), are denominated in the relevant source in the non-Australian currency that subsequently becomes the 'applicable functional currency'.

However, for paragraph (a) of subsection 960-85(1) of the ITAA 1997 to be satisfied, subsection 960-80(1) of the ITAA 1997 must require that the 'amount' that is not in the AFC is to be translated to the AFC.

Relevantly, in respect of an 'eligible entity' that is required to prepare financial reports under section 292 of the Corporations Act 2001, item 1 in the table in subsection 960-80(1) of the ITAA 1997 provides that, for the purpose of working out the entity's taxable income or tax loss, an amount that is not in the AFC is to be translated in to the AFC.

Although the Company's liabilities and receivables in this case are denominated in currency D, they are not in the AFC because they arose in a year prior to the application of Subdivision 960-D of the ITAA 1997.

Accordingly, in respect of the Company's currency D denominated liabilities and receivables, there is an 'amount' in existence as required by paragraph 960-85(1)(b) of the ITAA 1997, as the amount of the liabilities and receivables is attributable to 'an event that happened, or a state of affairs' that arose before an AFC choice takes effect.

However, whether there is a tax relevant amount in respect of any exchange gains or losses calculated pursuant to the operation of section 960-85 of the ITAA 1997 {for the purposes of subsection 960-80(1)} can be determined only by examining the application of other income tax provisions to the exchange gains and losses. This is because section 960-85 is not an assessing provision on its own.

In conclusion, section 960-85 of the ITAA 1997 applies to the currency D denominated liabilities and receivables of the Company. This will bring to account for income tax purposes any exchange gains or losses at the time of choice by the Company to use the AFC. However, it requires other income tax provisions to bring the gains and losses into assessable income, or create an allowable deduction.

This conclusion is in accordance with the ATO view contained in ATO ID 2010/59.

Question 2

Under subsection 775-15(1) of the ITAA 1997, foreign currency gains referred to as "forex realisation gains" are included in an entity's assessable income. Foreign currency losses referred to as "forex realisation losses" are deductible under subsection 775-30(1) of the ITAA 1997. Forex realisation gains and losses are recognised when a particular "forex realisation event" happens.

Where a taxpayer incurs an obligation to repay foreign currency in return for receiving an amount of foreign currency, Foreign Exchange Realisation Event 4 (FRE4) will occur at the time of each repayment of the borrowing, pursuant to subparagraph 775-55(1)(b)(ix) of the ITAA 1997.

The Company assumed an obligation to pay foreign currency by raising funds denominated in currency D. The Company's liabilities comprise of amounts owing in respect of its borrowings.

It is considered that for the purposes of Division 775, the appropriate realisation event that will apply at the time of discharge by the Company of its obligation is FRE4.

Therefore, a repayment of currency D borrowed by the Company will give rise to either a forex realisation gain or a forex realisation loss depending on the difference in the Australian dollar equivalent of the repaid amount at the time of its repayment as opposed to the time when that amount was borrowed.

Where a taxpayer ceases to have a right to receive foreign currency in return for paying an amount of foreign currency, Forex Realisation Event 2 (FRE 2) happens under subparagraph 775-45(1)(b)(iii) of the ITAA 1997.

Therefore, a receipt of currency D payments by the Company from its Country D subsidiaries in satisfaction of moneys loaned to them will give rise to either a forex realisation gain or a forex realisation loss depending on the difference in the Australian dollar equivalent of the amount received at the time of its receipt as opposed to the time when that amount was lent by the Company.

We have also considered the application of the other FRE events in Division 775 to the Company's circumstances. In this regard it is considered that, the discharge by the Company of its obligation to pay foreign currency to its creditors or the Company's right to receive foreign currency in respect of moneys lent to its subsidiaries is not characterised by:

. the disposal of foreign currency or a right, or a part of a right, to receive foreign currency

(FRE1 in section 775-40 of the ITAA 1997); or

. the cessation of an obligation (or a part of an obligation) to receive foreign currency

(FRE 3 in section 775-50 of the ITAA 1997); or

. the cessation of a right to pay foreign currency in return for assuming an obligation to pay

foreign or Australian currency (FRE5 in section 775-60 of the ITAA 1997); or

. the discharge of obligation to pay the principal amount of a notional loan under a

facility agreement (FRE6 in section 775-215 of the ITAA 1997).

The choice to use currency D as its applicable functional currency does not result in the discharge of the Company's obligation to pay foreign currency for the purposes of subparagraph 775-55(1)(b)(ix) of the ITAA 1997. Similarly, such a choice does not mark the cessation of the Company's right to receive foreign currency for the purposes of subparagraph 775-45(1)(b)(iii) of the ITAA 1997.

Consequently, the election to choose the AFC will not trigger FRE4 and FRE2 in respect of the Company's liabilities and receivables, respectively.

As a result, subsection 775-15(1) of the ITAA 1997 and subsection 775-30(1) of the ITAA 1997 will not apply, respectively, to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997 in respect of the Company's liabilities and receivables, at the time of the election by the Company to use the AFC.

Question 3

In respect of the income tax consequences under sections 6-5 and 8-1 of the ITAA 1997 of any embedded gains or losses calculated under section 960-85 of the ITAA 1997, it is necessary to determine whether the borrowing and lending activities of the Company form an integral part of its business or whether the activities simply add to the capital structure and provide funds for financing the business operations of the Company's Country D based subsidiaries (see Federal Commissioner of Taxation v. Hunter Douglas Limited 83 ATC 4562; 50 ALR 97 (1983); 14 ATR 629 (1983)).

In Avco Financial Services Ltd v FC of T, 82 ATC 4246; 13 ATR63(Avco Case), the High Court held that foreign exchange gains and losses arising from the repayment of foreign currency loans used in the ordinary course of business of a finance company were revenue in nature. In doing so, the Court recognised that revenue gains and losses could arise in relation to liabilities arising from borrowing money, even though the borrowing itself is typically an affair of capital.

The lending and borrowing activities of the Company in the present circumstances can be distinguished from those of the taxpayer in the Avco Case. The Company is an investment entity that has borrowed funds to fund its acquisition of shares in various Country D entities. Following the acquisition, the Company has provided finance to the Country D entities to fund the development of their business. This includes funding for business programs, acquisition of plant and equipment and other business projects.

The Company did not raise the borrowings in the course of carrying on a business of providing finance. Similarly, the lending of funds to its Country D based subsidiaries was also not carried out as part of the core activity of providing finance.

On the above basis, any embedded gains or losses arising at the time of the election by the Company to use the AFC will take on the character of the borrowings and moneys lent, both of which are of a capital nature.

Accordingly, the embedded gains and losses referred to previously will not be ordinary income or general deductions, respectively, for the purposes of sections 6-5 or 8-1 of the ITAA 1997.

As a result, sections 6-5 or 8-1 of the ITAA 1997 will not apply, respectively, to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997 in respect of the Company's liabilities and receivables, at the time of the election by the Company to use the AFC.

Question 4

Subsections 775-15(1) and 775-30(1) of the ITAA 1997 deal with foreign currency gains and losses, respectively, and generally provide that forex realisation gains are included in assessable income and that forex realisation losses can be deducted from assessable income.

As explained in response to Question 2 of this report, Foreign Exchange Realisation Event 4 (FRE4) will generally occur at the time of each repayment in foreign currency by the Company of its borrowings, pursuant to subparagraph 775-55(1)(b)(ix) of the ITAA 1997.

Similarly, Foreign Exchange Realisation Event 2 (FRE2) will generally occur at the time of each occasion of receipt by the Company of foreign currency on account of the repayment of moneys lent to its subsidiaries, pursuant to subparagraph 775-45(1)(b)(iii) of the ITAA 1997.

Also, as explained in the response to Question 2, no other event applies in respect of the repayment of the Company's liabilities and receivables.

However, once the Company has made an effective AFC choice to maintain its record keeping in currency D, currency D ceases to be a foreign currency for the purposes of the relevant provisions of Division 775 of the ITAA 1997.

Therefore, any repayments of the Company's liabilities are deemed not to be repayments of 'foreign currency'. Similarly payments received by the Company from its Country D subsidiaries are also not deemed to be receipts of 'foreign currency'.

As a result, there will be no foreign currency realisation gains or losses arising upon repayment of the borrowings by the Company or receipt of amounts lent by the Company pursuant to the relevant provisions of Division 775 of the ITAA 1997.

Consequently, Subsections 775-15(1) and 775-30(1) of the ITAA 1997 do not apply, respectively, to bring to account for income tax purposes any gains or losses on the repayment of the Company's liabilities and receivables.

Question 5

The Company did not raise its borrowings in the course of carrying on a business of providing finance. Similarly, the lending of funds to its Country D based subsidiaries was also not carried out as part of the core activity of providing finance.

As explained in response to Question 3 of this report, any embedded gains or losses calculated under section 960-85 of the ITAA 1997 in respect of the Company's liabilities and receivables at the time of the Company's functional currency choice will take on the character of the borrowings and moneys lent which are of a capital nature.

Accordingly, the embedded gains and losses referred to previously will not constitute ordinary income or general deductions under sections 6-5 or 8-1 of the ITAA 1997 at the time of the Company's functional currency choice.

Similarly, those embedded gains and losses will not constitute ordinary income or general deductions under sections 6-5 or 8-1 of the ITAA 1997 at the time of the repayment of the Company's liabilities and receivables.

As a result, sections 6-5 or 8-1 of the ITAA 1997 will not apply to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997, at the time of repayment of the Company's liabilities and receivables.

Question 6

Australian residents are subject to capital gains tax (CGT), where a CGT event happens in relation to their CGT assets with effect from 19 September 1985.

Broadly, a "CGT asset" is defined in section 995-1(1) of the ITAA 1997 by reference to section 108-5 of the ITAA 1997, as any kind of property or a legal or equitable right that is not property, that is acquired after 19 September 1985.

The concept of a CGT event is fundamental to the CGT provisions in that, if no CGT event happens in relation to a taxpayer, a capital gain or loss cannot arise in the hands of the taxpayer for the purposes of section 102-20 of the ITAA 1997.

A capital gain from each CGT event is used in the calculation of a taxpayer's net capital gain which is to be included in the taxpayer's assessable income pursuant to section 102-5 of the ITAA 1997.

A net capital loss determined under section 102-10 of the ITAA 1997 can be applied against a taxpayer's capital gains for a later income year (section 102-5 and subsection 102-15(3) of the ITAA 1997).

In the present circumstances, one of the two aspects of the scheme being considered concerns the repayment of the Company's liabilities represented by funds borrowed by the Company.

Taxation Ruling TR 96/23 deals with repayments made under a guaranteed loan agreement where there are three parties, the principal debtor who borrows an amount of money, the creditor, which lends the money to the debtor and the guarantor who agrees that, if the debtor defaults on the loan, he or she will contribute a part or all of the debt owed to the creditor.

TR 96/23 provides that a payment made under the guarantee by the principal debtor or guarantor does not give rise to any capital gains tax consequences for the principal debtor because that person does not own nor dispose of an asset (paragraphs 15, 52 and 53).

Similarly, where a creditor forgives or waives a principal debtor's debt, there are no capital gains tax consequences for the debtor (Taxation Determination TD 3).

The circumstance of the Company's borrowings, in comparison with the arrangement considered in TR 96/23, does not involve a guarantor. However, the Company in the capacity of a debtor (borrower) is not considered to own a CGT asset in line with the conclusion in TR 96/23. Therefore a repayment of the Company's liabilities does not amount to the disposal of an asset. Additionally, none of the specific CGT events in section 104-5 of the ITAA 1997 would apply upon the repayment by the Company of the liabilities denominated in currency D.

On this basis, section 102-5 or section 102-10 of the ITAA 1997 do not apply on the repayment of the Company's liabilities and to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997.

The second aspect of the scheme being considered relates to the Company's receivables, i.e. amounts lent by the Company to its Country D subsidiaries. In this regard, the Company is the creditor under the relevant loan arrangement.

Where a lender (creditor) loans an amount of money to a borrower the debt will be a CGT asset of the lender under section 108-5 of the ITAA 1997. A debt is an intangible CGT asset and is specifically listed as an example of a CGT asset in Note 1 to subsection 108-5(2) of the ITAA 1997.

CGT event C2 in section 104-25 of the ITAA 1997 happens if ownership of an intangible CGT asset ends in certain ways, including, because the asset is satisfied.

Subsection 104-25(2) of the ITAA 1997 provides that the time that CGT event C2 occurs is:

(a) when you enter into the contract that results in the asset ending; or

(b) if there is no contract, when the asset ends.

Operation of section 960-85 of the ITAA 1997 in respect of the cost base of an asset

TR 2007/5, at paragraph 92, provides (through an example) that, in respect of the sale of an asset that is acquired by a taxpayer prior to a functional currency choice by the taxpayer, any capital gain or loss will be calculated in the functional currency chosen. Accordingly, the cost base of the asset acquired in a currency that later becomes the taxpayer's functional currency, is subject to the two step translation process under section 960-85 of the ITAA 1997.

The process involves the translation of the cost base into A$ at the exchange rate prevailing at the time the asset was acquired. The A$ is then translated into the functional currency equivalent at the exchange rate prevailing at the time the choice to use the functional currency takes effect. The resulting functional currency amount is the cost base for the purposes of calculating the capital gain or loss on the disposal of the asset.

In the present circumstances, event C2 will occur at the time the amount lent by the Company is fully repaid by its subsidiaries.

At paragraph 13, TR 96/23 provides that for capital gains tax purposes, the creditors relevant cost base of the asset as defined in former paragraph 160ZH(4) of the ITAA 1936 (subsection 110-25 of the ITAA 1997) is the amount of the debt, i.e. the amount paid by the creditor to the debtor to acquire the asset.

TR 96/23 further provides at paragraph 15 that, if the principal debtor pays the debt in full, the debt is taken by former paragraph 160M(3)(b) (subsection 104-25(1) of the ITAA 1997), to be disposed of by the creditor by way of satisfaction. The consideration received for the disposal is the amount of the debt paid, which is equal to the cost base of the debt.

The cost base of the Company's receivables in the first instance is the currency D amount lent by the Company to its subsidiaries. The cost base is subject to the operation of section 960-85 of the ITAA 1997 at the time of the election by the Company of its applicable functional currency, being currency D. The revised cost base in currency D will be the cost base for the calculation of the capital gain or capital loss when the Company disposes of its debt (asset) through repayment in full by the subsidiaries.

The consideration received by the Company is the amount in currency D of the funds originally lent to the subsidiaries.

Therefore, the Company will make a capital gain or loss for the purposes of section 102-20 of the ITAA 1997 depending on whether the revised cost base (pursuant to the operation of section 960-85 of the ITAA 1997) of the debt is lesser or higher than the consideration received on full repayment of the debt by the subsidiaries..

In conclusion, section 102-5 and section 102-10 of the ITAA 1997, as the case may be, applies on the ultimate repayment of the Company's receivables and to bring to account for income tax purposes any embedded gains or losses calculated under section 960-85 of the ITAA 1997.

Question 7

TR 2007/5 emphasises at paragraph 33 that section 960-85 of the ITAA 1997 applies only to an event or state of affairs that took place in a year of income prior to the effective time of a functional currency choice. Therefore, section 960-85 has no application to an event that happens or a state of affairs that comes into existence after a change to (or a change of) functional currency.

In this regard, section 960-85 of the ITAA 1997 is essentially targeting relevant amounts in existence, and events that have already happened, at the effective time of a functional currency choice. That is, elements in the calculation of post choice amounts of assessable income and allowable deductions, that are 'attributable to an event that happened, or a state of affairs that came into existence at a time before the current choice took effect', are the amounts that are targeted by section 960-85.

In effect, section 960-85 of the ITAA 1997 takes a 'snapshot' of these amounts at one point in time (the effective time of the functional currency choice) - being the date of transition to the 'applicable functional currency'. These amounts are then translated to the 'applicable functional currency' under the two step translation process. It is important to note that, after this point in time, section 960-85 has no further application unless there is a subsequent change in the 'applicable functional currency'.

In the present circumstances, the post functional currency choice repayment of principal amounts, on loans denominated in currency D which later becomes the 'applicable functional currency', are all events that occur following the effective time of the functional currency choice. They are all 'post-choice' events and so give rise to post functional currency choice amounts. As such, these repayments of principal are clearly not subject to the two step translation under subsection 960-85(1) of the ITAA 1997.

Consequently, the 'post -choice' principal repayments by the Company of loans and receipts of principal amounts lent by the Company denominated in currency D, will all be repayments and receipts of amounts that are now in the 'applicable functional currency' of currency D. Thus, these amounts of principal cannot be subject to translation under either subsection 960-80(1) of the ITAA 1997 or section 960-85 of the ITAA 1997.

This conclusion accords with the ATO view contained in ATO ID 2010/70.

Cases / ATO view references

Income Tax Ruling IT 2185

Taxation Ruling 96/23

Taxation Ruling TR 2007/5

Taxation Determination TD 2006/4

ATO ID 2010/59

ATO ID 2010/70

ATO ID 2002/941

ATO ID 2008/58

Federal Commissioner of Taxation v. Hunter Douglas Limited 83 ATC 4562; 50 ALR 97 (1983); 14 ATR 629 (1983)).

Avco Financial Services Ltd v FC of T, 82 ATC 4246; 13 ATR63

Does Part IVA, or any other anti-avoidance provision, 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.

Part IVA may apply where the choice to use a functional currency is made with the sole or dominant purpose of obtaining a tax benefit. Section 177C(2) of the Income Tax Assessment Act 1936 (ITAA 1936) includes the making of a functional currency choice under subdivision 960-D of the ITAA 1997 in the list of exceptions to the general rule that the making of declaration, election, choice etc. will not create a tax benefit.

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'.