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Ruling

Subject: Income tax - Foreign exchange losses - Foreign bank account

Question 1:

Are foreign exchange losses in relation to your foreign bank account considered to be on capital account?

Answer:

No.

Question 2:

Are foreign exchange losses in relation to your foreign bank account considered to be on revenue account?

Answer:

Yes.

Question 3:

Are you entitled to a deduction for foreign exchange losses incurred in the 2007-08 income year?

Answer:

Yes.

This ruling applies for the following period:

2007-08 income year

The scheme commences on:

1 July 2007

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.

You are a citizen of a foreign country.

You came to Australia travelling on a temporary working Visa.

You later became permanent resident of Australia when you obtained a permanent residency visa.

You were a temporary resident prior to becoming a permanent resident.

You had sold your foreign property (your residence) just after you arrived in Australia.

The proceeds were kept in your interest bearing foreign denominated savings account.

The balance of the foreign bank account at the time you became a permanent resident of Australia was (amount specified in foreign and Australian currency).

Some months later, you transferred some of this amount to an Australian foreign currency account denominated in the same currency. The exchange rates meant that the Australian dollar value of the amount transferred was (amount specified in Australian currency). Your foreign bank account was then closed.

A little later, some funds were withdrawn and used to pay the deposit on a house (amount specified in foreign and Australian currency).

One month later, further funds were withdrawn and used to offset the new mortgage (amount specified in foreign and Australian currency).

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1,

Income Tax Assessment Act 1997 Subdivision 11-B,

Income Tax Assessment Act 1997 Section 11-55,

Income Tax Assessment Act 1997 Section 108-5,

Income Tax Assessment Act 1997 Subdivision 768-R,

Income Tax Assessment Act 1997 Section 768-910,

Income Tax Assessment Act 1997 Section 768-955,

Income Tax Assessment Act 1997 Division 775,

Income Tax Assessment Act 1997 Section 775-30,

Income Tax Assessment Act 1997 Section 775-45,

Income Tax Assessment Act 1936 Section 26BB,

Income Tax Assessment Act 1936 Section 70B and

Income Tax Assessment Act 1936 Section 159GP.

Reasons for decision

Questions 1 and 2

Summary

Foreign exchange losses in relation to your foreign bank account are considered to be on revenue account and not capital account.

Detailed reasoning

The traditional securities provisions and the foreign exchange (forex) measures can both apply to foreign currency denominated bank accounts.

The traditional securities provisions

The term 'security' as defined at subsection 159GP(1) of the Income Tax Assessment Act 1936 (ITAA 1936) includes deposits with banks, building societies and other financial institutions.

These securities are then further categorised on the basis of them paying amounts other than periodic interest (their 'eligible return') into:

· Qualifying securities - those having eligible returns above a specified threshold, and

· Traditional securities - most other securities held by normal investors.

Your foreign bank account was a traditional security as it did not have an eligible return and met all of the other relevant criteria.

Taxation Ruling TR 96/14 makes the following statements in concluding that gains and losses on traditional securities are made on revenue account:

21. … sections 26BB and 70B are primarily concerned with the characterisation of certain receipts and losses as assessable income or allowable deductions.

22. It was intended that sections 26BB and 70B would apply upon the disposal or redemption of a security to gains and losses attributable to changes in the value of the security due to movements in interest rates or other market adjustments. In one sense the gain or loss due to those changes is the equivalent of a return on funds invested, the return being of a revenue nature.

Sections 26BB and 70B of the ITAA 1936 only apply when you redeem or dispose of a traditional security. These sections do not apply to withdrawals from a continuing traditional security. When denominated in Australian currency, there isn't a gain or loss due to a withdrawal from a continuing traditional security, however, foreign currency fluctuations can cause gains or losses in relation to a foreign currency denominated traditional security.

The forex measures

The forex measures of Division 775 of the Income Tax Assessment Act 1997 (ITAA 1997) cover both foreign currency denominated arrangements, and also, broadly, arrangements to be cash-settled in Australian currency with reference to a currency exchange rate.

Some forex gains and losses of a private or domestic nature, or relating to exempt income or non-assessable non-exempt income, will not be taken into account under the forex measures.

The Explanatory Memorandum to the New Business Tax System (Taxation of Financial Arrangements) Bill (No 1) 2003 (the EM) includes a table that provides an outline of the main differences between the law that applied before the start of the 2003-04 income year and the new forex measures.

The table includes references to where a foreign currency gain or loss arising upon the acquisition or realisation of a capital asset is not automatically embedded in another gain or loss calculation (e.g. CGT or Division 40), it is generally recognised on revenue account.

The EM further clarifies at paragraph 2.10

'The general principle is that foreign currency gains are included in an entity's assessable income, and foreign currency losses are deductible. Gains and losses of this nature are treated as being on revenue account. Where they are brought to account under Division 775, they are referred to as 'forex realisation gains' and 'forex realisation losses' '

Effectively, the forex measures adopt the same principle as the traditional securities provisions in treating foreign currency fluctuations as a component of any return on your investment and therefore being on revenue account.

Generally, the forex measures will apply in precedence to the traditional securities provisions.

Question 3

Summary

You are entitled to a deduction for foreign exchange losses incurred in the 2007-08 income year.

Detailed reasoning

Section 8-1 of the ITAA 1997 provides that you can deduct any loss or outgoing to the extent that it was incurred in producing your assessable income. However paragraph 8-1(2)(c) of the ITAA 1997 provides that you cannot deduct a loss or outgoing to the extent that it is incurred in relation to gaining or producing your 'exempt income ' or 'non-assessable non-exempt income'.

Subdivision 11-B of the ITAA 1997 lists particular kinds of non-assessable non-exempt income at section 11-55 of the ITAA 1997 to include foreign aspects of taxation including income derived by temporary residents in respect of section 768-910 of the ITAA 1997.

You arrived in Australia on a temporary Visa and you became an Australian resident for income tax purposes soon thereafter.

On 6 April 2006 changes to Australian income tax legislation became effective in regard to temporary residents.

You become and are a temporary resident if:

· you hold a temporary visa granted under the Migration Act 1958

· you are not an Australian resident within the meaning of the Social Security Act 1991, and

· your spouse (if applicable) is not an Australian resident within the meaning of the Social Security Act 1991.

The new legislation sought to treat temporary residents more like non-residents for tax purposes on certain aspects of their world wide income. If you were a resident of Australia for tax purposes and meet the definition of a temporary resident, the changes meant the following:

· Most of your foreign income is non-assessable non-exempt income (although individuals who earn income from employment performed overseas for short periods while a temporary resident are generally subject to tax in Australia on that income).

· Capital gains and losses made from the disposal of assets that are not taxable Australian property are disregarded for Australian tax law purposes (although an exception applies to certain gains on shares and rights acquired under employee share schemes).

· Interest you pay to foreign residents (for example, foreign lenders) is not subject to withholding tax.

· Controlled foreign company and foreign investment fund record keeping obligations are partly removed.

The amendments introduced Subdivision 768-R of the ITAA 1997 and applied for income years that began on or after 1 July 2006.

You have enjoyed the benefits of the temporary residents exemption provided by Subdivision 768-R of the ITAA 1997 - temporary residents from the introduction of the provision in 2006.

You subsequently ceased to be a temporary resident and became a permanent resident of Australia and subject to operative provisions of the Australian Income tax legislation applicable to Australian residents.

Application of Foreign Exchange Rules:

Forex realisation event 2

Subsection 775-30(1) of the ITAA 1997 provides that you can deduct a forex realisation loss you make as a result of a forex realisation event that happens during the year.

Subsection 775-30(2) of the ITAA 1997 provides for exemptions to deduction if:

(a) it is a loss of private and domestic nature

(b) it is not covered by an item in the table.

The table includes a forex realisation event 2. A forex realisation event 2 is considered at section 775-45 of the ITAA 1997.

A forex realisation event 2 occurs when you cease to have a right or part of a right to receive foreign currency. A right to receive foreign currency includes an amount of Australian currency that is calculated in reference to an exchange rate.

You had the right to receive the balance of funds in the foreign bank account, (a right to receive a certain amount of foreign currency) as per subparagraph 775-45(1)(b)(iii) of the ITAA 1997. Part of your right to receive foreign currency ceased with each withdrawal from your foreign bank account or your Australian foreign currency denominated bank account.

As previously stated, on (specified date) you ceased to be a temporary resident and became a permanent resident of Australia and subject to operative provisions of the Australian income tax legislation applicable to Australian residents. Exemptions provided to temporary residents no longer apply to you.

The effect on you when you ceased to be a temporary resident and became an Australian resident is that you were taken to have acquired assets (Section 108-5 of the ITAA 1997 provides an example of a CGT asset to include foreign currency, other than those acquired before 20 September 1985) that are not taxable Australian property for the market value at the time you ceased being a temporary resident as per sections 768-955(1) and (2) of the ITAA 1997.

When you became an Australian resident, your foreign bank accounts were recognised as assets that are subject the foreign exchange rules of Division 775 of the ITAA 1997.

On that date, you had a right to receive foreign currency from your foreign bank account holding a balance of (amount specified in foreign and Australian currency).

Some months later, you closed your foreign bank account and transferred (amount specified in Australian currency) to an Australian foreign currency denominated bank account. The balance of this account has been reduced by subsequent withdrawals and currency conversions to AUD.

A little later, you ceased to have a right to some foreign currency by the conversion of the foreign currency amount into Australian dollars.

One month later, you ceased to have a right to more foreign currency by the conversion of the foreign currency amount into Australian dollars.

When an amount is withdrawn from a foreign currency denominated bank account or exchanged for Australian dollars, the right to acquire that equivalent amount of foreign currency is extinguished.

You make a forex realisation loss to the extent the value of the foreign currency you receive when each forex event happens is less the forex cost base of the right measured at the tax recognition time because of a currency exchange effect (subsection 775-45(4) of the ITAA 1997).

Tax recognition time is defined at Item 5 of the table in subsection 775-45(7) of the ITAA 1997, when the amount is paid (deposited into the foreign currency denominated bank account).

In applying the First in First out method of calculation the starting balance will be the balance of the foreign bank account converted into Australian dollars in reference to the exchange rate on the day you became an Australian permanent resident (the market value).

You will have to perform forex calculations as a result of each of the forex realisation events identified above. You will also have to perform forex calculations at the time of any other forex realisation events in relation to your foreign currency denominated bank accounts.

We note that at the time you became an Australian resident, the balance in your foreign bank account was (amount specified in foreign currency) and you have identified withdrawals totalling (lesser amount specified in foreign currency) leaving a shortfall. This shortfall (plus any interest credited to your foreign currency denominated bank accounts) must also be factored into the calculation of your foreign exchange loss for the 2007-08 income year.