Edited version of your private ruling

Authorisation Number: 1012454062541

Ruling

Subject: Taxation of Financial Arrangement - Hedging Financial Arrangement

Recording requirements and determining basis for allocating gain or loss in respect of Hedging Financial Arrangements pursuant to Subdivision 230-E of the Income Tax Assessment Act 1997 (’ITAA 1997’)

Question 1

Will the proposed hedging process satisfy the recording requirements in subsections 230-355(1) and (4) of the ITAA 1997?

Answer

Yes

Question 2

For the purpose of section 230-360 of the ITAA 1997, will the basis proposed to be adopted by Fund X for the allocation of hedging gains and losses from forward foreign exchange contracts (FFX gains and losses) satisfy the requirements in subsection 230-360(2) of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

01/07/20XX to 30/06/20XX.

Relevant facts and circumstances

Background

Fund X is an Australian resident unit trust, with units listed on the Australian Securities Exchange. (ASX)

Fund X will invest in units in another unit trust, Fund Y and hold forward foreign exchange contracts (FFX).

Fund Y is an Australian resident unit trust with units listed on the ASX. It invests in a portfolio of international equities.

Fund X uses FFX contracts to hedge the foreign currency risk arising from its unit holding in Fund Y.

The FFX contracts will be designated from inception as hedges for accounting purposes.

Hedging process

Fund X hedges the underlying currency exposures by entering into FFX contracts. The hedge is rebalanced regularly so that the exposure to AUD is at a predetermined percentage of the Net Asset Value.

Where a FFX gain is realised, the funds are applied towards the purchase of additional units in Fund Y (to the value of the FFX contract gain). Where there is an FFX loss, units in Fund Y are redeemed to fund that loss.

Units in Fund Y may be either sold on the ASX, or redeemed in accordance with the constitution of Fund Y.

Fund X will make a taxation of financial arrangement (TOFA) hedging financial arrangement election under subsection 230-315(1) of the ITAA 1997 in respect of all Fund X’s financial arrangements that are treated as hedges for accounting purposes in relevant income years.

Fund X prepares financial statements.

The financial statements will be prepared in accordance with the accounting principles, and audited in accordance with the auditing principles.

Both the units in Fund Y, and the FFX contracts, will appear in the audited financial statements of Fund X. The FFX contracts will satisfy the requirements of the accounting principles to be a hedging instrument, and will be recorded as a hedging instrument in the audited financial statements of Fund X.

Other information

The applicant advises that the FFX contracts will satisfy the primary definition of ‘hedging financial arrangements; pursuant to subsection 230-355(5) of the ITAA 1997 and will be recorded as hedging instrument in the financial reports of Fund X.

The ’hedged item’ for the purpose of subsection 230-335(10) of the ITAA 1997 is the Australian dollar denominated units held in Fund X.

Assumptions

Division 230 of the ITAA 1997 will apply to Fund X.

The hedging financial arrangement election under Subdivision 230-E of the ITAA 1997 will be valid.

The FFX contracts designated as hedges for accounting purposes will be highly effective for accounting purposes, and will satisfy the hedge effectiveness requirements in section 230-365 of the ITAA 1997.

Fund X will not make an assessable capital gain under CGT Event E4, pursuant to section 104-70 of the ITAA 1997.

Fund X will qualify as an eligible Management Investment Trust and will make the election for deemed capital treatment under Division 275 of the ITAA 1997.

The proposed hedge accounting approach is in full compliance with AASB 139 Financial Instruments: Recognition and Measurement.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 230-E

Income Tax Assessment Act 1997 Section 230-315

Income Tax Assessment Act 1997 Subparagraph 230-260(2)(c)(i),

Income Tax Assessment Act 1997 Subparagraph 230-260(2)(c)(ii),

Income Tax Assessment Act 1997 Subsection 230-310(4)

Income Tax Assessment Act 1997 Subsection 230-315(1)

Income Tax Assessment Act 1997 Section 230-325

Income Tax Assessment Act 1997 Section 230-335(10)

Income Tax Assessment Act 1997 Section 230-355

Income Tax Assessment Act 1997 Subsection 230-355(1)

Income Tax Assessment Act 1997 Subsection 230-355(4)

Income Tax Assessment Act 1997 Subparagraph 230-355(1)(a)(i)

Income Tax Assessment Act 1997 Subparagraph 230-355(1)(a)(ii)

Income Tax Assessment Act 1997 Subparagraph 230-355(1)(a)(iii)

Income Tax Assessment Act 1997 Subparagraph 230-355(1)(a)(iv)

Income Tax Assessment Act 1997 Subparagraph 230-355(1)(a)(v)

Income Tax Assessment Act 1997 Paragraph 230-355(1)(b)

Income Tax Assessment Act 1997 Paragraph 230-355(1)(c)

Income Tax Assessment Act 1997 Subsection 230-355(3)

Income Tax Assessment Act 1997 Subsection 230-355(5)

Income Tax Assessment Act 1997 Section 230-360

Income Tax Assessment Act 1997 Paragraph 230-360(2)(a)

Income Tax Assessment Act 1997 Paragraph 230-360(2)(b)

Income Tax Assessment Act 1997 Paragraph 230-360(2)(c)

Income Tax Assessment Act 1997 Section 230-365

Acts Interpretation Act 1901 Section 25

Reasons for decision

Unless otherwise indicated references to legislative provisions are to the Income Tax Assessment Act 1997

Question 1

Summary

The proposed hedging process will satisfy the recording requirements in subsections 230-355(1) and (4).

Reasoning

Recording requirements – documentation of the hedging relationship

1. Section 230-355 sets out the recording requirements that a hedging financial arrangement must satisfy in order for the hedging financial arrangement election to apply to it.

2. Section 25 of the Acts Interpretation Act 1901 provides, inter alia, that “record” includes information stored or recorded by means of a computer.

3. In the present case, the applicant advises that the risk management objective and strategy of Fund X, including the nature of the risk being hedged, is explicitly stated in the documentation.

4. The documentation states the ’the objective of the hedge program is to negate the impact of currency fluctuation from unit holdings in Fund Y’.

5. The FFX contracts are entered into to hedge Fund X’s exposure to the currency fluctuations as reflected in the unit price of the units held by Fund X in Fund Y.

6. The documentation provides that Fund X is to prospectively assess the proposed hedging effectiveness by matching the notional value of the FFX to the market value of Fund Y with Foreign Exchange Exposures on a currency by currency basis.

7. The applicant advises that a schedule outlines the process of Fund X for entering into and recording the risk management objective and strategy of Fund X’s hedging financial arrangements.

8. Having regards to the relevant documentation, it is considered that Fund X will satisfy the recording requirements in subsection 230-355(1).

9. Fund X will also satisfy the recording requirements in subsection 230-355(4) as the documentation specifically state that the risk in respect of the hedged item was hedged by the hedging financial arrangement, the extent to which the risk was hedged, and that the rights and obligations comprising the hedging financial arrangement were created, acquired or applied for the purpose of hedging the risk.

Question 2

Summary

The basis proposed to be adopted by the Fund for the allocation of hedging gains and losses from forward foreign exchange contracts (’FFX gains and losses’) will satisfy the requirements in subsection 230-360(2).

Reasoning

1. Before assessing whether the requirements of section 230-360 have been satisfied, it is necessary to establish that Subdivision 230-E otherwise applies, namely:

· That the FFX contract is a hedging financial arrangement for section 230-335 purposes.

· That Subdivision 230-E election applies to the FFX contract as required by section 230-325

· Finally, that the requirements of section 230-360 are satisfied.

Section 230-335

2. The FFX contract will be a hedging financial arrangement as defined under section 230-335, for the following reasons:

· The ‘hedged item’ for subsection 230-335(10) purposes in this case is an asset, the unit in Fund Y, which is recognised in the financial statement of Fund X.

· The FFX contract is a ‘derivative financial arrangement’ as defined by subsection 230-350(1), which has been acquired for the purpose of hedging a risk in relation to a hedged item (paragraph 230-335(1)(a)).

· The FFX contract, as it appears in the financial statement, satisfies the requirements of AASB 139 to be a hedging instrument, and is recognised in the financial statement as a hedging instrument (paragraph 230-335(1)(b) and 230-335(c)(i)).

Section 230-325

3. The FFX contract, which satisfies the definition of hedging financial arrangement, is an hedging financial arrangement to which the Subdivision 230-E election applies pursuant to s 230-325, as:

· Fund X starts to have the arrangement in an income year in which it makes the election, or a later income year.

· The requirements in sections 230-355 and 230-365 are satisfied.

.This is subject to the satisfying the requirements of s 230-360, as addressed below.

Section 230-360

4. Fund X has made a determination setting out the basis for allocating gains/losses from the FFX contract (subsection 230-360(1)).

5. It is considered the basis of allocation set out in the determination fairly and reasonably corresponds with the basis on which gains, losses or other amounts in relation to the hedged item are recognised under the ITAA 1997 for paragraph 230-360(2)(b) purposes.

6. It is considered the basis of allocation is objective for paragraph 230-360(2)(b) purposes. The basis of allocation is comprehensively set out in the determination. There is little to no discretion to alter or amend gains/losses allocated to recognition events, and the basis of allocation applies to all recognition events relating to the hedged risk with a view to ensuring the matching principle of Subdivision 230-E is satisfied.

7. Finally, the record made under section 230-355 is sufficiently clear for paragraph 230-360(2)(c) purposes.

8. As such, the requirements of section 230-360 and subsection 230-360(2) in particular, are satisfied.