Edited version of your private ruling

Authorisation Number: 1012532321670

Ruling

Subject: Functional currency

Question 1

Should the allocable cost amount (ACA) calculation for Company N, and the allocation of this ACA to the assets of Company N at the time it joins the Company L income tax consolidated group, be performed in Australian dollars (AUD) with the resulting tax cost setting amounts being translated to the foreign currency (ForC) in accordance with Subdivision 960-D thereafter?

Answer

Yes.

Question 2

On the basis that the tax cost setting amounts for the assets of the Company N are to be worked out in Australian dollars, is the exchange rate that applied at the time Company N joined the Company L income tax consolidated group the appropriate rate to translate these AUD asset tax cost setting amounts to their ForC equivalent?

Answer

Yes.

Relevant facts and circumstances

Company L is the head company of an income tax 'consolidated group' which made a choice under subsection 960-60(1) of Subdivision 960-D of the Income Tax Assessment Act 1997 (ITAA 1997) to use ForC as its applicable functional currency for income tax purposes.

Company M is a subsidiary member of the Company L tax consolidated group.

Subsequently, Company M acquired all of the shares in Company N. Prior to acquisition, Company N was the head company of an income tax consolidated group and had not made a subsection 960-60(1) choice to use a foreign currency as its applicable functional currency to work out its taxable income or tax loss.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-90
Income Tax Assessment Act 1997 Section 701-5
Income Tax Assessment Act 1997 Subsection 701-10(4)
Income Tax Assessment Act 1997 Subsection 705-25(5)
Income Tax Assessment Act 1997 Section 701-55
Income Tax Assessment Act 1997 Subsection 701-55(2)
Income Tax Assessment Act 1997 Subsection 701-55(6)

Income Tax Assessment Act 1997 Subdivision 705-C

Income Tax Assessment Act 1997 Subdivision 960-C
Income Tax Assessment Act 1997 Subdivision 960-D
Income Tax Assessment Act 1997 Subsection 960-50(6)
Income Tax Assessment Act 1997 Subsection 960-60(1)
Income Tax Assessment Act 1997 Subsection 960-80(1)
Income Tax Assessment Act 1997 Subsection 960-80(2)
Income Tax Assessment Act 1997 Subsection 960-80(4)
Income Tax Assessment Act 1997 Subsection 960-80(6)
Income Tax Assessment Act 1997 Section 960-85

Reasons for decision

All legislative references are to provisions of the Income Tax Assessment Act 1997 unless specified otherwise.

Question 1

Summary

Company L is required to work out the ACA of the Company N group and allocate this ACA to the assets of the group in AUD. If any of the amounts in respect of the 7 ACA steps (listed at section 705-60) are required to be translated into AUD for the purpose of working out the total ACA of the Company N group, then these amounts must be translated to AUD using the exchange rate applying at joining time.

Once the tax cost setting amount of each of the assets of the Company N group has been worked out (under Division 705) in AUD, Company L is then required to translate the resulting AUD amount to ForC for the section 701-55 purpose of using the tax cost setting amount for its income tax core purposes. This is because Company L is a ForC functional currency taxpayer, and subsection 960-80(1) of Subdivision 960-D requires that all amounts that are not in the 'applicable functional currency' must be translated to this currency. In translating the AUD asset tax cost setting amounts to ForC (for section 701-55 and subsection 960-80(1) purposes), Company L must use the same exchange rate as that used to translate any Division 705 ACA step amounts from ForC to AUD.

Detailed reasoning

Preliminary

Section 715-660 Head Company's choice overriding entry history rule

On joining the Company L income tax consolidated group, Company N became subject to Company L's choice (in its capacity as head company) pursuant to subsection 960-60(1) to use ForC as its functional currency for tax purposes. [This is in accordance with the single entity rule (SER) in section 701-1 and the direction in section 715-660. Section 715-660 provides that when an entity joins a tax consolidated group, certain specified choices the entity previously made are not inherited by the acquiring head company under the entry history rule. Nor is the failure to make such a choice inherited. Included in these choices [per Item 3 of the table in subsection 715-660(1)], is a choice under Item 1 of the table in subsection 960-60(1) to use an applicable functional currency.]

The Division 705 process

On joining a tax consolidated group, the tax cost setting amount of the assets of Company N are worked out under Division 705 by first calculating the ACA for Company N and then allocating the ACA to its retained cost base assets and its reset cost base assets. When one consolidated (or MEC) group is acquired by another consolidated (or MEC) group, the Division 705 process is modified by Subdivision 705-C to treat the acquired consolidated group as if it were a single entity joining the consolidated group.

The Division 705 entry ACA calculation is based broadly on the amount paid by the Company L income tax consolidated group through Company M to acquire all the shares in Company N (Step 1), plus the cost to the Company L group of assuming the accounting liabilities of Company N (Step 2), plus where relevant any taxed retained (undistributed) profits of Company N that accrued to the Company L group prior to the joining time [plus or minus a number of other adjustments (Steps 4 to 7)].

Reasoning

The issue in respect of Question 1 is essentially whether a Subdivision 960-D choice made by Company L as head company of a tax consolidated group to use ForC as its applicable functional currency, applies for the purpose of Division 705.

The functional currency rules in Subdivision 960-D are an exception to the core translation rule or principle in subsection 960-50(1) that for the purposes of this Act, an amount in a *foreign currency is to be translated into Australian currency. The object of the functional currency rules is to reduce compliance costs and to reflect commercial practices by allowing certain entities, whose accounts are kept solely or predominantly in a particular foreign currency (the functional currency), to work out their taxable income or tax loss for an income year in their (chosen) functional currency, refer to the respective Item 1s of the tables in subsections 960-60(1) and 960-80(1). This taxable income or tax loss is then translated into Australian currency [using an exchange rate specified in the regulations, per subsection 960-80(7)].

A consequence of making a Subdivision 960-D functional currency choice is that the applicable functional currency is taken not to be foreign currency, and Australian currency is taken to be a foreign currency [refer Item 1 of subsection 960-80(1) and subsection 960-80(6)].

It is noted that a choice made under Item 1 of subsection 960-60(1) being for the purpose of working out the taxable income or tax loss for an income year, meets the respective definitions of the head company core purposes and entity core purposes; subsections 701-1(2) and (3). Such a choice, where made by the head company of the group, will therefore apply to all the subsidiary members of that group in accordance with the section 701-1 single entity rule (SER) and section 715-660.

If the Subdivision 960-D ForC functional currency choice of the head Company L applies for the purpose of Division 705, this would arguably require the entry ACA of the joining entity (each of the seven steps listed at section 705-60) to be worked out in ForC. It would also arguably require the subsection 705-25(5) definition of a retained cost base asset to be applied on the basis the assets of the joining entity are already subject to the ForC choice of the head company [noting the assets will be subject to the ForC choice in the hands of the Company L after joining time pursuant to section 715-660 and the section 701-1 single entity rule (SER)].

As a Subdivision 960-D functional currency choice of the head company applies for the purpose of the SER [i.e. applies for the purpose of working out the income tax liability of Company L], the issue in respect of Question 1 depends on whether the Division 705 process may be said to also come within the scope of the section 701-1 single entity rule (SER) or, more specifically, whether the Division 705 ACA working out and allocation process forms part of the working out the amount of the liability (if any) for income tax or a tax loss (if any) of the head company.

When an entity becomes a subsidiary member of a tax consolidated group, section 701-10 applies for the head company's income tax (core) purposes to require the tax cost setting amount of the assets of the entity to be worked out under Division 705 and to then use the tax cost setting amount worked out for each asset under Division 705 for the head company's core purposes under section 701-55; refer subsection 701-10(4). Although Division 705 may (on first glance) appear to come within the scope of the SER, subsection 701-10(2) provides as follows:

This section applies in relation to each asset that would be an asset of the entity at the time it becomes a subsidiary member of the group, assuming that subsection 701-1(1) (the single entity rule) did not apply. (Emphasis added).

The direction in subsection 701-10(2) is a direction to apply Division 705 on the basis that the SER does not apply. It means the Division 705 process is outside the scope of the SER. Although the main role of subsection 701-10(2) is to ensure assets that 'become intra-group' under the SER receive tax cost setting amounts under Division 705, it confirms that the tax cost setting process is carried out without regard to the SER. If the SER does not apply in respect of the Division 705 process, then it also means the Subdivision 960-D functional currency choice of Company L does not apply in respect of this process. The direction in subsection 701-10(2) means the ACA of the joining entity, Company N, is to be worked out in AUD (and not ForC). It also means the subsection 705-25(5) definition of a retained cost base asset is to be applied to the assets of the Company N on the basis of how the assets are held by the Company N group (for its income tax purposes) at the joining time - and not on the basis of how the assets are to be held by Company L after joining time (noting these AUD assets will be held as foreign currency assets by Company L after joining time pursuant to section 715-660 and the SER).

Further, where applicable, carrying out the ACA process in AUD enables the proper application of section 705-90 (Step 3 of the ACA). Section 705-90 provides the formula to calculate the amount of the undistributed taxed profit to be added at step 3. The undistributed taxed profit is calculated based on the franking account balance at the joining time. As the franking account of a company is always accounted for in AUD, it is appropriate that the ACA process is only carried out in AUD.

Taxation Determination TD 2005/22 addresses the situation where the joining entity (rather than the head company) has made the Subdivision 960-D choice. The specific issue in TD 2005/22 is whether the tax costs of the AUD assets (for example AUD bank accounts, receivables, debts, loans) that are held by the joining entity (pursuant to its Subdivision 960-D choice) as foreign currency assets, must be set as Australian currency and a right to receive a specified amount of Australian currency as retained cost base assets as defined in paragraphs 705-25(5)(a) and (b) of Division 705. The TD, at paragraph 6 implies that the tax costs of the AUD assets of the joining entity must be set as retained cost base assets:

While Australian currency is taken to be foreign currency for the purposes of applying the functional currency provision, that deeming effect does not extend beyond those purposes to affect the application of the consolidation provisions.

Question 2

Detailed reasoning

With regard to Question 1 (above) we have advised that, once the tax cost setting amounts of the assets of Company N have been worked out (under Division 705) in AUD, then Company L is required to translate the AUD amounts to ForC for the section 701-55 purpose of using the tax cost setting amount for Company L's income tax core purposes. We have also advised that, in translating the AUD asset tax cost setting amounts to ForC (for section 701-55 purposes), Company L must use the same exchange rate as that used to translate any of the Division 705 ACA step amounts from ForC to AUD.

The requirement to translate the AUD tax cost setting amounts into ForC using the exchange rate applying at joining time (this being the same exchange rate as that used to translate any of the Division 705 ACA step amounts from ForC to AUD), is provided for by Item 11A of the table in subsection 960-50(6) (added to the table by Regulation 960-50.01) in combination with section 701-55.