Edited version of private advice

Authorisation Number: 1051827343283

Date of advice: 18 October 2021

Ruling

Subject: Functional currency election

Question 1

Can ABC choose to use United States Dollars as its functional currency, pursuant to section 960-60 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the Commissioner apply section 177D of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of ABC choosing United States Dollars as its functional currency?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

30 June 2018

Relevant facts and circumstances

All amounts described below are in United States Dollars (USD) unless otherwise stated.

An individual (X) is a director and shareholder of ABC Pty Ltd (ABC).

X is a citizen of the United States of America and has moved to Australia with Y.

X is taxed as a USA resident because of their USA citizenship. Y has a USA Resident card. Both are taxed as USA residents.

In addition, both X and Y became residents of Australia for tax purposes.

Trust

Before X and Y moved to Australia, they established a trust that was established under US law (Trust).

X and Y are joint trustees and beneficiaries of the Trust.

The Trust is described as a revocable trust and was established as a grantor trust, designed to operate as a living will, so that it would not be necessary for probate to be sought with respect to any of the trusts' assets. X sought tax advice from advisors in relation to a restructure of the arrangement.

Restructure

The purpose of the restructure is to reduce USA gift and estate taxes that X, or their estate, would otherwise be liable for. To achieve this, assets will be transferred to and held in an Australian corporate entity.

X began an arrangement involving the Trust whereby its assets were migrated to ABC.

ABC was registered and became incorporated in Australia, and X became its sole director and shareholder.

ABC issued an additional share to Y such that X and Y became equal shareholders of the company.

The Trust's assets were transferred to ABC. Until this time, ABC remained dormant.

The Trust held solely cash and no other form of investments leading up to the time of transfer. On the day of the transfer, the Trust held cash reserves of in USD. The Trust distributed this amount as a trust distribution to X. At X's direction, this amount was transferred to ABC. A further minor transfer was made for income accrued on the cash reserves in the previous month. With no investments left, the Trust was terminated.

An amount in USD was recorded in the accounts as a "director loan" made by X to ABC.

ABC used the loan from X to acquire assets in the United States.

All accrued income and net realised forex gains derived up to and upon the transfer of assets from the Trust to ABC were subject to tax in Australia. ABC made a functional currency election pursuant to section 960-60 of the ITAA 1997 to use USD as its functional currency. The shareholders provided a direction to ABC to prepare company reports pursuant to section 293 of the Corporations Act 2001 (Cth).

The reasons for ABC's election under section 960-60 of the ITAA 1997 to use USD as its functional currency are as follows:

•         USD is the currency in which all, or predominantly all, of ABC's investments are expected to be denominated;

•         relevant accounting standards allow ABC to keep its accounts in USD;

•         USD is the sole or predominant foreign currency in which it keeps its accounts at the time when it makes the choice; and consequently

•         the adoption of USD under the election would be an administrative/compliance cost saving measure.

It is expected that all income earned from the investments will be accumulated and used by ABC to acquire additional investments. Dividends may be declared to X and Y as ordinary shareholders from time to time, if additional funds are required by them. No dividends were declared in the relevant income years.

Relevant legislative provisions

Section 6 Income Tax Assessment Act 1936

Section 177A Income Tax Assessment Act 1936

Section 177C Income Tax Assessment Act 1936

Section 177CB Income Tax Assessment Act 1936

Section 177D Income Tax Assessment Act 1936

Part IVA Income Tax Assessment Act 1936

Section 960-60 Income Tax Assessment Act 1997

Section 960-65 Income Tax Assessment Act 1997

Section 960-70 Income Tax Assessment Act 1997

Section 960-80 Income Tax Assessment Act 1997

Section 960-85 Income Tax Assessment Act 1997

Section 292 Corporations Act 2001

Section 293 Corporations Act 2001

Reasons for decision

Question 1

Summary

ABC may choose to use USD as its functional currency, pursuant to section 960-60 of the ITAA 1997.

Detailed reasoning

Under item 1 in subsection 960-60(1) of the ITAA 1997, if:

•         a taxpayer is 'an Australian resident who is required to prepare financial reports under section 292 of the Corporations Act 2001'; then

•         they may choose to use the 'applicable functional currency' to 'work out so much of your taxable income or tax loss as is not subject to a choice made by you under any of the other items of this table'.

The term 'resident' is defined in paragraph 6(b) of the ITAA 1936 and it can mean "a company which is incorporated in Australia".

On the facts of this case, ABC will satisfy the requirements of item 1 because:

•         it was registered and became incorporated in Australia; therefore, it is an 'Australian resident'; and

•         it is required to prepare financial reports under section 292 of the Corporations Act 2001 for the following reasons:

-                      the shareholders of ABC directed it to prepare financial reports for the relevant income years, pursuant to section 293 of the Corporations Act 2001.

-                      if a small proprietary company is required to prepare the financial report and directors' report under section 293, it will fall within the scope of subparagraph 292(2)(a) of the Corporations Act 2001. Therefore, ABC is a taxpayer 'who is required to prepare financial reports under section 292 of the Corporations Act 2001'.

ABC chose USD to work out its taxable income or loss. USD was the 'applicable functional currency' referred to in subsection 960-60(1) in this case, as it was the sole or predominant foreign currency in which ABC kept its accounts under subsection 960-70(1) at the time it made the choice.

As ABC satisfies the requirements in item 1 of subsection 960-60(1), it is able to choose to use USD as its 'applicable functional currency' to work out its taxable income or tax loss.

Question 2

Summary

The Commissioner will not apply section 177D of the ITAA 1936 in respect of ABC choosing USD as its functional currency.

Detailed reasoning

Subsection 177D(1) of the ITAA 1936 provides:

This Part applies to a scheme if it would be concluded (having regard to the matters in subsection (2)) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of:

(a)        enabling a taxpayer (a relevant taxpayer) to obtain a tax benefit in connection with the scheme; or

(b)        enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit in connection with the scheme;

whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers.

Broadly, the three key requirements of subsection 177D(1) are:

•         a 'scheme', which is given wide definition in subsection 177A(1);

•         a 'tax benefit in connection with the scheme', as defined in section 177C together with section 177CB; and

•         the requisite purpose, the subject matter of section 177D.

'Scheme' is defined in subsection 177A(1) of the ITAA 1936 to mean:

(a)         any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b)         any scheme, plan, proposal, action, course of action or course of conduct.

In this case, the 'scheme' is the choice exercised by ABC under section 960-60 of the ITAA 1997 to use USD as its applicable functional currency.

Tax benefit

The operation of section 177D depends on the finding that a 'tax benefit' was obtained by a taxpayer in connection with the scheme.

Subsection 177C(1) specifies various kinds of tax benefit associated with a scheme, and they broadly include:

•         an amount not being included in the assessable income of the taxpayer of a year of income;

•         a deduction being allowable to the taxpayer in relation to a year of income;

•         a capital loss being incurred by the taxpayer during a year of income;

•         a loss carry back offset being allowable to the taxpayer in relation to a year of income;

•         a foreign income tax offset being allowable to the taxpayer;

•         an amount of withholding tax not being incurred by the taxpayer in a year of income.

For schemes entered into on or after 16 November 2012, section 177CB must be read in conjunction with section 177C. It clarifies that there are two postulates under which tax benefits under section 177C may arise:

1)    the first comprises all of the events or circumstances that actually happened or existed other than those forming part of the scheme;

2)    the second is a reasonable alternative to the scheme, having regard to the substance of the scheme and its effect for the taxpayer, but disregarding any potential tax costs.

The scheme in the present case comprises solely the exercise of the choice by ABC under section 960-60 of the ITAA 1997 to use USD as its applicable functional currency.

The exercise of this choice is not excluded from the operation of section 177C by the exceptions contemplated under subsection 177C(2), which confirms that a choice made pursuant to Subdivision 960-D of the ITAA 1997 may still be regarded as conferring a 'tax benefit' where the relevant conditions are satisfied.

The question is therefore whether the scheme as defined in this case - being the mere exercise of the choice, without more - would give rise to a tax benefit for ABC.

Broadly, under section 960-80 an entity that has exercised the choice to use an applicable functional currency is required to:

•         translate their currency amounts into the applicable functional currency; and then

•         translate an annual net amount from the applicable functional currency to Australian currency, for the purpose of calculating income tax payable.

It is noted that, in this case, the exercise of the choice under section 960-60 will also bring in the operation of the special translation rule in section 960-85. Very generally, under this provision as applied to the present case:

•         The purchase price of the asset must be converted into Australian dollars at the exchange rate applicable to the date on which the purchase was made.

•         This amount must again be converted, this time into USD, at the exchange rate on the day 'the current choice took effect'.

The resulting amount is the (recalculated) cost base of the asset in USD. In very general terms, this process, as described in the EM to New Business Tax System (Taxation of Financial Arrangements) Bill (No. 1) 2003 at paragraph 3.84:

'ensures that any unrealised gain or loss at the time of the election is made, does not escape taxation simply because the election is made. Such an unrealised gain or loss is not brought to account at the time of the choice taking effect but will be brought to account when the asset is ultimately realised. The unrealised gain or loss could be either increased or reduced prior to realisation because of changes in value occurring after the time that the choice takes effect...'

The provision ensures that the choice to use an applicable functional currency is effectively tax neutral: see TR 2007/5: Income tax: functional currency - when is an amount not in the 'applicable functional currency'?

This does not mean that a tax benefit may never be said to arise from the making of a choice under section 960-60: where a scheme involves, for example, other mechanisms that collude to create a tax advantage, the exercise of the choice may well be considered to be instrumental to the production of the relevant identified tax benefit.

However, in the ordinary case such as that of the present, and in the absence of any additional elements in the scheme as defined in this ruling, the effect of the exercise of the choice is neutral. As noted in the EM above, ''the unrealised gain or loss could be either increased or reduced prior to realisation because of changes in value occurring after the time that the choice takes effect''.

Similarly, the tax treatment of the future purchase, holding and sale of investments by ABC following the exercise of the choice under section 960-60, does not - of itself - attract the operation of section 177C. However, again, this does not mean that the anti-avoidance provisions are precluded from applying, in specific cases as they arise in the future, on the basis of the individual circumstances pertaining to a particular asset when it is acquired, used and sold.

As no tax benefit arises from the scheme as defined in this case, section 177D does not apply.