Edited version of private advice

Authorisation Number: 1051864293644

Date of advice: 14 July 2021

Ruling

Subject: Source of foreign exchange hedging gains

Question

Will foreign currency hedging gains arising from transactions entered into by Hedge Manager Co, on behalf of Entity A, with Liquidity Co, as the liquidity provider, on the basis of the terms of the arrangement between Hedge Manager Co and Liquidity Co, have an Australian source for the purposes of subparagraph 770-75(4)(a)(ii) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period:

XXX to XXX

The scheme commences on:

XXX

Relevant facts and circumstances

1.            Entity A seeks to manage foreign exchange risk by entering into hedging transactions. As part of this program, Entity A undertakes foreign exchange (FX) hedging on an overlay basis to hedge its currency exposure in relation to its portfolios of foreign assets.

2.            Hedge Manager Co is the primary hedge manager acting on behalf of Entity A.

3.            Hedge Manager Co uses a number of liquidity providers, including Liquidity Co.

4.            Hedge Manager Co acts as Entity A's agent in forming all relevant FX hedging contracts with Liquidity Co.

5.            Entity A and Liquidity Co have entered into an International Swaps and Derivatives Association agreement (Master ISDA).

6.            Liquidity Co has its head office located in Australia (Australian office).

7.            Liquidity Co undertakes all its FX transactions at or through its Australian office and each trade is executed by a representative of Liquidity Co who is located at Liquidity Co's Australian office.

8.            The parties communicate using a variety of media. Most trades are undertaken using a trading platform which contains an instant messaging function. From time to time, other electronic methods of communication may be used.

9.            The trading platform used provides a view of the relevant financial information and the ability for Hedge Manager Co and Liquidity Co to communicate the details of the proposed trade, including parties to the contract, time of the contract and the offer and acceptance of the contract.

10.         Hedge Manager Co will request through the trading platform for an FX trade to be executed. Hedge Manager Co (as Entity A's agent) accepts the margins being offered by Liquidity Co both through accepting within the trading platform, and verbally accepting via the trading platform's instant messaging system.

11.         Liquidity Co, as the liquidity provider, through its Australian office performs all FX trades for Hedge Manager Co based on instructions received from Hedge Manager Co. There is no 'last look clause' in the trades executed between Hedge Manager Co and Liquidity Co. That is, neither the Master ISDA nor the rules governing the use of the trading platform contain a clause the effect of which allows Liquidity Co to refuse to act on any instruction from Hedge Manager Co.

Relevant legislative provision

Income Tax Assessment Act 1997 subparagraph 770-75(4)(a)(ii)

Reasons for decision

In this Reasons for Decision, unless otherwise indicated, all legislative references are to the ITAA 1997.

Overview of Division 770

The rules relating to foreign income tax offsets (FITOs) are contained in Division 770. FITOs provide relief from double taxation that may arise where foreign tax is paid on an amount which is also taxable in Australia. The FITO rules allow a taxpayer to claim a FITO where they have paid foreign tax on amounts which are also included in their assessable income.

The amount of the FITO will be the amount of foreign income tax paid, subject to the FITO limit worked out under section 770-75. The FITO limit essentially limits the offset to the amount of Australian tax otherwise payable on the net foreign income (or other amounts in respect of which a taxpayer has paid foreign income tax) included in assessable income. Therefore, determining the source of FX hedging transactions is essential in calculating the FITO limit.

Source of FX hedging gains

Taxation Ruling TR 2014/7 Income Tax: foreign currency hedging transactions - applying the foreign income tax offset limit under section 770-75 of the Income Tax Assessment Act 1997 (TR 2014/7) provides at paragraph 13:

While the source of income will always depend on the particular facts and circumstances, for the transactions the subject of this Ruling, the place where each foreign currency hedging contract is formed is the most important element in determining the source of any resulting foreign currency hedging gain.

In Appendix 1 to TR 2014/7 it is stated at paragraph 101:

Absent express or implied terms to the contrary, a contract is formed where the communication of the acceptance is received.

The trading platform is a dedicated channel evidencing the interactions and wishes of buyers and sellers undertaking an FX transaction and is used by Hedge Manager Co and Liquidity Co to execute FX trades.

Liquidity Co as the liquidity provider, through its Australian office provides FX rates to Hedge Manager Co (as Entity A's agent) via the trading platform (although occasionally other electronic means of communication may be used instead of the trading platform), and acts as the offeror in making an offer to Hedge Manager Co. Hedge Manager Co communicates its acceptance of the offer through accepting within the trading platform and verbally via the instant messaging system.

Section 14B of the Electronic Transactions Act 1999 (ET Act 1999)provides the circumstances in which, for the purposes of a Commonwealth law, where electronic communications are deemed to have taken place:

(1) For the purposes of a law of the Commonwealth, unless otherwise agreed between the originator and the addressee of an electronic communication:

(a) the electronic communication is taken to have been dispatched at the place where the originator has its place of business; and

(b) the electronic communication is taken to have been received at the place where the addressee has its place of business.

(2) For the purposes of the application of subsection (1) to an electronic communication:

(a) a party's place of business is assumed to be the location indicated by that party, unless another party demonstrates that the party making the indication does not have a place of business at that location; and

(b) if a party has not indicated a place of business and has only one place of business, it is to be assumed that that place is the party's place of business; and

(c) if a party has not indicated a place of business and has more than one place of business, the place of business is that which has the closest relationship to the underlying transaction, having regard to the circumstances known to or contemplated by the parties at any time before or at the conclusion of the transaction; and

(d) if a party has not indicated a place of business and has more than one place of business, but paragraph (c) does not apply--it is to be assumed that the party's principal place of business is the party's only place of business; and

(e) if a party is a natural person and does not have a place of business--it is to be assumed that the party's place of business is the place of the party's habitual residence.

(3) A location is not a place of business merely because that is:

(a)          where equipment and technology supporting an information system used by a party are located; or

(b)          where the information system may be accessed by other parties.

(4) The sole fact that a party makes use of a domain name or email address connected to a specific country does not create a presumption that its place of business is located in that country.

When Hedge Manager Co (as Entity A's agent) communicates to Liquidity Co, electronically, its acceptance of an FX trade, Liquidity Co receives the communication from Hedge Manager Co through its Australian office. In accordance with paragraph 14B(1)(b) of the ET Act 1999 an electronic communication is taken to be received for an FX trade at the addressee's place of business, being Liquidity Co's Australian office.

Therefore, when Hedge Manager Co accepts, on behalf of Entity A, FX trade offers made by Liquidity Co through its Australian office that acceptance is taken to be received by Liquidity Co's Australian office. Since the acceptance of FX trades takes place at Liquidity Co's Australian office then in accordance with TR 2014/7 the formation of the FX hedging contract is considered to be in Australia.

Therefore, any foreign currency gains from transactions entered into by Hedge Manager Co, on behalf of Entity A, with Liquidity Co through its Australian office, as the liquidity provider, on the basis of the terms of the arrangement between Hedge Manager Co and Liquidity Co, have an Australian source for the purposes of subparagraph 770-75(4)(a)(ii).