Corporate Tax Masterclass

Transcription

1 -- Corporate Tax Masterclass Taxation of foreign exchange gains and losses for corporates Written and presented by: Abdol Mostafavi Special Counsel Greenwoods & Freehills Craig Marston Senior Associate Greenwoods & Freehills New South Wales Division 23 October 2013 Doltone House Hyde Park, Sydney Mostafavi and Marston, Greenwoods & Freehills 2013 Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this paper and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.

2 CONTENTS 1 Introduction Scope of Paper and overview Foreign exchange rate volatility Division 3B Background Continuing application of Division 3B the transitional rules Overview of Division 3B Operative provisions Eligible contract Currency exchange gain / currency exchange loss Translation rules Conversion (exchange) vs. translation Taxation Ruling TR 93/ The High Court s decision in ERA Withdrawal of TR 93/ Chief Tax Counsel s letter ostensible re-instatement of TR 93/ The Full Federal Court s recent decision in Messenger Press ATO s Decision Impact Statement on Messenger Press Division Background Continuing application of Division 775 the transitional rules Interaction with Division 3B Interaction with Division 230 (TOFA) Overview of Division Operative provisions of Division The most common FREs FRE 1: Disposal of foreign currency or right to receive foreign currency Mostafavi and Marston, Greenwoods & Freehills

3 3.5.2 FRE 2: Ceasing to have a right to receive foreign currency FRE 3: Ceasing to have an obligation to receive foreign currency FRE 4: Ceasing to have an obligation to pay foreign currency FRE 5: Ceasing to have a right to pay foreign currency Assistant Treasurer s Media Release Amendments to the foreign currency provisions Compliance cost saving measures The translation rules in Subdivisions 960-C and 960-D (and the associated Regulations) Subdivision 960-C Regulations Subdivision 960-D The TOFA regime (Division 230) Introduction Transitional rules Thresholds for the mandatory application of TOFA Financial arrangements Primary definition of financial arrangement Extended definition of financial arrangement Main exceptions from the application of TOFA Operative provisions of TOFA Tax-timing methods under TOFA Overview of the methods The default methods Foreign exchange retranslation method Fair value method Reliance on financial reports method Hedging financial arrangement method Case studies: Abbott Limited Mostafavi and Marston, Greenwoods & Freehills

4 7 Case study 1: US$ borrowing The facts The TOFA regime - general Financial arrangement Interest on the Notes Accruals method vs. realisation method Translation into A$ Running balancing adjustment Repayment of US$10 million principal Case study 2: FX Forward The facts Financial arrangement under TOFA No application of the accruals method Balancing adjustment Case study 3: Historic rate roll-over of FX Forward The facts Balancing adjustments Roll of FX Forward Final settlement of the FX Forward Case study 4: Cross-Currency Swap The facts Financial arrangement No application of the accruals method to the swap Disposal of US$ at the spot rate Balancing adjustment Case study 5: FX Option The facts Financial arrangement Mostafavi and Marston, Greenwoods & Freehills

5 11.3 Application of the tax-timing method(s) Balancing adjustment Case study 6: Acquisition of a depreciating asset The facts Whether the TOFA regime applies The construction contract for the vessel The US$ bank account The FX gains and losses recognised for income tax purposes The US$ bank account generally The payment of the US$5 million deposit on 1 January The withdrawal of US$10 million from the bank account on 1 December The making of the US$10 million progress payment on 1 December The withdrawal of US$10 million from the bank account on 1 January The payment of the final instalment of the purchase price on 1 January The cost of the vessel for tax depreciation purposes Case study 7: US$ borrowing to finance an offshore equity investment Financial arrangement TOFA balancing adjustment gain Nexus with NANE income Case study 8: Hedging the FX risk on an offshore equity investment Financial arrangement TOFA balancing adjustment gain Nexus with NANE income Mostafavi and Marston, Greenwoods & Freehills

6 1 Introduction 1.1 Scope of Paper and overview The Australian income tax treatment of foreign exchange ( FX ) gains and losses has had a long and chequered history. This Paper 1 provides an overview of the various regimes that govern the taxation of FX gains and losses made by Australian taxpayers, and the manner in which they interact. The focus of the Paper is on corporate taxpayers other than financial institutions. In particular, this Paper considers: Division 3B of Part III of the Income Tax Assessment Act 1936 ( Division 3B ); Division 775 ( Division 775 ) of the Income Tax Assessment Act 1997; the currency translation rules in Subdivisions 960-C ( Subdivision 960-C ) and 960-D ( Subdivision 960-D ) and the associated Regulations; and the Taxation of Financial Arrangements ( TOFA ) regime in Division 230 ( Division 230 ). This Paper also considers the extent to which Division 3B and Division 775 can now be considered as legacy regimes, and the extent to which they have on-going relevance for taxpayers. As will become apparent, Division 775 is still very much relevant, even for taxpayers who are now subject to the TOFA regime. After addressing the above background, this Paper then examines several practical case studies that address the way in which the current TOFA regime treats FX gains and losses in certain common situations. The case studies consider the following scenarios for a typical Australian corporate taxpayer: entry into a borrowing arrangement in foreign currency; entry into foreign currency derivatives (i.e. FX forwards, swaps and options); and the making of investments using foreign currency; and the making of outbound investments in foreign currency. 1 This Paper contains the views of the authors, which are not necessarily the views of Greenwoods & Freehills, the Tax Institute or any other organisation. Mostafavi and Marston, Greenwoods & Freehills

7 Unless indicated otherwise, all legislative references in this Paper are to the Income Tax Assessment Act 1936 ( ITAA 1936 ) or the Income Tax Assessment Act 1997 ( ITAA 1997 ), as the context requires. The law and practice discussed in this Paper is that applicable as at 30 September Foreign exchange rate volatility The graph below depicts the significant fluctuations that we have witnessed in the A$:US$ exchange rate since January 2000: source: The volatility in the exchange rate, and the income tax treatment of FX gains and losses, can have a significant impact on the financial performance of Australian corporate taxpayers. If a taxpayer has an A$ functional currency, then any transactions that it enters into in a foreign currency will have FX implications for income tax purposes. The types of transactions would include (but is by no means limited to): borrowing or lending in a foreign currency; holding foreign currency denominated assets, such as shares, depreciating assets and in-themoney FX derivatives; and having foreign currency denominated liabilities, such as loans and out-of-the-money FX derivatives. Mostafavi and Marston, Greenwoods & Freehills

8 2 Division 3B 2.1 Background For many decades, Australia did not have any tax rules specifically dealing with FX gains and losses, and various cases were handed down dealing with the revenue/capital distinction and timing recognition. 2 Only FX gains/losses that were considered to be on revenue account were included in a taxpayer s assessable income (under former s.25(1)) or deductible (under former s.51(1)). The capital gains tax ( CGT ) regime 3 was enacted with effect from 20 September The CGT regime attempted to capture (in a relatively basic fashion) foreign exchange gains/losses as a component of the overall capital gain/loss on a CGT asset. 4 However, the CGT regime only applied to CGT assets as defined, and it did not deal at all with liabilities denominated in a foreign currency. It was not until 1987 that the first set of specific rules dealing with FX gains and losses (in Division 3B of Part III of the ITAA 1936) was enacted. The objective of Division 3B, which took effect from 19 February 1986, was to ensure that foreign exchange gains and losses that were considered to be of a capital nature under the case law, particularly in relation to liabilities denominated in foreign currency, would be recognised for income tax purposes on revenue account when they were realised. 2.2 Continuing application of Division 3B the transitional rules As discussed below, Division 3B applies to eligible contracts. That is, eligible contracts are the unit of taxation to which Division 3B applies. Division 3B continues to apply to gains and losses of a capital nature arising from eligible contracts entered into on or after the commencing day (19 February 1986) but before the applicable commencement date 5 of Division 775 (generally the first day of the taxpayer s 2004 income year, ie 1 July 2003), subject to the following exceptions: If the taxpayer made an election under s to un-grandfather transactions (including eligible contracts) that the taxpayer had entered into before the applicable commencement date of 2 Refer, for example, the Full Federal Court decision in FCT v Hunter Douglas Ltd (1983) 80 FLR 143, which broadly speaking, dealt with the tax consequences of having US$-denominated working capital. 3 The current CGT provisions are contained in Parts 3-1 and 3-3 of the ITAA Refer s , which was essentially a currency translation rule. 5 Refer s Mostafavi and Marston, Greenwoods & Freehills

9 Division 775, Division 775 would potentially apply to the eligible contract from the applicable commencement date of Division 775. If: o o under a pre-division 775 loan agreement (ie a loan agreement entered into before the applicable commencement date of Division 775), there is an extension (after the applicable commencement date) of the period for which the money has been lent; and either: the contract is separate from the original loan contract; or the extension amounts to a variation of the original contract, then Division 3B will not apply to the extended loan (refer ss (3) and (5)). Instead, Division 775 will apply to the extended loan from the time of the extension. If the taxpayer made an election under sub-item 104(2) of the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 (the TOFA Act ) to un-grandfather its pre-tofa financial arrangements, ie financial arrangements that the taxpayer started to have before the commencement date of the TOFA regime 6, the TOFA regime would potentially apply to the preexisting eligible contract from the commencement date of TOFA. If the taxpayer made both un-grandfathering elections (under Division 775 and TOFA), then: Division 775 should have potential application to the transaction from the applicable commencement date of Division 775; and the TOFA regime should have potential application to the arrangement from the commencement date of TOFA. Given that many corporate taxpayers have never made either of the above un-grandfathering elections, Division 3B continues to play a role in the taxation of FX gains and losses for such taxpayers. However, that role is diminishing as pre-1 July 2003 eligible contracts mature. Furthermore, in some cases where a transaction has ostensibly taken place under an eligible contract, it is possible that, due to the extent of the subsequent variations made to the contract, the taxpayer may be regarded as having entered into a new transaction or financial arrangement (with the effect that the new transaction or arrangement is in fact subject to Division 775 and/or TOFA). For example, a draw-down by a taxpayer before 1 July 2003 under a foreign currency denominated facility agreement entered into before that day would generally remain subject to Division 3B. 6 The commencement date of the TOFA regime was the first day of the income year commencing on or after 1 July 2010 (refer sub-item 103(1) of the TOFA Act), unless the taxpayer also made the early start election under sub-item 103(2) of the TOFA Act to apply TOFA from the start of its income year commencing on or after 1 July Mostafavi and Marston, Greenwoods & Freehills

10 However, a difficult issue arises if the taxpayer makes a draw-down after 1 July 2003 under the same facility agreement. Provided that there has been no extension or variation of the facility agreement since 1 July 2003, it could be argued that, for the purposes of Division 3B, the relevant eligible contract is the facility agreement (which remains subject to Division 3B), such that all subsequent draw-downs under the same facility should be grandfathered under Division 3B. In the authors view, this is an issue that should be governed by contract law, and it may be necessary for the taxpayer to obtain advice from a contract lawyer on the point. 2.3 Overview of Division 3B Operative provisions Section 82Y provides: The assessable income of a taxpayer of a year of income shall include any currency exchange gain made by the taxpayer in the year of income under an eligible contract. [underlining added] Subsection 82Z(1) provides that (subject to certain exceptions):... a currency exchange loss incurred by a taxpayer in a year of income under an eligible contract is an allowable deduction in respect of the year of income. [underlining added] Accordingly, there are three key concepts here: eligible contract, currency exchange gain and currency exchange loss. These concepts are considered below. Also considered below are the translation rules that complemented Division 3B. The references in the above provisions to a gain being made and a loss being incurred were understood to mean that currency exchange gains/losses were to be recognised on realisation Eligible contract Division 3B applies to eligible contracts. As noted above, eligible contracts are the unit of taxation to which Division 3B applies. In this regard, s.82v (in Division 3B) defines an eligible contract as follows: eligible contract, in relation to a taxpayer, means (a) (b) a contract entered into by the taxpayer on or after the commencing day, other than a hedging contract; or a hedging contract entered into by the taxpayer, on or after the commencing day, in relation to a contract to which Paragraph (a) applies. Mostafavi and Marston, Greenwoods & Freehills

11 Division 3B only applies to gains and losses to the extent that they are of a capital nature (having regard to the case law) Currency exchange gain / currency exchange loss Subsection 82V(1) provides the following definitions: currency exchange gain means a gain to the extent to which it is attributable to currency exchange rate fluctuations currency exchange loss means a loss to the extent to which it is attributable to currency exchange rate fluctuations Translation rules Division 3B, where it applies, is supported by a number of currency translation rules. Former s.20(1) provided a general translation rule requiring that, for all purposes of the Act income and expenses wherever derived and incurred must be expressed in Australian dollars. Subsections (2), (3) and (4) of former s.20 then provided specific rules for when certain types of income and expenses are to be translated into A$. For the purpose of calculating capital gains and capital losses arising before the applicable commencement date of Division 775, the CGT regime contained its own translation rule in former s : If a transaction or event involving an amount of money or the *market value of other property: (a) is to be taken into account under this Part or Part 3-3; and (b) the money or market value is in a foreign currency; the amount or value is to be converted into the equivalent amount of Australian currency at the time of the transaction or event.. Former s.20 and s were repealed by the New Business Tax System (Taxation of Financial Arrangements) Act 2003 (the 2003 Act ). The 2003 Act also repealed Division 3B and introduced Division 775 and the current translation rules in Subdivisions 960-C and 960-D. 2.4 Conversion (exchange) vs. translation As mentioned above, it was generally understood that currency exchange gains/losses were to be recognised under Division 3B on realisation. Mostafavi and Marston, Greenwoods & Freehills

12 An enduring conundrum of Division 3B is whether, for realisation to occur, it is necessary that there be an actual conversion or exchange of foreign currency into A$ Taxation Ruling TR 93/8 In Taxation Ruling TR 93/8, the Commissioner expressed the view that no actual conversion to Australian currency is required for Division 3B to apply. The Commissioner stated the following regarding his view as to when an FX gain or loss is realised under Division 3B. 8. The general principles are as follows. If a foreign exchange gain or loss arises from a liability in a foreign currency, the taxpayer realises the gain or loss when the liability is discharged by actual or constructive payment. Conversely, if a foreign exchange gain or loss arises from a right to receive foreign currency, the taxpayer realises the gain or loss on the actual or constructive receipt of payment. 9. If a taxpayer has a liability in a foreign currency and pays part of that liability, the taxpayer realises any foreign exchange gain or loss on the amount repaid at the time of the part payment. Similarly, if a taxpayer entitled to receive an amount of foreign currency receives part of that amount, the taxpayer realises any foreign exchange gain or loss on the amount received at the time the taxpayer receives part payment. In this regard, the Ruling provides the following comments regarding the realisation. 10. A taxpayer can realise a foreign exchange gain or loss arising from a liability in a foreign currency without outlaying Australian dollars to acquire the relevant currency to satisfy the liability. Similarly, a taxpayer can realise a foreign exchange gain or loss arising from a right to receive foreign currency without converting the amount received to Australian dollars. [emphasis added] Consequently, adopting the Commissioner s interpretation, in broad terms, when an arrangement denominated in a foreign currency ends, a currency exchange gain/loss would be realised having regard to the A$ equivalents of the foreign currency amounts at the start and end of the transaction. On one view, the Commissioner s position in this Ruling seems quite defensible. It reflects the economics of the situation where A$ is the taxpayer s functional currency, the taxpayer makes an economic gain or loss in A$ that should be recognised for income tax purposes. However, as discussed below, in 1996, the High Court in Federal Commissioner of Taxation v Energy Resources of Australia Ltd (1996) 185 CLR 66; 96 ATC 4536 ( ERA ) rejected the Commissioner s interpretation in TR 93/8. In doing so, the High Court exposed a seemingly major defect in the drafting of Division 3B The High Court s decision in ERA In ERA, the taxpayer, an Australian mining company, had issued a series of US$ denominated 90 day Euronotes ( Notes ) at a discount through a number of banks. The taxpayer used the US$ issue proceeds from the first series of Notes to discharge its US$ liabilities under an earlier facility which had been used to finance the development and operation of a uranium mine in the Northern Territory. Mostafavi and Marston, Greenwoods & Freehills

13 Each series of Notes were refinanced after their 90 day term. That is, the US$ proceeds from subsequent issues of Notes under the facility were used to discharge the taxpayer s liabilities to pay the US$ face value of each preceding issue of Notes. None of the proceeds of any issue of Notes were converted into A$ or remitted to Australia. Three alternative approaches were considered by the High Court regarding the calculation of the deductible discount on the Notes: Taxpayer s calculation: Translate the US$ amount of the discount (ie the difference between the face value of a Notes and the issue proceeds) into A$ using the spot rate on the maturity date. Commissioner s calculation: Translate into A$ the US$ amounts: o o the US$ issue proceeds of the Notes into A$ using the spot rate at the issue date of the Note; and the US$ face value of the Note paid on maturity into A$ using the spot rate on the maturity date. The difference between these A$ amounts would be the deductible amount of the discount. High Court s calculation: Translate the US$ discount into A$ using the spot rate at the issue date of the Note. In this regard, the High Court reasoned that the deduction was incurred when the relevant Note was issued. This was because, at that time, the Note was issued at a discount and the obligation to pay the face value arose at that time. The consequence of the High Court s view was that economic gains and losses due to FX movements between the issue date of a Note and the maturity date of a Note were not factored into the calculation of the discount expense incurred by the taxpayer on the Notes. The High Court rejected the Commissioner s assumption that a notional conversion of the proceeds of each issue and a notional conversion of the payments in discharge of each issue had to be made on the day that each of those events took place and that the difference between the respective sums was the taxpayer s gain or loss. The High Court rejected this assumption because: the Commissioner treated the lack of any actual conversion of the proceeds or payments as irrelevant. But there is nothing in the Act that requires the making of notional conversions of the taxpayer s transactions. 7 The Court was of the view that the US$ issue proceeds of each Note was not income, as they were on capital account, and that the US$ principal repayments made by the taxpayer on maturity were not expenses. In the Court s view, the only expense incurred by the taxpayer under each Note was the discount expense, and that it was the discount expense which needed to be translated into A$ for the purposes of former s.20(1) (discussed above). 7 ERA, op. cit., 96 ATC 4536, at Mostafavi and Marston, Greenwoods & Freehills

14 Whilst the central issue in this case was whether the taxpayer was entitled to a deduction for the discount expense under former s.51(1) (and if so, how much), the High Court also considered the application of Division 3B. The Court held that Division 3B did not apply in this case because the discount on the Notes represented a revenue loss, and as discussed above, Division 3B only applies to gains and losses to the extent that they are of a capital nature. In addition, the Court concluded that, in terms of Division 3B, the taxpayer made no currency exchange gain or loss, nor was there any gain or loss that was attributable to currency exchange rate fluctuations. In this regard, the Court made the following comments: This case has nothing to do with currency gains and losses, for the simple reason that the taxpayer dealt only in US dollars. The taxpayer made no currency gains or losses because it never converted any of the proceeds of the notes into Australian dollars. For Australian tax purposes, the only relevant conversion was the cost in Australian dollars of the loss made in US dollars when the taxpayer incurred its liability to pay the face value of the notes. 8 The taxpayer received US dollars, paid US dollars, and did not convert the US dollars into Australian dollars. Where a taxpayer borrows money on capital account in US dollars and repays the loan in US dollars, it makes no revenue profit or loss from the borrowing even though the exchange rate may be different at each date. Indeed, arguably, it makes no profit or loss.for income tax purposes, the fluctuations of the US/Australia exchange rate were as irrelevant to the taxpayer s transactions as the fluctuations in the Japan/Australia exchange rate. 9.for the reasons that we have already given, the taxpayer made no currency exchange gain or loss. The unit of account and the unit of payment under the contract or contracts involved in this case were US dollars. 10 The High Court s decision in ERA caused considerable confusion and uncertainty. Seemingly, the implication of this case was that a taxpayer having an FX-denominated liability on capital account would not make an FX gain or loss recognised for tax purposes without an actual physical conversion of the foreign currency into A$. On the other hand, in relation to FX-denominated assets, FX gains/losses would still be recognised at least under the CGT regime even if no actual conversions took place, and possibly also under the general assessing provisions (s.6-5 and s.8-1) and/or the traditional securities provisions in ss.26bb/70b. This resulted in asymmetry between the tax treatment of FX-denominated assets and FX-denominated liabilities. 8 Loc. cit. 9 ERA, op. cit. 96 ATC 4536, at ERA, op. cit. 96 ATC 4536, at Mostafavi and Marston, Greenwoods & Freehills

15 2.4.3 Withdrawal of TR 93/8 Shortly after the High Court s decision in ERA, the Australian Taxation Office ( ATO ) withdrew Taxation Ruling 93/8. The Withdrawal Notice for the Ruling indicated that the case necessitates a review of matters addressed by the Ruling Chief Tax Counsel s letter ostensible re-instatement of TR 93/8 In response to concerns expressed by a taxpayer representative body regarding the implications of ERA, on 17 February 1997, the ATO s then Chief Tax Counsel, Mr Michael D Ascenzo (who subsequently became the Commissioner), sent a letter to various external stakeholders, including the National Tax Liaison Group. The letter stated: The High Court has thrown considerable doubt on the Commissioner s view in Taxation Ruling TR 93/8 that conversion between foreign currency and Australian dollars is not necessary for a foreign exchange gain or loss to be brought to account for tax purposes. It is now not at all clear whether Division 3B does or does not apply.. To alleviate these uncertainties, unless there is clearer legislative or judicial direction on these matters, or until it is considered necessary and appropriate to issue or amend Taxation Rulings on the matters, the ATO s practice will be to..not disturb assessments which bring or have brought to account for tax purposes foreign exchange gains and losses in accordance with the principles in Taxation Ruling TR 93/8 [notwithstanding the High Court s decision in ERA]. Therefore, there was a de facto interim re-instatement of TR 93/8 by the ATO. However, although it was not stated in the letter, the authors understand that the ATO intended that taxpayers should consistently apply either TR 93/8 or ERA principles (rather than cherry-picking individual transactions for either treatment). Since it was published, many taxpayers have relied upon this letter for the purposes of Division 3B (and continue to do so). 11 The status of the letter for the purposes of administrative law is as interesting as it is unclear. Could a taxpayer who relies on this letter in good faith seek an estoppel under principles of administrative law if the Commissioner sought to resile from it? 11 Refer the Full Federal Court s decision in Victoria Co Ltd v Deputy Commissioner of Taxation [2001] FCA 641, where the Commissioner sought not to follow the principles in TR 93/8, and the Court ruled in favour of the ATO, as the transaction entered into by the taxpayer pre-dated the date of effect of TR 93/8. Mostafavi and Marston, Greenwoods & Freehills

16 2.4.5 The Full Federal Court s recent decision in Messenger Press The scope of Division 3B was recently considered again by the Full Federal Court in Commissioner of Taxation v Messenger Press Pty Ltd [2013] FACFC 77 ( Messenger Press ), in a decision which was handed down on 25 July Justices Jessup, Robertson and Griffiths JJ unanimously held that some 20 News Corp group companies were entitled to claim tax deductions for more than A$2 billion of foreign exchange losses under Division 3B. Those losses had arisen in the relevant taxpayers 2001 and 2002 income years. The foreign exchange losses had arisen because of a restructure of the funding/debt arrangements of the News Corp global group. The restructure involved a complicated series of internal transactions, including various issuances and endorsements of promissory notes. However, two transactions were of particular relevance: 1. (Transaction 1) On 8 June 2001, News Publishers Holdings Pty Limited ( NPHP ) purchased two US$-denominated promissory notes with face values of US$750 million and US$265 million respectively from The News Corporation Limited ( TNCL ) in consideration for approximately A$1.9 billion (ie A$ consideration. NPHP then endorsed these two promissory notes in favour of News Publishers Investments Pty Limited ( NPIP ) in partial reduction of a pre-existing US$-denominated loan which had been advanced from NPIP to NPHP. 2. (Transaction 2) On 28 June 2002, NPIP issued two promissory notes (with face values of approximately US$3.4 billion and A$1.2 billion) to NPHP in satisfaction of an A$-denominated liability that NPIP owed to NPHP. NPHP then presented the US$ denominated promissory note (with a face value of approximately US$3.4 billion) back to NPIP in satisfaction of a US$denominated liability that NPHP owed to NPIP. In other words, the US$ amounts that NPIP and NPHP owed to each other were effectively set-off against each other. NPHP claimed a tax deduction under Division 3B for FX losses that it incurred when it undertook each of these two transactions. Specifically, NPHP argued that it incurred currency exchange losses when it endorsed the two promissory notes (under Transaction 1) and when it presented the US$ denominated promissory note (under Transaction 2). The first issue addressed by the Full Federal Court in this case was whether there had been a realisation of a currency exchange loss for the purposes of Division 3B. The Commissioner argued that there had been no physical exchange of foreign currency, and that there had been merely an exchange of promissory notes (also referred to as an exchange of liabilities ). In this regard, the Commissioner contended that the High Court s decision in ERA stood as authority for the proposition that an actual exchange or physical conversion of currencies was necessary for a foreign exchange loss to arise under Division 3B, and that in the present case there had been none. Mostafavi and Marston, Greenwoods & Freehills