Walter Gianotti and Erin Gordon, ATO 2009 Lost in Translation: Foreign Exchange Gains and Losses Disclaimer: The material in this presentation is published on the basis that the opinions expressed are not to be regarded as the official opinions of the Taxation Institute of Australia. The material 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. Erin Gordon and Walter Gianotti (FTIA) ATO Disclaimer The Australian dollar versus the US dollar Exchange Rate A$ per US dollar 0.9900 0.9600 The following material is presented for discussion purposes only and is not legally or administratively binding on the Australian Taxation Office. 0.9300 0.9000 0.8700 0.8400 0.8100 0.7800 0.7500 0.7200 0.6900 0.6600 0.6300 May-04 Nov-04 May-05 Nov-05 May-06 Nov-06 May-07 Nov-07 May-08 Nov-08 May-09 4 Foreign denominated transactions Example Foreign Exchange Gain When a transaction is denominated in a foreign...... and the transaction occurs on one date (for example a credit sale)...... but the cash flow or settlement of the transaction is at a later date...... fluctuating exchange rates can result in exchange rate gains or losses. On 31 July 2008 A Co sells trading stock to UK Co (a UK company) on credit. UK Co will pay A Co 10,000 Pounds Sterling in 3 months. The exchange rate on the day of sale is $1 = 0.48, therefore the A$ value of the 10,000 that A Co expects to collect on 31 October 2008 is: 10,000 0.48 = $20,833 On 31 October 2008, when the exchange rate is $1 = 0.41, A Co receives the 10,000 from UK Co. 31/07/08 31/10/08 Sale of trading stock on credit 10,000 Sale proceeds received 10,000 Foreign Exchange Gain 1 AUD = 0.48 GBP 1 AUD = 0.41 GBP $20,833 $24,390 $3,557
Core principles of the forex regime Forex regime The purpose of this framework is to ensure that economic gains and losses arising from exchange rate effects are brought to account for income tax purposes when realised, regardless of whether there is an actual conversion of amounts into A$. - EM, paragraph 2.22 Subdivision 960-C Foreign Currency Translation rules Division 775 Foreign gains and losses Calculation rules Forex regime taxpayers affected When did the rules commence? For most taxpayers, transactions entered into on or after 1 July 2003. Which taxpayers are affected by the forex rules? All taxpayers that have foreign dealings, except for ADIs, non-adi financial institutions and securitisation vehicles. Interaction with TOFA legislation (Division 230). Translation rules [Subdivision 960-C] General translation rule to translate amounts of foreign into Australian dollars. Ensures that Australian income tax liability is calculated by reference to a common unit of measurement. Taxpayers can elect out of the operation of the general translation rule, by means of the functional election. Translation rules some common examples Division 775 basic building blocks Item: 960-50(2) Ordinary income Deductions Depreciating asset CGT asset Receipts/payments Trading stock Withholding Translation rule: 960-50(6) Exchange rate at earlier of derivation or receipt Exchange rate at earlier of when amount first becomes deductible or on payment Exchange rate at earlier of when you hold the asset or obligation to pay is satisfied. Time you acquired asset under Div. 109 Exchange rate on date of receipt/payment Valued at cost exchange rate at time stock on hand Valued at market selling value or replacement exchange rate at end of income year Exchange rate at time when amount required to be withheld Rights or obligations over foreign Disposal or cessation Currency Exchange Rate Effect Forex gains & losses are assessable / deductible
Rights or obligations over foreign Disposal or cessation Rights and obligations not defined Pecuniary or monetary Calculated by reference to a exchange rate effect rights to pay and obligations to receive foreign Contingencies Realisation Constructive receipts and payments Economic set-off Currency exchange rate effect 775-105 Currency exchange rate effect (1) A exchange rate effect is: (a) any exchange rate fluctuations; or (b) a difference between: (i) an expressly or implicitly agreed exchange rate for a future date or time; and (ii) the applicable exchange rate at that date or time. Forex gains & losses are assessable / deductible Forex realisation gains are assessable and forex realisation losses are deductible Exclusive code? Revenue account except for limited exceptions Division 775 applying the rules Identify a forex realisation event Applying the rules Step 1: Identify a forex realisation event Step 2: Calculate the forex gain or loss Step 3: Consider exceptions and special rules FRE 1 FRE 2 FRE 3 FRE 4 FRE 5 FRE 6 & 7 FRE 8 FRE 9 Disposing of foreign or a right to foreign Ceasing to have a right, or part of a right, to receive foreign Ceasing to have an obligation, or part of an obligation, to receive foreign Ceasing to have an obligation, or part of an obligation, to pay foreign Ceasing to have a right, or part of a right, to pay foreign Facility agreements Retranslation election qualifying forex accounts Foreign exchange retranslation election
Calculate the forex gain or loss To work out if a forex gain or loss arises on one of the forex realisation events happening, generally you need to compare in Australian dollar terms the: 1) consideration received or paid in respect of the right or obligation in relation to foreign ceasing; with 2) cost incurred in acquiring that right or obligation Consider exceptions and special rules Generally forex gains or losses are assessable/deductible Exceptions: Private/domestic Exempt income; and Non-assessable non-exempt income Short term rules Special rules: Finance facility agreements; and Foreign denominated accounts Proposed amendments the elephant in the room 5 August 2004 Press Release Policy changes Drafting errors and technical corrections Retrospective Tax Office administration of proposed amendments Keep a copy of the amendments next to the legislation when considering the provisions Tax v Accounting Generally coincides Regulations Some of the differences separate treatment of hedge and underlying rollover of hedges option premiums economic close out bank accounts depreciating assets Summary of key points Summary of key points Rights and obligations to pay or receive foreign Forex gains and losses recognised on realisation Conversion of not required Includes only the loss or gain attributable to exchange rate effects Revenue treatment (except certain short-term forex gains and losses) No hedging regime Exclusive code? General and specific translation rules s
Foreign denominated accounts Rights and obligations Forex realisation events base rules FIFO Weighted average Compliance cost savers Limited balance election Retranslation election s Case study Relevant rights and obligations Right to receive foreign Example: foreign denominated bank account with credit balance Obligation to pay foreign : Example: foreign denominated loan or credit card account Relevant forex realisation events Fungible, rights and obligations Disposal of foreign : FRE 1 Right to receive foreign ceases: FRE 2 Obligation to pay foreign ceases: FRE 4 FRE 8 and FRE 9 retranslation for qualifying forex accounts Special rules for fungibles Deposit 1 AUD = 0.60 + - Deposit 2 AUD = 0.80 base? Withdrawal Proceeds AUD = 0.70 base rules: First-in first-out method (FIFO) base rules: Weighted average method + - + - Deposit 1 AUD = 0.60 Deposit 2 AUD = 0.80 Withdrawal Proceeds AUD = 0.70 Deposit 1 AUD = 0.60 Deposit 2 AUD = 0.80 Withdrawal Proceeds AUD = 0.70
Elections for qualifying forex accounts A qualifying forex account (QFA) is an account denominated in a particular foreign that: primary purpose of facilitating transactions; or is a credit card account held with an ADI or similar* *recent amendment has removed this requirement Elections available for QFAs to take them out of the cost base rules (FIFO and Weighted Average): Limited balance election (Subdivision 775-D) Retranslation election (Subdivision 775-E) Limited balance election Balance of less than $250,000 (buffering rules apply) Commences on written election Tax consequences: FRE 2 (cessation of right to receive) and FRE 4 (cessation of obligation to pay) disregarded CGT event C1 and C2 disregarded QFAs subject to Limited Balance election are effectively out of tax net Retranslation election Retranslation election Alternative to limited balance Commences on written election Tax consequences: FRE 2 (cessation of right to receive) and FRE 4 (cessation of obligation to pay) disregarded CGT events C1 and C2 disregarded QFAs subject to Retranslation election have otherwise unrealised gains and losses brought to account under FRE 8 Gains and losses calculated using this formula: Closing balance of account for the retranslation period - Opening balance of account for the retranslation period Total deposits made to account during the retranslation period - + Retranslation method reflects accounting practice Total withdrawals made from account during the retranslation period A2.3 Calculating forex cost base and other values where a taxpayer becomes as Australian resident Amendments will be made so that the cost base (or value) for a new resident of a foreign right or obligation that gives rise to a non-australian sourced gain or loss is based on the exchange rate applicable at the time that the taxpayer became an Australian resident A2.6 Application to pre-existing bank accounts Amendments will clarify that: Taxpayers can bring bank accounts that existed prior to the commencement of the foreign provisions within the scope of Division 775; and Where such a bank account is brought within the scope of the foreign provision a taxpayer cannot then chose to have the bank account subject to the law as it existed prior to the commencement of the foreign provisions
A1.2 Extension of retranslation election to non-adi accounts Amendments will: Remove the requirement in Subdivision 775-E limiting the availability of the retranslation election to accounts maintained with an ADI or with a financial institution similar to an ADI; and Allow regulations to be made to include other types of accounts A1.5 Deemed election into limited balance rules for individuals Subdivision 775-D will be amended so that individual taxpayers with appropriate small foreign holdings will be able to benefit from the limited balance account election even though the taxpayer has not made an election A2.2 Sections 775-85 to 775-100: Include interest and other income in the forex cost base of a right to receive foreign An amendment will ensure that the cost base of a right or obligation to pay or receive foreign appropriately takes into account, in calculating costs and benefits, amounts which do not form cash or noncash benefits A3.7 Realisation of gains and losses on entering or leaving retranslation A3.10 Change limited balance election comparison time A3.11 Setting proceeds of deemed realisation on entry to limited balance exception Case Study Additional slides Pre Division 775 transactions Examples of forex realisation events Translation rules Functional election Short term rules Rollover relief for facility agreements Options FRE 9
Pre Division 775 Forex realisation event 1 [section 775-40] Foreign Exchange Gain or Loss Disposing of foreign or right to receive foreign Is it of a revenue or capital nature? Revenue Capital Calculated by taking so much of any capital gain or loss on the disposal of foreign (or of a right to receive foreign ) as is attributable to a exchange rate effect Division 3B satisfied Division 3B not satisfied Example: Disposal of foreign Loss is deductible Loss is not deductible 31/7/08 31/8/08 Bought US$6m Disposed of US$6m A$1 = US$0.94 A$1 = US$0.86 $6,382,978 $6,976,744 Gain is assessable Gain is not assessable 31/8/08 Forex Loss under FRE 1 (recognised as assessable income) $593,766 Forex realisation event 2 [section 775-45] Forex realisation event 3 [section 775-50] Ceasing to have a right to receive foreign Generally occurs where a right to receive foreign is discharged by way of receipt or a call option you acquired to buy foreign lapses unexercised. Example: Sale of foreign denominated trading stock 1/8/08 30/9/08 Sale of widgets US$10,000 (payable in 60 days) Sale proceeds received Forex Gain under FRE 2 (recognised as assessable income) A$1=US$0.93 A$1 = US$0.79 $10,753 $12,658 $1,905 Ceasing to have an obligation to receive foreign Generally occurs where: an obligation to receive foreign is fulfilled by buying the, or a put option to sell foreign, which you have sold, expires unexercised Example: Sale and exercise of a foreign put option 30/9/08 30/9/08 Received 800,000 when option exercised (at the spot rate) Amount paid when option exercised less premium received Net cost of assuming obligation Forex Loss under FRE 3 (recognised as an allowable deduction) A$1= 0.56 $1,428,571 $1,500,000 $10,000 $1490,000 $61,429 Forex realisation event 4 [section 775-55] Forex realisation event 5 [section 775-60] Ceasing to have an obligation to pay foreign Generally occurs where an obligation to pay foreign is discharged by payment Example: Acquisition of foreign denominated trading stock Ceasing to have an right to pay foreign Generally occurs where: a right to pay foreign is exercised by way of payment, or a put option to sell foreign, which you acquired, expires unexercised, or an obligation to pay foreign is discharged by payment 1/10/08 31/10/08 Purchase of stock US$500,000 payable in 30 days Paid for stock Forex Loss under FRE 4 (recognised as an allowable deduction) A$1=US$0.79 A$1 = US$0.66 $632,911 $757,576 $124,665 Example: Put option which you acquired expires unexercised 31/7/03 31/7/04 OZ Co buys a put option to sell 1,000m Option premium paid Option expires unexercised Forex Loss under FRE 5 (recognised as an allowable deduction) A$1= 96 A$1= 91 $100,000 $100,000
Translation rules - Regulations Functional election [Subdivision 960-D] Regulations enacted, with retrospective effect from 1 July 2003, provide specific translation rules for: FX bad debts Spot FX contracts Regulations enacted, with effect from 28 April 2005, allow taxpayers the following alternative translation rules: If none of the items in section 960-50(6) apply, use a reasonable exchange rate (item 11A of 960-50(6)) As an alternative to any of the items, item 12 allows taxpayers to utilise the following methods: Average rates Taxpayer s choose time period (provided < 12 months) Average rate must be a reasonable approximation of the spot rate which would have been used for the transactions Exchange rates consistent with those used by the entity in preparing its audited financial reports Arms length daily exchange rate that is appropriate to the taxpayer s business or activities Transactional Currency A$, US$,,, etc Translation 1 Translation 2 Functional Currency Final Australian Tax Liability A$ Functional election: eligibility Residents who are required to prepare financial reports under section 292 of the Corporations Act 2001 Residents carrying on business through an overseas permanent establishment. Non-residents carrying on a business through an Australian permanent establishment Offshore Banking Units Attributable taxpayers of CFC Transferor Trusts Short-term rules [775-70 and 775-75] Limited character matching applies to the following transactions: (a) Disposal of CGT asset (b) Acquisition of CGT asset (c) Acquisition of depreciating asset (d) Second element of cost of depreciating asset (e) Project amount in project pool Forex gain capital gain event K10 Forex loss capital loss event K11 Forex gain reduces/ loss-increases cost base or RCB Forex gain reduces/ loss increases cost or adjustable value Forex gain reduces/ loss increases adjustable value Forex gain reduces/ loss increases value of project pool Electing out of the short-term rules Practical effect of the short term rules is that forex gains & losses are folded into the capital treatment of the asset Taxpayers can make an irrevocable election not to have the 12 month rule apply Election only available if taxpayer in existence at applicable commencement date or came into existence within 90 days of the commencement date, or such longer time as the Commissioner allows A1.4 Section 775-80: Availability of election for short-term forex realisation gains and losses rules to apply to new entities Section 775-80 will be amended to allow new entities a period of time after they come into existence to make an election not to apply the short-term forex realisation gains and losses rules. Proposed amendment
Facility Agreements [Subdivision 775-C] Options that expire unexercised Available only for liabilities and therefore for issuers, not holders. Allows issuer to defer tax recognition of forex gains and losses on rollover. Requirements: facility agreement eligible securities Irrevocable election writing Consequences of choosing roll-over: disregard any forex gain or loss that might otherwise arise by discharging each eligible security through the issue of a new eligible security discharge of notional loan (forex realisation event 6) material variation of a facility agreement (forex realisation event 7) OPTIONS PUT CALL BUY Right to sell (pay) foreign FRE 5 775-90 Right to buy (receive) foreign FRE 2 775-85 Option lapses - Forex loss s775-60(5) Option lapses - Forex loss s775-45(5) SELL Obligation to buy (receive) foreign FRE 3 775-100 Obligation to sell (pay) foreign FRE 4 775-95 Option lapses - Forex gain s775-50(4) Options lapses - Forex gain s775-55(4)) FRE 9 - Retranslation election for Division 230 Only applies where an entity has made the General retranslation election under subdivision 230-D. An arrangement to which the General retranslation election applies will have its forex gains and losses subject to Div 775 (FRE 9) if it is: a financial arrangement whose gains and losses are not subject to Div 230 (as set out in subdivision 230-H) a financial arrangement in respect of which the general retranslation election does not apply for the purposes of Div 230; or an arrangement, which constitutes a right and/or an obligation to receive or provide foreign, which is not a financial arrangement. Broadly, a forex gain or loss will be recognised on a retranslation basis when the accounting standards (AASB 121) recognise an amount attributable to foreign exchange movements in profit or loss