ATO ID 2006/105: Foreign exchange (forex) gains and losses on payment of foreign currency on the re-exchange of currencies under a foreign exchange swap contract
Date of decision: 29 March 2006
Year of income: Year ended 30 June 2006 Year ending 30 June 2007
Business line: Finance and Investment Centre of Expertise

Issue
Will forex realisation event 4 (FRE 4) happen under subsection 775-55(1) of the Income Tax Assessment Act 1997 (ITAA 1997) where a payment of foreign currency is made on the re-exchange of currencies under a foreign exchange swap contract (FX swap)?

Decision
Yes. FRE 4 will happen under subsection 775-55(1) of the ITAA 1997 where a payment of foreign currency is made on the re-exchange of currencies under a FX swap.

Facts
The taxpayer entered into a business transaction where it will receive an amount of United States dollars (USD) on a future date. The taxpayer enters into a FX swap on 31 March 2006 to hedge the business transaction against adverse movements in the Australian dollar (AUD)/USD exchange rates. Under the terms of the swap, the taxpayer initially exchanged AUD for USD at an agreed exchange rate on 31 March 2006. The taxpayer will re-exchange the USD for AUD on 30 March 2007, at a rate agreed upon when the FX swap was entered into.

Reasons for decision
Summary: Under the FX swap the taxpayer has an obligation to pay foreign currency in return for receiving an amount of AUD on the re-exchange of currencies on 30 March 2007. Under subsection 775-55(1) of the ITAA 1997, FRE 4 happens if an entity ceases to have the obligation to pay foreign currency. Subsection 775-55(2) of the ITAA 1997 provides that FRE 4 happens when the entity ceases to have the obligation. The obligation to pay foreign currency will cease when the USD amount is paid on the re-exchange of currencies under the FX swap on 30 March 2007. Subsection 775-55(3) of the ITAA 1997 provides that a forex realisation gain is made if the amount paid in respect of FRE 4 happening falls short of the proceeds of assuming the obligation at the tax recognition time. In this instance, the proceeds of assuming the obligation under section 775-95 of the ITAA 1997 is the money the taxpayer will receive for incurring the obligation, that is the AUD the taxpayer will receive for the USD under the swap. The 'tax recognition time' is essentially when an event occurs which creates tax consequences. Where the obligation is incurred in return for receiving an amount of AUD, the tax recognition time is when the AUD is received (item 8 of subsection 775-55(7) of the ITAA 1997). A forex realisation loss is made under subsection 775-55(5) of the ITAA 1997 if the amount paid in respect of FRE 4 happening exceeds the proceeds of assuming the obligation as determined at the tax recognition time. The amount paid in respect of FRE 4 happening is converted to AUD using the spot rate applicable on the date the payment is made (item 11 of the table in subsection 960-50(6) of the ITAA 1997). The amount of forex realisation gain or loss is so much of the shortfall or excess that is attributable to a currency exchange rate effect. A currency exchange rate effect is defined in subsection 775-105(1) of the ITAA 1997. It is described as any currency exchange rate fluctuation or as the difference between an expressly or implicitly agreed currency exchange rate for a future time and the actual currency exchange rate at that time. Subsections 775-15(1) and 775-30(1) of the ITAA 1997 respectively provide that any forex realisation gain or loss is included in the calculation of taxable income in the income year in which FRE 4 happens. That is, in the 2006-07 income year.

Legislative references: Income Tax Assessment Act 1997 subsection 775-15(1) subsection 775-30(1) subsection 775-55(1) subsection 775-55(2) subsection 775-55(3) subsection 775-55(5) subsection 775-55(7) section 775-95 subsection 775-105(1) subsection 960-50(6)
Related ATO interpretative decisions: ATO ID 2005/322 | ATO ID 2005/323
Subject references: Assuming an obligation Currency exchange rate Currency swaps Financial derivatives Foreign currency Foreign exchange gains and losses Forex realisation event Forex realisation gain Forex realisation loss Hedging Swaps Tax recognition time