ATO ID 2005/324: Foreign exchange (forex) gains and losses: delivery of currency under a foreign currency spot contract
Date of decision: 11 November 2005
Year of income: Year ended 30 June 2005
Business line: Private Groups and High Wealth Individuals

Issue
Does forex realisation event 4 (FRE 4) happen under subsection 775-55(1) of the Income Tax Assessment Act 1997 (ITAA 1997) when a taxpayer delivers foreign currency under a foreign currency spot contract (spot FX deal)?

Decision
Yes. FRE 4 will happen under subsection 775-55(1) of the ITAA 1997 when a taxpayer delivers foreign currency under a spot FX deal.

Facts
The taxpayer entered into a business transaction requiring it to pay United States dollars (USD) at a future date. On 28 June 2005, the taxpayer entered into a spot FX deal to economically close out an earlier foreign exchange swap contract it had entered into as part of a hedging strategy to fix the Australian dollar (AUD) cost of the transaction. Under the terms of the spot FX deal, the taxpayer contracted to sell USD 1,000,000 on 28 June 2005 for the agreed amount of AUD 1,300,898 with settlement of the transaction to take place on 30 June 2005. The actual exchange rate on 30 June 2005 was AUD 1.00 = USD 0.7680, giving the USD received and paid an equivalent value of AUD 1,302,083. On 30 June 2005, the taxpayer settled the spot FX deal by electronic transfer of the USD to the counterparty's bank account. The taxpayer recognises gains and losses under spot FX deals in its accounting records.

Reasons for decision
Summary: On entering into the spot FX deal, the taxpayer had an obligation to pay an amount of foreign currency incurred in return for acquiring a right to receive AUD. Under subsection 775-55(1) of the ITAA 1997, FRE 4 happens if an entity ceases to have an obligation to pay foreign currency. Subsection 775-55(2) provides that FRE 4 happens when the entity ceases to have the obligation. The taxpayer ceased to have the obligation to pay foreign currency when it paid the USD on 30 June 2005 and received AUD 1,300,898 in exchange. Subsection 775-55(5) of the ITAA 1997 provides that a forex realisation loss is made if the amount paid in respect of FRE 4 happening exceeds 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 received for incurring the obligation. The taxpayer works out the Australian dollar value of the USD amount paid using the spot rate applicable on the date the USD amount is paid (item 11 of the table in subsection 960-50(6) of the ITAA 1997). The 'tax recognition time' is essentially when an event occurs which creates tax consequences. Item 8 of subsection 775-55(7) of the ITAA 1997 provides that for an obligation incurred in return for acquiring a right to receive AUD, the tax recognition time is when the AUD is received. The forex realisation loss is so much of the 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. The taxpayer has made a forex realisation loss under subsection 775-55(5) of the ITAA 1997 of AUD 1,185. It is attributable to a currency exchange rate effect and is deductible from assessable income pursuant to subsection 775-30(1) of the ITAA 1997 in the income year in which FRE 4 happens being the year ended 30 June 2005.

Legislative references: Income Tax Assessment Act 1997 subsection 775-30(1) subsection 775-55(1) subsection 775-55(2) subsection 775-55(5) subsection 775-55(7) subsection 775-105(1) subsection 960-50(6)
Subject references: Assuming an obligation Currency exchange rate Currency swaps Disposal of foreign currency Financial derivatives Foreign currency Foreign currency obligations Foreign exchange gains and losses Forex realisation event Forex realisation loss Hedging Swaps Tax recognition time