ATO ID 2005/318: Foreign exchange (forex) gains and losses: effect on holder of lapsed foreign currency denominated call option
Date of decision: 11 November 2005
Year of income: Year ended 30 June 2005
Business line: Private Groups and High Wealth Individuals

Issue
Is a forex realisation loss made under subsection 775-45(5) of the Income Tax Assessment Act 1997 (ITAA 1997) when a foreign currency denominated call option a taxpayer has acquired lapses?

Decision
Yes. A forex realisation loss is made under subsection 775-45(5) of the ITAA 1997 when a foreign currency denominated call option a taxpayer has acquired lapses.

Facts
The taxpayer entered into a business transaction requiring it to pay United States dollars (USD) at a future date. As part of a hedging strategy to protect against adverse movements in the Australian dollar (AUD)/USD exchange rates, the taxpayer acquired a twelve month USD call option which gave it the right, but not the obligation, to buy a predetermined amount of USD in exchange for a predetermined amount of AUD. The taxpayer paid a premium of AUD 75,000 on acquiring the option. The USD call option had an expiry date of 31 May 2005. Due to unfavourable movements in exchange rates, the taxpayer did not exercise its rights under the option. The rights and obligations under the option continued to subsist until the option lapsed on 31 May 2005.

Reasons for decision
Summary: On purchasing the option, the taxpayer acquired a right to receive an amount of foreign currency in return for it agreeing to pay AUD. Subsection 775-135(2) of the ITAA 1997 provides that a 'right to receive foreign currency' includes a right subject to a contingency. Under subsection 775-45(1) of the ITAA 1997, forex realisation event 2 (FRE 2) happens if an entity ceases to have a right to receive foreign currency. Subsection 775-45(2) of the ITAA 1997 provides that FRE 2 happens when an entity ceases to have the right. The taxpayer ceased to have the right to receive foreign currency when the option lapsed. The taxpayer made a forex realisation loss under subsection 775-45(5) of the ITAA 1997 as the option expired without having been exercised and, immediately before FRE 2 happened, the taxpayer was capable of exercising the option. The forex realisation loss is the AUD 75,000 paid by the taxpayer in respect of acquiring the option (the premium paid). The taxpayer is entitled to claim a deduction under subsection 775-30(1) of the ITAA 1997 for this loss in the income year ending 30 June 2005.

Legislative references: Income Tax Assessment Act 1997 subsection 775-30(1) subsection 775-45(1) subsection 775-45(2) subsection 775-45(5) subsection 775-135(2)
Related ATO interpretative decisions: ATO ID 2005/319
Subject references: Call options Financial derivatives Foreign currency Foreign currency rights Foreign exchange gains and losses Forex realisation event Forex realisation loss Hedging