ATO ID 2004/571: Foreign Exchange (Forex): Forex realisation gain on repayment of borrowings to acquire non-portfolio dividend
Date of decision: 4 June 2004
Year of income: Year ended 30 June 2004.
Business line: Public Groups and International

Issue
Will any foreign exchange (forex) realisation gain made on the repayment of borrowings used to acquire shares in certain foreign companies, be non-assessable non-exempt income under section 775-25 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. A forex realisation gain made on the repayment of borrowings used to acquire shares in certain foreign companies will be non-assessable non-exempt income under section 775-25 of the ITAA 1997.

Facts
The taxpayer is an Australian resident company. The taxpayer acquired certain foreign companies. These foreign companies will pay non-portfolio dividends, as defined in section 317 of Part X of the Income Tax Assessment Act 1936 (ITAA 1936), that are non-assessable non-exempt income (as defined in section 6-23 of the ITAA 1997) to the taxpayer. To partly fund the acquisition of these companies, the taxpayer entered into an agreement to borrow foreign currency. The agreement comprises an obligation to repay amounts borrowed, and to pay interest on the borrowings to the financier. Amounts borrowed by the taxpayer under the agreement (the borrowings) were only used to acquire shares in the foreign companies.

Reasons for decision
Summary: Forex realisation event 4 occurs when the obligation to pay the borrowings is discharged by way of payment. Under the borrowing agreement, the taxpayer received foreign currency. In return for receipt of this foreign currency, the taxpayer incurred an obligation to repay foreign currency to the financier. When the taxpayer repays all or part of the borrowings, its obligation to pay foreign currency to the financier will cease to the extent of that repayment. Since the taxpayer's obligation to repay foreign currency was incurred in return for receiving an amount of foreign currency, forex realisation event 4 (FRE 4) will happen each time the taxpayer repays some or all of the borrowings (paragraph 775-55(1)(a) and subparagraph 775-55(1)(b)(ix) of the ITAA 1997 apply). FRE 4 will happen at the time of each repayment, pursuant to subsection 775-55(2). Whether a FRE 4 arising on a repayment of some or all of the borrowings, gives rise to a forex realisation gain (under subsection 775-55(3) of the ITAA 1997) or a forex realisation loss (under subsection 775-55(5)), requires a comparison to be made between: and Where the amount in paragraph (a) above falls short of the amount in paragraph (b) above, so much of that shortfall that is attributable to a currency exchange rate effect (as defined in section 775-105 of the ITAA 1997), is a forex realisation gain of the taxpayer (pursuant to subsection 775-55(3) of the ITAA 1997). A forex realisation gain made by the taxpayer under FRE 4 on a complete or partial repayment of the borrowings will be non-assessable non-exempt income to the taxpayer if, had it been a forex realisation loss, it would have been made in gaining or producing non-assessable non-exempt income (section 775-25 of the ITAA 1997). To determine the link or nexus between a forex realisation loss that could arise on a complete or partial repayment of the borrowings, and what it is 'made in gaining or producing', the purpose for, or use to which, the taxpayer put those borrowings must be considered (see Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613, Kidston Goldmines Ltd v. Federal Commissioner of Taxation (1991) 30 FCR 77; 91 ATC 4538; (1991) 22 ATR 168). This is because the taxpayer only incurred the obligation in relation to which any forex realisation loss arises (the obligation to repay the borrowings) in return for receiving the amount of those borrowings. The taxpayer used the borrowings to acquire shares in the foreign companies. The shares which the taxpayer acquired, like those considered in Federal Commissioner of Taxation v. Total Holdings (Australia) Pty Ltd 79 ATC 4279; (1979) 9 ATR 885, are inherently capable of generating income (see in particular Lockhart J at ATC 4282-4284; ATR 890). The taxpayer will be paid non-portfolio dividends from its shareholdings in the foreign companies. Non-portfolio dividends paid to the taxpayer from the foreign companies will be non-assessable non-exempt income of the taxpayer under either: (Note that any dividends paid by the foreign companies will be treated as first paid from profits that have been attributed to the taxpayer, and then from other profits.) Therefore, the borrowings will be used in gaining or producing non-assessable, non-exempt income of the taxpayer. John Fairfax & Sons Pty Ltd v. Federal Commissioner of Taxation (1959) 101 CLR 30; (1959) 11 ATD 510; (1959) 7 AITR 346 tells us that an outgoing can be incurred in gaining or producing income despite being an outgoing of a capital nature. A repayment of the borrowings, while itself an obligation of a capital nature, is an outgoing that the taxpayer will incur in gaining or producing non-assessable, non-exempt income. Any forex realisation loss arising on a complete or partial repayment of the borrowings will similarly be made by the taxpayer in gaining or producing non-assessable non-exempt income. Therefore, pursuant to section 775-25 of the ITAA 1997, any forex realisation gain made by the taxpayer on a complete or partial repayment of the borrowings to the financier will be treated as non-assessable non-exempt income.

Legislative references: Income Tax Assessment Act 1936 section 23AI section 23AJ section 317
Case references: Federal Commissioner of Taxation v. Total Holdings (Australia) Pty Ltd 79 ATC 4279 (1979) 9 ATR 885
Related ATO interpretative decisions: ATO ID 2004/572
Subject references: Foreign exchange gains and losses Forex realisation event Forex realisation gain International loans Non portfolio foreign income