ATO ID 2010/29: Controlled foreign companies: financial intermediary business - currency forward agreements and currency swap agreements hedging foreign currency transactions
Date of decision: 18 December 2009
Year of income: Year ended 30 June 2008
Business line: Public Groups and International

Issue
Does 'income... derived from the lending of money' within the meaning of paragraph (b) of the definition of 'financial intermediary business' in subsection 317(1) of the Income Tax Assessment Act 1936 (ITAA 1936) include any assessable profit or gain derived by an Australian financial institution (AFI) subsidiary under a currency swap agreement or currency forward agreement that hedges a borrowing, share issue or loan, by the AFI subsidiary which is designated in a foreign currency.

Decision
No. The amount of any assessable profit or gain under a currency swap agreement or currency forward agreement that hedges a borrowing, share issue or loan by the AFI subsidiary designated in a foreign currency is not 'income... derived from the lending of money' within the meaning of paragraph (b) of the definition of 'financial intermediary business' in subsection 317(1) of the ITAA 1936.

Facts
A non-resident subsidiary of an Australian resident company is a controlled foreign company (CFC) as defined in subsection 317(1) and section 340 of the ITAA 1936. The CFC enters into a currency swap agreement or currency forward agreement in order to hedge against movements in the rate of exchange for the foreign currency in which the CFC has borrowed, issued shares or made loans.

Reasons for decision
Summary: Paragraph (b) of the definition of 'financial intermediary business' in section 317 of the ITAA 1936 requires that the business must be either: a 'banking business' or, 'a business whose income is principally derived from the lending of money'. If the sole or principal business of an AFI subsidiary is 'financial intermediary business' as defined, the AFI subsidiary may be able to satisfy the requirements of subparagraph 439(1)(a)(iv) and/or sections 449 or 450 of the ITAA 1936 (which operate to exclude certain types of otherwise 'adjusted tainted income,' 'passive income' or 'tainted services income'). '[I]ncome ... derived from the lending of money' is income arising by reason of the provision of loan funds, for example, interest or other amounts assessable to the lender that are payable under the terms of the loan. In this sense, 'income ... derived from lending' is necessarily legally distinguished from income from a business which includes (or is characterised by) lending, such as a banking business. Any assessable profit or gain that arises from the execution or disposal of a currency swap agreement or currency forward agreement entered into by the CFC to hedge a borrowing, share issue or loan designated in a foreign currency is not 'income ... derived from the lending of money' in the requisite sense. Such assessable profit or gain arises under the terms of an agreement which is not the lending of money and is instead contingent on the particular terms of the swap agreement or the forward agreement (including any relevant movement in rate(s) of foreign exchange determinative of the rights and liabilities under the agreement). The requirement in paragraph (b) of the definition of 'financial intermediary business' in subsection 317(1) of the ITAA 1936 reflects a characterising feature of a business of financial intermediation through money lending. In Commercial Banking Co. of Sydney Ltd. v. Federal Commissioner of Taxation (1950) 81 CLR 263; 9 ATD 112; 4 AITR 406, in holding that the principal business of a bank was the lending of money, Dixon J said (at 81 CLR 304) that: The profit-making side of his [a banker's] activities is in putting out the money so as to increase it, and that substantially means to obtain interest. In the same case, Latham CJ said at 81 CLR 295: In determining whether the lending of money is the principal business of a taxpayer it is proper to look at the business of the taxpayer in relation to its proceeds, that is the income which it produces. In the present case seventy-five per cent of the income is interest derived from the lending of money and the activity of gaining that income is, from the point of view of proceeds of the business of the taxpayer, the principal business activity of the taxpayer. In my opinion, therefore, the Board of Review properly held that the principal business of the bank was the lending of money... In the Privy Council decision in American Leaf Blending Co Sdn Bhd v. Director-General of Inland Revenue [1979] AC 676; [1978] 3 WLR 985; [1978] 3 All ER 1185; Lord Diplock noted [1978] 3 All ER 1185 at 1189: The gains or profit from the business of a bank or moneylender are largely derived from interest received on money lent. The concessional rules in subparagraph 439(1)(a)(iv) and sections 449 and 450 of the ITAA 1936 apply if, and only if, the AFI subsidiary is a bank or satisfies the requirement that its assessable income principally consists of income from lending. In particular, section 450 of the ITAA 1936 distinguishes between income from the lending of money (for example, interest income) and the other kinds of income that may be derived by an eligible AFI subsidiary in the course of undertaking a business that principally derives its income from the lending of money. The key to understanding section 450 of the ITAA 1936 is that the sole or principal business must be a 'financial intermediary business' before income from the disposal of specified kinds of financial assets will be afforded concessional treatment in applying the active income test.

Legislative references: Income Tax Assessment Act 1936 subsection 317(1) section 340 subparagraph 439(1)(a)(iv) section 449 section 450
Case references: Commercial Banking Co of Sydney Ltd v Federal Commissioner of Taxation (1950) 81 CLR 263 9 ATD 112 4 AITR 406
Related ATO interpretative decisions: ATO ID 2010/28 | ATO ID 2008/109 | ATO ID 2007/1
Subject references: Australian financial institution foreign subsidiaries Controlled foreign companies International tax