ATO ID 2005/323: Foreign exchange (forex) gains and losses: re-exchange of currency under a foreign exchange swap contract
Date of decision: 11 November 2005
Year of income: Year ended 30 June 2005
Business line: Private Groups and High Wealth Individuals

Issue
Will forex realisation event 2 (FRE 2) happen under subsection 775-45(1) of the Income Tax Assessment Act 1997 (ITAA 1997) on the receipt of foreign currency when currencies are re-exchanged under a foreign exchange swap contract (FX swap)?

Decision
Yes. FRE 2 will happen under subsection 775-45(1) of the ITAA 1997 on the receipt of foreign currency when currencies are re-exchanged under a FX swap.

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 entered into a FX swap on 30 May 2005. Under the terms of the FX swap, the taxpayer initially exchanged USD for AUD on 30 May 2005 at an agreed exchange rate. On 20 June 2005 the taxpayer then re-exchanged the AUD for USD at a rate agreed upon when the FX swap was entered into.

Reasons for decision
Summary: Under the FX swap the taxpayer had a right to receive an amount of foreign currency which was created in return for it agreeing to pay an amount of AUD. Under subsection 775-45(1) of the ITAA 1997 FRE 2 happens if an entity ceases to have a right to receive foreign currency. Subsection 775-45(2) provides that FRE 2 happens when the entity ceases to have the right. The taxpayer ceased to have the right to receive foreign currency when it paid AUD in exchange for USD on 20 June 2005. Subsection 775-45(3) of the ITAA 1997 provides that a forex realisation gain is made if the AUD equivalent of the amount received in respect of FRE 2 happening exceeds the forex cost base of the right as determined at the tax recognition time. In this instance, the forex cost base under section 775-85 of the ITAA 1997 is the money the taxpayer is required to pay for acquiring the right. That is, the AUD the taxpayer paid for the USD it exchanged on 20 June 2005. The 'tax recognition time' is essentially when an event occurs which creates tax consequences. Item 4 of subsection 775-45(7) of the ITAA 1997 provides that for a right created in return for agreeing to pay AUD, the tax recognition time is when the amount is paid. Subsection 775-45(4) of the ITAA 1997 provides that a forex realisation loss is made if the AUD equivalent of the amount received in respect of FRE 2 happening falls short of the AUD equivalent of the amount the entity was entitled to receive as determined at the tax recognition time. The amount received is converted to AUD using the spot rate applicable on the date of receipt (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 excess or shortfall 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 2 happens. That is, in the income year ended 30 June 2005.

Legislative references: Income Tax Assessment Act 1997 subsection 775-15(1) subsection 775-30(1) subsection 775-45(1) subsection 775-45(2) subsection 775-45(3) subsection 775-45(4) subsection 775-45(7) section 775-85 subsection 775-105(1) subsection 960-50(6)
Related ATO interpretative decisions: ATO ID 2005/322
Subject references: Currency exchange rate Currency swaps Financial derivatives Foreign currency Foreign currency rights Foreign exchange gains and losses Forex cost base Forex realisation event Forex realisation gain Forex realisation loss Hedging Tax recognition time