ATO ID 2005/319: Foreign exchange (forex) gains and losses: effect on grantor 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 gain made under subsection 775-55(4) of the Income Tax Assessment Act 1997 (ITAA 1997) when a foreign currency denominated call option a taxpayer has granted lapses?

Decision
Yes. A forex realisation gain is made under subsection 775-55(4) of the ITAA 1997 when a foreign currency denominated call option a taxpayer has granted lapses.

Facts
The taxpayer entered into a business transaction requiring it to pay United Sates 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 sold a twelve month USD call option which gave it the obligation (if the buyer exercised the option) to sell a predetermined amount of USD in exchange for a predetermined amount of AUD. The taxpayer received a premium of AUD 40,000 on granting the option. The USD call option had an expiry date of 31 May 2005. Due to unfavourable movements in exchange rates, the option holder 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 granting the option, the taxpayer had an obligation to pay foreign currency incurred in return for it acquiring a right to receive AUD. Subsection 775-140(2) of the ITAA 1997 provides that an 'obligation to pay foreign currency' includes an obligation subject to a contingency. Under subsection 775-55(1) of the ITAA 1997, forex realisation event 4 (FRE 4) happens if an entity ceases to have the obligation to pay foreign currency. Subsection 775-55(2) of the ITAA 1997 provides that FRE 4 happens when an entity ceases to have the obligation. The taxpayer ceased to have the obligation to pay foreign currency when the option lapsed. The taxpayer made a forex realisation gain under subsection 775-55(4) of the ITAA 1997, as the option expired without having been exercised and, immediately before FRE 4 happened, had the option been exercised the taxpayer would have been obliged to pay the foreign currency. The forex realisation gain is the AUD 40,000 received by the taxpayer for granting the option (the premium received). This gain is included in the taxpayer's assessable income under subsection 775-15(1) of the ITAA 1997 in the income year ended 30 June 2005.

Legislative references: Income Tax Assessment Act 1997 subsection 775-15(1) subsection 775-55(1) subsection 775-55(2) subsection 775-55(4) subsection 775-140(2)
Related ATO interpretative decisions: ATO ID 2005/318
Subject references: Call options Financial derivatives Foreign currency Foreign currency obligations Foreign exchange gains and losses Forex realisation event Forex realisation gain Hedging