ATO ID 2010/59: Functional currency choice: amounts borrowed/lent in a non-AUD currency which later becomes the 'applicable functional currency'
Date of decision: 4 March 2010
Year of income: Year ended 30 June 2010 Year ended 30 June 2011 Year ended 30 June 2012 Year ended 30 June 2013
Business line: Public Groups and International

Issue
Where amounts have been borrowed/lent in a non-AUD currency which later becomes the 'applicable functional currency', is the principal amount outstanding at the effective time of the functional currency choice an amount that needs to be translated under the two step translation in section 960-85 of Subdivision 960-D of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes, where amounts have been borrowed/lent in a non-AUD currency which later becomes the 'applicable functional currency', the principal amount outstanding at the effective time of the functional currency choice is an amount that needs to be translated under the two step translation in section 960-85 of Subdivision 960-D of the ITAA 1997.

Facts
The taxpayer is the head company of a consolidated group with effect from 1 July 2002. The taxpayer has been preparing its financial statements in USD and is intending to make a functional currency choice under Item 1 of subsection 960-60(1) of the ITAA 1997 to use USD, with effect from 1 July 2010. The taxpayer has not previously chosen to use a non-AUD 'applicable functional currency'. The taxpayer has entered into various loan agreements prior to the effective time of the functional currency choice under which it assumed various obligations. Some of these loan agreements were denominated in USD.

Reasons for decision
Summary: Section 960-85 Special rule about translation - events that happened before the current choice took effect Australian resident required to prepare financial reports under section 292 of the Corporations Act 2001 960-85(1) If: (a) as the result of a choice (the current choice ) made by you under item 1 of the table in subsection 960-60(1), subsection 960-80(1) requires that an amount be translated to the *applicable functional currency; and (b) the amount is attributable to an event that happened, or a state of affairs that came into existence, at a time (the event time ) before the current choice took effect; Taxation Ruling TR 2007/5 'Income tax: functional currency - when is an amount not in the 'applicable functional currency'?' states at paragraphs 32-34 and 101 that: 32. ... An 'amount' is not in the 'applicable functional currency' for the purposes of section 960-85, where the provisions within Subdivision 960-D have not previously recognised it as such. 33. Section 960-85 is concerned with amounts which are 'attributable to an event that happened or a state of affairs that came into existence' in a prior year, (a 'prior year event'), being a year in which the use of the 'applicable functional currency' did not occur. The concept of 'applicable functional currency' in this respect is purely an income tax law one. In the absence of a valid choice under subsection 960-60(1) to use this currency, there is no 'applicable functional currency' and the appropriate currency required to be used for income tax purposes is Australian currency. 34. It is considered that amounts which are 'attributable to' a 'prior year event' in a year in which the use of the 'applicable functional currency' did not apply, are thereby amounts which are not in the 'applicable functional currency'. This is so even where the amounts (or their elements), are denominated in the relevant source in the non-Australian currency that subsequently becomes the 'applicable functional currency'. 101. ... under the scheme of Subdivision 960-D, there cannot exist prior to the time of application of section 960-80, any amounts in the 'applicable functional currency', notwithstanding what the position may have been (say) for accounting purposes. This is because the 'applicable functional currency' is a statutory concept under section 960-70 which cannot have applied before this time. It follows that where loans were taken out or made in USD prior to the USD being chosen as the 'applicable functional currency', the amount of principal outstanding in USD as at the effective date of the functional currency choice is an amount that is not in the 'applicable functional currency'. This is because there is no 'applicable functional currency' (and hence can be no amount in the 'applicable functional currency') for income tax purposes, prior to the effective time of a functional currency choice. In a practical sense, if the loan is a post 30 June 2003 loan, the USD amount will have already been translated to Australian dollars pursuant to subsection 960-50(1) of Subdivision 960-C of the ITAA 1997. This means that the first step of the two step translation under section 960-85 of the ITAA 1997 will have already happened (see also former section 103-20 of the ITAA 1997 with regard to pre 1 July 2003 CGT amounts). The amount of principal in USD, which is outstanding at the effective time of a functional currency choice, is both a 'pre choice' amount that is attributable to a 'prior year event' and also a 'relevant amount' with potential ongoing tax significance. In particular, it is also an amount that is not in the 'applicable functional currency' and so is subject to translation under section 960-85 of the ITAA 1997 - even where the 'applicable functional currency' subsequently chosen is USD.

Legislative references: Income Tax Assessment Act 1997 Subdivision 960-C subsection 960-50(1) Subdivision 960-D subsection 960-60(1) section 960-85
Related public rulings and determinations: Taxation Ruling TR 2007/5
Subject references: Applicable functional currency Functional currency Functional currency choice Borrowings & loans