Private ruling: TOFA section 230-30 - income tax treatment of gains and losses
Published: July 2014
Ruling period: 1 January 20XX - 31 December 20XX | 1 January 20YY - 31 December 20YY
Date scheme commenced: The scheme has commenced

Ruling: Q1: Will subsection 230-30(3) of the Income Tax Assessment Act 1997 (ITAA 1997) apply such that any loss Ausco makes from the loan to Ausco from an offshore related entity (the Loan) that is attributable to currency exchange rate movements is not an allowable deduction to Ausco, to the extent that the Loan was used to recapitalise a foreign subsidiary (Forsub)? | A1: Yes | Q2: Will subsection 230-30(2) of the ITAA 1997 apply such that any gain Ausco makes from the Loan that is attributable to currency exchange rate movements is non-assessable non-exempt (NANE) income of Ausco, to the extent that the Loan was used to recapitalise Forsub? | A2: Yes

Relevant facts and circumstances: 1. The Ausco Group ( Group ) is comprised of the head office in Australia, and global divisions. 2. Ausco is a Part X Australian resident company and is the head entity of the Ausco income tax consolidated group (the Ausco TCG ). 3. Forsub, is a wholly owned subsidiary of Ausco. 4. The CFO of Forsub requested a capital contribution to Forsub. The memo requesting the funds provided details of the flow of funds to Forsub and its wholly owned subsidiaries. 5. The funding request was approved by the Ausco Board. 6. Ausco borrowed funds from an offshore related entity on a short term basis with the intention at that time to extinguish the debt through a dividend from the offshore related entity. The funds were paid into Ausco's Demand Deposit Account. The terms of the loan are detailed in the Intra-Group Loan Facility Agreement ( Agreement ) and include: a. Loan: The facility was advanced to the borrower on an unsecured basis (Clause 2.1) b. Use of loan funds: The Borrower shall use the Loan for general commercial purposes, and as working capital (Clause 3.1) c. Interest: The Borrower shall pay interest on the Loan at a fixed rate of x% over the six month US Dollar LIBOR rate fixed by the British Bankers Association (Clause 4.1). Interest accrues daily (Clause 10.1). d. Repayment Date: xx/xx/xxxx, or such other date as the parties agree in writing (Clause 1.1). The Borrower shall repay the Loan and any accrued interest on the Repayment Date (Clause 6.1). 7. The funds were transferred to Forsub on the agreed date. 8. The Loan funds were used to recapitalise Forsub. The recapitalisation of Forsub was required in order to reduce debt facilities prior to the end of the relevant financial year. The repayment of debt provided a number of benefits, including improvements to the balance sheet, additional flexibility to the offshore operations to quickly draw down cash in the future and retiring a facility (which had an interest rate significantly above current market rates). 9. From an overall perspective, the retiring of external debt prior to year end improved the Group's debt to equity ratio. As detailed in the Group Capital Strategy and Plans, the reduction of the debt to equity ratio was a major driver of capital and funding activity in the relevant year. 10. Ausco has a history of providing funding to subsidiaries by way of recapitalisation rather than debt where possible. 11. Ausco has a minimum requirement that each division remit a significant percentage of earned profits to head office in order to support the funding of the ultimate dividend to external shareholders. 12. The dividend policy is predicated on the profits of a division being repatriated. 13. The ability of Ausco entities to pay dividends is only constrained where the entities are subject to industry specific regulatory requirements. 14. Forsub has paid dividends to Ausco in previous years.

Relevant legislative provisions: Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 Section 6 | Income Tax Assessment Act 1936 Section 23AJ | Income Tax Assessment Act 1936 Sections 317 | Income Tax Assessment Act 1936 Section 334A | Income Tax Assessment Act 1936 Paragraph 336(c) | Income Tax Assessment Act 1997 Subsection 8–1(1) | Income Tax Assessment Act 1997 Paragraph 8–1(2)(c) | Income Tax Assessment Act 1997 Division 230 | Income Tax Assessment Act 1997 Subdivision 230-H | Income Tax Assessment Act 1997 Subsection 230-15(1) | Income Tax Assessment Act 1997 Subsection 230-15(2) | Income Tax Assessment Act 1997 Subsection 230-15(3) | Income Tax Assessment Act 1997 Subsection 230–30(2) | Income Tax Assessment Act 1997 Subsection 230–30(3) | Income Tax Assessment Act 1997 Section 230-45 | Income Tax Assessment Act 1997 Subsection 230-45(1) | Income Tax Assessment Act 1997 Paragraph 230-45(1)(b) | Income Tax Assessment Act 1997 Paragraph 820–40(1)(a) | Income Tax Assessment Act 1997 Subparagraph 820–40(1)(a)(ii) | Income Tax Assessment Act 1997 Paragraph 820-40(3)(b) | Income Tax Assessment Act 1997 Section 974-160

Reasons for decision: Summary: Note: All legislative references are to the ITAA 1997 unless stated otherwise. Division 230 deals with the income tax treatment of financial arrangements that began on or after 1 July 2010. Subsection 230-45(1) defines the term 'financial arrangement' as follows: You have a financial arrangement if you have, under an *arrangement: (a) a *cash settlable legal or equitable right to receive a *financial benefit; or (b) a cash settlable legal or equitable obligation to provide a financial benefit; or (c) a combination of one or more such rights and/or one or more such obligations; unless: … The right, obligation or combination covered by paragraph (a), (b) or (c) constitutes the financial arrangement. (Note: the exception described in paragraphs (d) - (f) of the definition is not reproduced here as it is not relevant to the present case.) Subsection 230-45(2) defines the term 'cash settlable' as follows: A right you have to receive, or an obligation you have to provide, a *financial benefit is cash settlable if, and only if: (a) the benefit is money or a *money equivalent; or (b) in the case of a right - you intend to satisfy or settle it by receiving money or a money equivalent or by starting to have, or ceasing to have, another *financial arrangement; or (c) in the case of an obligation - you intend to satisfy or settle it by providing money or a money equivalent or by starting to have, or ceasing to have, another financial arrangement; or … (Note: Paragraphs (d) - (g) of the definition, not reproduced here, deal with additional ways of satisfying the definition that are not relevant to the present case.) A financial benefit is anything of economic value (section 974-160). A typical loan arrangement, under which a borrower has a contractual right to receive a principal sum in cash from the lender and a contractual obligation to repay the principal plus interest in cash by a certain date, would be a financial arrangement under paragraph 230-45(1)(c). Division 230 does not apply to the gains and losses of all financial arrangements. The exceptions are dealt with in Subdivision 230-H, none of which apply to the present case. If Division 230 applies to gains or losses from a financial arrangement, the arrangement is called a 'Division 230 financial arrangement'. Generally, under Division 230 a gain you make from a financial arrangement is included in your assessable income (subsection 230-15(1)). A loss you make from a financial arrangement is deductible to the extent that you make the loss in gaining or producing your assessable income, or you necessarily make it in carrying on a business for the purpose of gaining or producing assessable income (subsection 230-15(2)). The tax treatment of gains and losses related to NANE income are exceptions to this general approach of being assessable or deductible. Subsection 230-30(2) provides that despite section 230-15, a gain made from a financial arrangement will be NANE income to the extent that, if the gain had been a loss instead (a 'hypothetical loss'), the hypothetical loss would have been made in gaining or producing NANE income. Subsection 230-30(3) provides that a loss made from a financial arrangement is not an allowable deduction under any provision of the income tax law other than subsection 230-15(3) to the extent it is made in gaining or producing NANE income. Subsection 230-15(3) permits an Australian entity to deduct a loss that it makes from a financial arrangement that is made in deriving NANE income from a foreign source under section 23AJ of the ITAA 1936 to the extent (if any) that the loss is a cost in relation to a debt interest issued by the taxpayer that is covered by paragraph 820-40(1)(a) of the ITAA 1997. That paragraph states: (a) the cost is: (i) interest, an amount in the nature of interest, or any other amount that is calculated by reference to the time value of money; or (ii) the difference between the *financial benefits received, or to be received, by the entity under the *scheme giving rise to the debt interest and the financial benefits provided, or to be provided, under that scheme; or … However, paragraph 820-40(3)(b) provides that where a loss that would be a cost covered by subparagraph 820-40(1)(a)(ii) except for the fact that the relevant financial benefits are measured in a foreign currency and the loss is due solely to changes in the rate of converting that foreign currency into Australian currency, the cost is not covered by paragraph 820-40(1)(a). 'Australian entity' is a defined term that includes an entity (other than a partnership or a trust) that is a 'Part X Australian resident' (see subsection 995-1(1) and sections 317 and paragraph 336(c) of the ITAA 1936). A Part X Australian resident is a resident within the meaning of section 6 of the ITAA 1936 that is not taken under a tie-breaker provision in a double tax agreement in force in respect of a foreign country to be a resident solely of that country (see section 317 of the ITAA 1936). Section 23AJ of the ITAA 1936 provides: A non-portfolio dividend (as defined in section 317 [of the ITAA 1936]) paid to a company is not assessable income, and is not exempt income, of the company if: (a) the company is an Australian resident and does not receive the dividend in the capacity of a trustee; and (b) the company that paid the dividend is not a Part X Australian resident (as defined in that section). A non-portfolio dividend means a dividend (other than an eligible finance share dividend or a widely distributed finance share dividend) paid to a company where that company has a voting interest, within the meaning of section 334A of the ITAA 1936, amounting to at least 10% of the voting power, within the meaning of that section, in the company paying the dividend. Taxation Ruling TR 2012/3 Income tax: taxation of financial arrangements - application of subsections 230-30(2) and 230-30(3) of the Income Tax Assessment Act 1997 to gains and losses relating to exempt income or non-assessable non-exempt income ( TR 2012/3 ) explains the principles that apply in deciding whether or not a loss you make, or hypothetical loss you would have made, from a financial arrangement is made in gaining or producing exempt income or NANE income for the purposes of subsections 230-30(2) and 230-30(3). The principles relevant to the present case are set out in paragraphs 9-14 of TR 2012/3 and are as follows: • As with subsection 8-1(1) and paragraph 8-1(2)(c), the words 'in gaining or producing' require an examination of whether or not there is a sufficient connection between the identified loss and an income producing activity. Whether a sufficient connection exists will depend on the nature of the loss and the degree of its connection with the activities by which the taxpayer is gaining or producing the relevant income. • The words 'in gaining or producing' have a wide application ( Amalgamated Zinc (De Bavay's) Ltd v. Federal Commissioner of Taxation (1935) 54 CLR 295 at 309; [1935] HCA 81). • A loss is made in gaining or producing exempt income or NANE income if the loss is incidental and relevant to the exempt income or NANE income producing activity of the taxpayer ( Ronpibon Tin NL and Tongkah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; [1949] HCA 15 ( Ronpibon Tin )). • Incidence and relevance requires an examination of the connection that the making of the loss has with the operations which more directly gain or produce the exempt income or NANE income ( Charles Moore & Co (WA) Pty Ltd v. Federal commissioner of Taxation (1956) 95 CLR 344 at 351; [1956] HCA 77 at paragraph 7). • Whether a loss has a sufficient connection to the gaining or producing of exempt income or NANE income is a question of fact and circumstances. Paragraphs 132 - 139 of TR 2012/3 discuss the connection that a foreign exchange loss that is made in relation to a borrowing used to acquire a NANE income producing asset has with the production of NANE income. Paragraph 133 of TR 2012/3 states: A foreign exchange loss is akin to a cost of borrowing, or of obtaining and securing borrowed funds for use in the business. This characterisation of the loss being a cost of borrowing and having regard to the wide nature of the nexus test (assuming there is no issue of the expenditure being too soon or post-derivation) leads to the conclusion that such a loss is made in gaining or producing NANE income. Paragraph 9 of Taxation Ruling IT 2606 Income tax: deduction for interest on borrowings to fund share acquisitions (IT 2606) similarly states: As a general rule, interest on money borrowed to acquire shares will be deductible under the first limb of subsection 51(1) where it is expected that dividends or other assessable income will be derived from the investment. Such an expectation will usually exist as shares by their very nature are inherently capable of generating dividends, whether in the short or long term. However, such an expectation must be reasonable and not a mere theoretical possibility; there must be a prospect of dividends or other assessable income being received. Paragraph 20 of IT 2606 refers to the evidence before the Full Federal Court in FC of T v Total Holdings (Australia) Pty Ltd 79 ATC 4279 ( Total Holdings ). Paragraph 20 states: The parent had a policy of requiring dividends to be remitted and it had sufficient control over the subsidiary to ensure that this policy was followed. This was sufficient evidence to show an expectation of income by the parent at some time in the future. In 'Example 3 - borrowing for investment in shares' in TR 2012/3, an Australian resident company borrows to acquire shares in a foreign subsidiary and on repayment of the loan makes a foreign exchange gain. There was a reasonable expectation that the shares in the foreign subsidiary would pay dividends that would satisfy section 23AJ of the ITAA 1936. Example 3 at paragraph 35 provides: If the gain that arises in relation to the repayment of the loan principal had been a loss instead, this hypothetical loss would have been made in gaining or producing NANE income. The interest and the currency exchange rate movement on the principal are together a cost of financing. Consequently, the gain is NANE income under subsection 230-30(2). Example 3 concludes that: If an actual loss arose in these circumstances instead of the gain, such a loss would not be allowable as a deduction by virtue of subsection 230-30(3). The explanation in paragraph 70 of TR 2012/3 is also relevant. Paragraph 70 states: …a loss made in relation to the satisfaction of an obligation to pay interest on a loan, the funds from which were used to acquire an asset that produces NANE income, has a nexus with the production of NANE income. | Detailed Reasoning - Application to the facts: Whether gains or losses from currency exchange rate movements in respect of the Loan have a sufficient connection to the gaining or producing of NANE income is a question of fact and circumstances. The facts and circumstances in respect of the Loan are: 1. Ausco is an Australian entity and Part X Australian resident. 2. Ausco borrowed funds from its wholly owned foreign resident subsidiary (the Loan). 3. Under the terms of the Loan Agreement, the Loan is a financial arrangement for the purposes of section 230-45. 4. None of the exceptions in Subdivision 230-H apply, therefore the Loan is a Division 230 financial arrangement. 5. The Loan proceeds were deposited into the Ausco Demand Deposit Account on the agreed date. 6. The Loan proceeds were applied to recapitalise Forsub the next day. 7. Ausco has a dividend policy that requires each division within the group to remit a significant percentage of earned profits to Ausco. 8. Ausco has earned and expects to earn income in the form of non-portfolio dividends from Forsub. 9. These dividends are NANE income of Ausco under section 23AJ of the ITAA 1936. In previous years Ausco has received dividend payments from Forsub. Ausco recapitalised Forsub with the reasonable expectation that its investment would result in the payment of NANE dividends. As comparable with paragraph 20 of IT 2606, the policy that each division must remit a portion of its profits each year to Ausco is sufficient evidence to indicate an expectation of dividends from Forsub to Ausco. Ausco, as the holder of the issued share capital, has sufficient control over Forsub to ensure that the dividend policy is followed. According to TR 2012/3 a foreign exchange loss in respect of borrowings used to acquire a NANE income producing asset is akin to interest on the borrowings, and as such, the foreign exchange loss will also have a nexus with the production of NANE income. In the present case, the borrowings have been used to recapitalise Forsub and maintain its ability to generate NANE income for Ausco, but the principle is the same. In accordance with the principles identified above in TR 2012/3 and IT 2606, any foreign exchange loss in respect of the Loan is made 'in gaining or producing' NANE income, and any foreign exchange gain in respect of the Loan, if it were a loss, would be made in gaining or producing NANE income. As a result, • any foreign exchange loss in respect of the Loan is not allowable as a deduction under any provision of the ITAA 1997 or the ITAA 1936 to the extent that it is made in gaining or producing NANE income (subsection 230-30(3)); and • any foreign exchange gain in respect of the Loan is NANE income (subsection 230-30(2)) to the extent that, if it were a loss, it would be made in gaining or producing NANE income. Regarding the words 'to the extent' in the previous paragraph, it is considered that the Loan funds are utilised entirely for the purpose of recapitalising Forsub.