Private ruling: foreign exchange gains or losses and the making of an applicable functional currency choice
Published: December 2014
Ruling period: 1 January 2011 to 31 December 2015
Date scheme commenced: 1 January 2011

Ruling: Q1: Will forex realisation event 4 (FRE 4) happen pursuant to section 775-55 in respect of the Bridging Loan, being a loan obligation, as a consequence of making an applicable functional currency (AFC) choice? | A1: No | Q2: Does section 6-5 apply to include in the assessable income of HeadCo, as the head company of the MEC Group, any embedded gain in respect of the Bridging Loan by virtue of section 960-85 as a consequence of HeadCo's choice to adopt a functional currency? | A2: No | Q3: Will FRE 4 happen pursuant to section 775-55 as a consequence of the repayment of the Bridging Loan? | A3: No | Q4: Does section 6-5 apply to include in the assessable income of HeadCo, as head company of the MEC Group, any embedded gain calculated under section 960-85 as a consequence of the repayment of the Bridging Loan? | A4: No | Q5: Does section 102-5 apply to include in the assessable income of HeadCo, as head company of the MEC Group, any net capital gain calculated under section 960-85 in respect of the Bridging Loan as a consequence of the repayment of the Bridging Loan? | A5: No | Q7: Is it open to the Commissioner to make a determination under section 177F of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of any or all of the facts described in this ruling? | A6: No

Relevant facts and circumstances: OverseasCo is a foreign resident company with business interests around the world. Currently, OverseasCo's main Australian operating subsidiary is HeadCo. HeadCo prepares financial reports and directors' reports pursuant to section 292 of the Corporations Act 2001 (Cth). A multiple entry consolidated (MEC) group was formed for Australian tax purposes (the HeadCo MEC Group). HeadCo is the head company of the HeadCo MEC group. The HeadCo MEC Group comprises of HeadCo and HoldingCo. All interests in the members of the HeadCo MEC Group are directly held by the overseas parent entity, OverseasCo. HOLDINGCO HoldingCo is an Australian company which is 100% owned by OverseasCo. The principal activity of HoldingCo is to hold interests in InterestCo. InterestCo owns interests in various assets. This indirect investment is held through the following structure: a) HoldingCo holds interests in InterestCo, which is a foreign incorporated and tax resident company. b) InterestCo owns interests in various foreign assets. c) InterestCo owns 100% of ForCo a foreign resident company. ForCo is a participant, and holds an interest, in a large project (Project). HoldingCo is not a finance entity and the provision of finance is not a core part of its business activities. BRIDGING LOAN The relevant borrowing which is the subject of this Private Ruling is set out in detail below. OverseasCo obtained funds via a banking consortium loan. OverseasCo on lent the funds to HoldingCo pursuant to the Bridging Loan at interest. This created the intercompany debt between OverseasCo and HoldingCo. The funds received by HoldingCo under the Bridging Loan were used to acquire an interest in InterestCo and for ancillary and general expenses of HoldingCo. The drawdowns to fund the acquisition of an interest in InterestCo by HoldingCo were completed in 200X. Under the Bridging Loan facility, HoldingCo may borrow up to a specified limit. This facility limit may be varied at any time if both parties agree. All advances are to be made in overseas dollars. HoldingCo is required to give a drawdown notice to OverseasCo in order to draw advances under the loan facility. The advances have never been converted into any other currency. HeadCo, as head company of the HeadCo MEC Group, did not make an election for Division 230 to apply to financial arrangements the HeadCo MEC Group started to have prior to 1 January 2011. REPAYMENT OF THE BRIDGING LOAN The final repayment date of the Bridging Loan has been extended pursuant to the relevant clause of the Bridging Loan facility on numerous occasions and to date no repayments of the outstanding principal on the Bridging Loan have been made by HoldingCo. No interest payments in respect of the Bridging Loan have been made and a liability for the unpaid interest exists in the financials of HoldingCo. Pursuant to a separate agreement, HoldingCo has receivables from OverseasCo (Receivable). The market value of the Receivable is equal to its face value. The Receivable has not been the subject of any impairment as evidenced by the relevant entries in HoldingCo's audited Special Purpose Financial Reports. HoldingCo, with the agreement of OverseasCo, intends to satisfy its obligation to repay the Bridging Loan either by way of: (a) a set-off of the outstanding liability under the Bridging Loan against a portion of the Receivable owed to it by OverseasCo; or (b) a transfer of funds from HoldingCo to OverseasCo to repay in full the outstanding liability under the Bridging Loan; or (c) a combination of a partial set-off and transfer of funds as contemplated in subparagraphs (a) and (b) above to fully extinguish the outstanding liability under the Bridging Loan. The steps described above by which HoldingCo intends to discharge its liabilities under the Bridging Loan comprises the basis of repayment of the Bridging Loan (Repayment). The Bridging Loan will not be released, waived or otherwise extinguished other than by way of the repayment options listed above. APPLICABLE FUNCTIONAL CURRENCY CHOICE HeadCo, as head company of the HeadCo MEC Group, made a backdated start up choice to use its applicable functional currency (FC) pursuant to item 1 of the table in subsection 960-60(1). FC is the sole or dominant currency in which the HeadCo MEC Group kept its accounts at the time the applicable functional currency choice was made. HeadCo had not made a previous choice under item 1 of the table in subsection 960-60(1) of the ITAA 1997. CURRENCY MOVEMENTS Between the date that HoldingCo made the first drawdown of the Bridging Loan and the effective date of the applicable functional currency choice, the AUD had on average appreciated in value against the FC.

Relevant legislative provisions: Income Tax Assessment Act 1936 Subsection 177A(1), | Income Tax Assessment Act 1936 Subsection 177A(5), | Income Tax Assessment Act 1936 Subsection 177C(1), | Income Tax Assessment Act 1936 Subsection 177C(2), | Income Tax Assessment Act 1936 Subparagraph 177C(2)(a)(i), | Income Tax Assessment Act 1936 Section 177D, | Income Tax Assessment Act 1936 Paragraph 177D(b), | Income Tax Assessment Act 1936 Section 177F, | Income Tax Assessment Act 1936 Subsection 177F(1), | Income Tax Assessment Act 1997 Section 6-5, | Income Tax Assessment Act 1997 Subsection 100-10(2), | Income Tax Assessment Act 1997 Section 102-5, | Income Tax Assessment Act 1997 Section 102-20, | Income Tax Assessment Act 1997 Division 104, | Income Tax Assessment Act 1997 Section 108-5, | Income Tax Assessment Act 1997 Division 245, | Income Tax Assessment Act 1997 Section 245-10, | Income Tax Assessment Act 1997 Section 245-35, | Income Tax Assessment Act 1997 Sections 245-115 to 245-195 (inclusive), | Income Tax Assessment Act 1997 Section 701-1, | Income Tax Assessment Act 1997 Section 775-55, | Income Tax Assessment Act 1997 Paragraph 775-55(1)(a), | Income Tax Assessment Act 1997 Subdivision 960-D | Income Tax Assessment Act 1997 Subsection 960-80(1), | Income Tax Assessment Act 1997 Section 960-85 and | Income Tax Assessment Act 1997 Subsection 995-1(1).

Reasons for decision: Summary: Forex realisation event 4 (FRE 4) will not happen pursuant to section 775-55 in respect of the Bridging Loan, being a loan obligation, as a consequence of making an applicable functional currency (AFC) choice. | Detailed Reasoning - Detailed reasoning: FRE 4 is contained in section 775-55. Relevantly, that section provides: 775-55 Ceasing to have an obligation to pay foreign currency-forex realisation event 4 Forex realisation event 4 (1) Forex realisation event 4 happens if: (a) you cease to have an obligation, or a part of an obligation, to pay *foreign currency; and (b) any of the following applies: … (ix) you incurred the obligation, or the part of the obligation, in return for receiving an amount of Australian currency or foreign currency; … Note: For extended meaning of obligation to pay foreign currency , see section 775-140. Time of event (2) The time of the event is when you cease to have the obligation or the part of the obligation. Forex realisation gain (3) You make a forex realisation gain if: (a) the amount you paid in respect of the event happening falls short of the proceeds of assuming the obligation or the part of the obligation (the proceeds are worked out as at the tax recognition time); and (b) some or all of the shortfall is attributable to a *currency exchange rate effect. The amount of the forex realisation gain is so much of the shortfall as is attributable to a currency exchange rate effect. Note 1: For proceeds of assuming the obligation , see section 775-95. Note 2: For tax recognition time , see subsection (7). Note 3: For currency exchange rate effect , see section 775-105. … For FRE 4 to happen, one of the necessary conditions is that the taxpayer must cease to have an obligation, or part of an obligation, to pay 'foreign currency'. The choice by HeadCo to adopt USD as its applicable functional currency does not represent the cessation of an obligation to pay foreign currency for the purposes of paragraph 775-55(1)(a). Consequently, the AFC choice coming into effect will not trigger FRE 4. | Summary: Section 6-5 will not apply to include in the assessable income of HeadCo, as head company of the HeadCo MEC Group, any embedded gain in respect of the Bridging Loan by virtue of section 960-85 as a consequence of HeadCo's choice to adopt a FC functional currency. | Detailed Reasoning - Detailed reasoning: In respect of the income tax treatment under section 6-5 of any embedded gain calculated under section 960-85, it is necessary to determine whether the borrowing activities of the taxpayer form an integral part of its business that is revenue in nature, or whether these activities simply add to its capital structure and provide funds for financing its business operations ( Federal Commissioner of Taxation v Hunter Douglas Limited 83 ATC 4562, 50 ALR 97 (1983)). In Avco Financial Services Ltd v FC of T , 82 ATC 4246; 13 ATR 63 ( Avco ), the High Court held that foreign exchange gains and losses arising from the repayment of foreign currency loans used in the ordinary course of the business of a finance company were revenue in nature. In doing so, the Court recognised that revenue gains and losses could arise in relation to liabilities arising from borrowings, even though the borrowing itself is typically an affair of capital. In the present circumstances, HeadCo, head company of the HeadCo MEC Group, does not carry on business as a money lender. Accordingly, the borrowing activities of HeadCo can be distinguished from those of the taxpayer in Avco. Under the single entity rule in section 701-1, HeadCo is taken to have entered into the Bridging Loan with the purpose of using the borrowings to acquire an interest in InterestCo, cover other costs related to that acquisition and conduct its business activity. HeadCo did not raise the borrowings under the Bridging Loan in the course of carrying on a business of providing finance. On the above basis, any embedded gain made as a consequence of HeadCo's choice to adopt a FC functional currency will be capital in nature. As a result, section 6-5 will not apply to include in the assessable income of HeadCo any embedded gain calculated under section 960-85, as a consequence of HeadCo's choice to adopt a FC functional currency. | Summary: FRE 4 will not happen pursuant to section 775-55 as a consequence of the repayment of the Bridging Loan. | Detailed Reasoning - Detailed reasoning: For FRE 4 to happen, one of the necessary conditions is that the taxpayer must cease to have an obligation, or part of an obligation, to pay 'foreign currency'. Ordinarily, the repayment of FC borrowing represents the cessation of an obligation to pay foreign currency, and will potentially give rise to either a forex realisation gain or a forex realisation loss depending on the difference in the Australian dollar equivalent of the repaid amount at the time of its repayment as opposed to the time when that amount was borrowed. However, once an election has been made under subsection 960-60(1) for FC to become the applicable functional currency, FC ceases to be a foreign currency (Item 1(a)(iv) of the table in subsection 960-80(1)). It follows that the Bridging Loan to be repaid after 1 January 2012 (the effective date of HeadCo's election to adopt a FC functional currency) is not an obligation to pay foreign currency from the effective date of an applicable functional currency choice. Accordingly, there will be no cessation of an obligation to pay foreign currency as a consequence of the repayment of the Bridging Loan for the purposes of section 775-55 and FRE 4 will not be triggered. | Summary: Section 6-5 will not apply to include in the assessable income of HeadCo, as head company of the HeadCo MEC Group, any embedded gain calculated under section 960-85 as a consequence of the repayment of the Bridging Loan. | Detailed Reasoning - Detailed reasoning: As explained in our response to Question 2, any embedded gains in respect of the Bridging Loan will not constitute ordinary income under section 6-5. As a result, section 6-5 will not apply to include in the assessable income of HeadCo any embedded gain calculated under section 960-85 at the time of repayment of the Bridging Loan. | Summary: Section 102-5 will not apply to include in the assessable income of HeadCo, as head company of the HeadCo MEC Group, any net capital gain calculated under section 960-85 in respect of the Bridging Loan as a consequence of the repayment of the Bridging Loan. | Detailed Reasoning - Detailed reasoning: Section 102-5 provides that a taxpayer's assessable income includes a net capital gain made in the income year. The net capital gain is the total of the taxpayer's capital gains for the income year, reduced by certain capital losses the taxpayer has made (subsection 100-10(2)). A capital gain or capital loss cannot arise unless a CGT event happens (section 102-20). All the CGT events for which the taxpayer can make a capital gain or loss are set out in Division 104. Broadly, a 'CGT asset' is defined in section 995-1(1), by reference to section 108-5, as any kind of property, or a legal or equitable right that is not property. The CGT consequences for a debtor (borrower) have been considered in CGT Determination Number 3 - TD 3, Capital Gains: What are the CGT consequences for the borrower (debtor) when a debt is waived ? (TD 3). TD 3 states that the borrower is not considered to have an asset for CGT purposes. Therefore, a repayment of the Bridging Loan does not amount to the disposal of an asset for CGT purposes and none of the specific CGT events in Division 104 would apply when repayment occurs. Consequently, section 102-5 will not apply to include in the assessable income of HeadCo, as head company of the HeadCo MEC group, any gain calculated under section 960-85 in respect of the Bridging Loan as a consequence of the repayment of the Bridging Loan. | Summary: Sections 245-115 to 245-195 (inclusive) do not apply as a consequence of a repayment of the Bridging Loan. | Detailed Reasoning - Detailed reasoning: Sections 245-115 to 245-195 consider the application of net forgiven amounts on forgiven debts. For these rules to apply there must first be a forgiveness of a commercial debt. As per other provisions of the ITAA 1997, the ordinary meaning of 'debt' applies to Division 245. The Explanatory Memorandum to the Tax Law Amendment (Transfer of Provisions) Bill 2010 states that '[t]he ordinary meaning of "debt" requires an obligation to do something' which is enforceable. Further it provides that the references to the word 'paying' imply that the debts referred to are monetary debts. Generally, a debt is a commercial debt for purposes of the debt forgiveness provisions, if the whole or any part of the interest (or of an amount in the nature of the interest), payable in respect of the debt, has been or could be deducted by the taxpayer (section 245-10). Section 245-35 provides that a debt is forgiven if and when: (a) the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full; or (b) the period within which the creditor is entitled to sue for the recovery of the debt ends, because of the operation of a statute of limitations, without the debt having been paid. HoldingCo, with the agreement of OverseasCo, intends to satisfy its obligation to repay the Bridging Loan by way of one of the following: (a) a set-off of the outstanding liability under the Bridging Loan against a portion of the FC Receivable owed to it by OverseasCo; or (b) a transfer of funds from HoldingCo to OverseasCo to repay in full the outstanding liability under the Bridging Loan; or (c) a combination of a partial set-off and transfer of funds as contemplated in subparagraphs (a) and (b) above to fully extinguish the outstanding liability under the Bridging Loan. None of these options for repayment of the Bridging Loan constitute forgiveness of a debt for the purposes of section 245-35. Accordingly, there is no net forgiven amount which means that sections 245-115 to 245-195 (inclusive) will have no application. | Summary: It is not open to the Commissioner to make a determination under section 177F of the ITAA 1936 in respect of any or all of the facts described in this ruling. | Detailed Reasoning - Detailed reasoning: The amendments made to Part IVA of the ITAA 1936 ('Part IVA') by Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2013 do not apply to any scheme that is, comprises or includes, a choice to make a functional currency election before 16 November 2012. Accordingly, the following extracts are from Part IVA as in force before those amendments took effect. Subsection 177A(1) of the ITAA 1936 states: In this Part, unless the contrary intention appears: … scheme means: (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and (b) any scheme, plan, proposal, action, course of action or course of conduct. Subsection 177F(1) of the ITAA 1936 states: Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may: (a) in the case of a tax benefit that is referable to an amount not being included in the assessable income of the taxpayer of a year of income - determine that the whole or a part of that amount shall be included in the assessable income of the taxpayer of that year of income; or (b) … … Subsection 177C(1) of the ITAA 1936 states: Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to: (a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or (b) … … Subsection 177C(2) of the ITAA 1936 states: A reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as not including a reference to: (a) the assessable income of the taxpayer of a year of income not including an amount that would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out where: (i) the non-inclusion of the amount in the assessable income of the taxpayer is attributable to the making of an agreement, choice, declaration, election or selection, the giving of a notice or the exercise of an option (expressly provided for by this Act or the Income Tax Assessment Act 1997 ) by any person, except one under Subdivision 126-B, 170-B or 960-D of the Income Tax Assessment Act 1997 ; and (ii) … (b) … … [emphasis added] Section 177D of the ITAA 1936 states that: This Part applies to any scheme … where: (a) a taxpayer (in this section referred to as the relevant taxpayer ) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and (b) having regard to: (i) the manner in which the scheme was entered into or carried out; (ii) the form and substance of the scheme; (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out; (iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme; (v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme; (vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme; (vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi); (c) it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers). Subsection 177A(5) states that: A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose. | Detailed Reasoning - Application to the facts: Firstly, the choice to make a functional currency election under Subdivision 960-D is a scheme within the meaning of Part IVA. Secondly, assume (purely for the sake of argument) that HoldingCo were to repay the Bridging Loan in circumstances where, but for the foreign currency election under that Subdivision, an assessable forex realisation gain would arise due to FRE 4 happening. The making of this particular election would not prevent HeadCo being regarded as obtaining a tax benefit for the purposes of Part IVA under such circumstances (subsection 109C(1) and subparagraph 177C(2)(a)(i)). However, based on the facts provided in the ruling application and having regard to the matters listed in paragraph 177D(b) of the ITAA 1936, a reasonable person would not conclude that any person entered into or carried out that scheme for the sole or dominant purpose of obtaining a tax benefit. In particular, nothing about the manner in which the scheme was entered into or carried out suggests a tax avoidance purpose. There is no divergence between the substance and the form of the scheme. The choice to adopt a foreign currency as the taxpayer's functional currency is specifically allowed for by the legislation. The particular choice of the United States dollar is commercially explicable. Nothing about the timing of the choice is sufficient to establish a tax avoidance purpose; in particular, the choice is irrevocable. Therefore, it is not open to the Commissioner to make a determination under section 177F of the ITAA 1936 in respect of that scheme. Nothing in the facts described in this ruling suggests any other scheme to which Part IVA might potentially apply. This conclusion assumes that all of the facts described in this ruling are correct and that there are no other material facts.

Subject: foreign exchange gains or losses and the making of an applicable functional currency choice: All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated. | Question 6: Do sections 245-115 to 245-195 (inclusive) apply as a consequence of the repayment of the Bridging Loan?