Private ruling: Application of Division 775 of the Income Tax Assessment Act 1997 (ITAA 1997) to a related party loan from an overseas company
Date of advice: 7 December 2018
Published: April 2019
Ruling period: From income year ended 31 December 2004 to income year ending 31 December 2018
Date scheme commenced: DD January 2004

Ruling: Q1: Does Division 230 of the ITAA 1997 apply to the loan from an Overseas company to its related Australian company? | A1: No | Q2: For the purpose of calculating the forex realisation gain or loss under Division 775 of the ITAA 1997 in respect of the loan, did the ‘proceeds for assuming an obligation to pay foreign currency’ include the opening balance at inception of the principal amount? | A2: Yes | Q3: Did the relevant ‘forex realisation event’ under Division 775 of the ITAA 1997 happen on repayment of the loan? | A3: Yes | Q4: Is the deductible forex realisation loss incurred in accordance with section 775-30 of the ITAA 1997 on repayment of the loan, included in the opening carry forward tax loss balance as at 1 January 2018? | A4: Yes

Relevant facts and circumstances: 1. Company A is an Australian proprietary company limited by shares. 2. Company A is an eligible tier 1 company of an overseas company. 3. Company A is the provisional head company of the Company A MEC group. 4. Company A has a substituted accounting period and its income year ends on 31 December. 5. Company A did not make a transitional election under section 775-150 of the ITAA 1997. 6. Company A has not made a foreign currency election under subdivision 960-D of the ITAA 1997. 7. Company A has not made a transitional election under Division 230 of the ITAA 1997. 8. Company A relies upon the audited accounts method in regulation 1.1 of Schedule 2 of the Income Tax Assessment Regulations 1997 (ITAR 1997) for the purposes of translating amounts to Australian currency for income tax purposes. 9. Company A had a carry forward tax loss balance as at 31 December 2015, 31 December 2016 and 31 December 2017. 10. Company B was an Australian proprietary company limited by shares. 11. The principal activities of Company B consist of providing funding to related entities. 12. Company B is also an eligible tier 1 company of the same overseas company as Company A. Company B is a member of the Company A MEC group 13. Company B borrowed certain amount of overseas currency from the related overseas Company in January 2004. 14. The purpose of the Loan was to refinance Company B’s obligations under lending arrangements to support the acquisition of an income-producing business in Australia. 15. The Loan was not formally documented in a loan agreement. It was unsecured, interest bearing and repayable on demand. 16. The loan agreement between Company B and the related overseas company is evidenced by the implied conduct of both parties. 17. The Loan is not statute barred at any time during the arrangement. 18. The Loan (including capitalised interest) was recognised in Company B’s audited financial statements as a liability. 19. The loan was repaid on 31 December 2015. Assumption(s) Company A satisfies the Continuity of Ownership Test or Same Business Test under Division 166 of the ITAA 1997 as at 31 December 2018 in respect of the tax losses.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 230 | Income Tax Assessment Act 1997 subsection 230-45(1) | Income Tax Assessment Act 1997 subsection 230-55(4) | Income Tax Assessment Act 1997 subsection 230-455(7) | Income Tax Assessment Act 1997 section 36-17 | Income Tax Assessment Act 1997 Division 775 | Income Tax Assessment Act 1997 subsection 775-15(1) | Income Tax Assessment Act 1997 section 775-25 | Income Tax Assessment Act 1997 section 775-30 | Income Tax Assessment Act 1997 section 775-55 | Income Tax Assessment Act 1997 section 775-75 | Income Tax Assessment Act 1997 section 775-95 | Income Tax Assessment Act 1997 section 775-105 | Income Tax Assessment Act 1997 section 775-140 | Income Tax Assessment Act 1997 subdivision 960-C | Income Tax Assessment Act 1997 section 995-1 | Income Tax Assessment Regulations 1997 Schedule 2 Part 1

Reasons for decision: Detailed Reasoning - Consolidation: Company A is the provisional head company of the Company A MEC Group for Australian income tax purposes (section 703-5). By virtue of the single entity rule (section 701-1), the transactions entered into by Company B will be considered transactions of Company A for Australian income tax purposes. | Summary: Division 230 Taxation of Financial Arrangements (TOFA) does not apply to the loan from an overseas company to its related Australian company. | Detailed Reasoning - Detailed reasoning: The Taxation of Financial Arrangements ( TOFA ) rules under Division 230 provides a comprehensive framework for taxing financial arrangements that certain taxpayers start to have in an income year commencing on or after 1 July 2010 unless the entity is: ● an individual, or ● a superannuation entity, managed investment scheme or an entity substantially similar to a managed investment scheme under foreign law with assets of less than $100 million, or ● an ADI, a securitisation vehicle or other financial sector entity with an aggregated turnover of less than $20 million, or ● another entity with an aggregated turnover of less than $100 million, financial assets of less than $100 million and assets of less than $300 million. An entity may, notwithstanding that Division 230 does not apply to them based on the above thresholds, irrevocably elect under subsection 230-455(7) to have Division 230 apply to financial arrangements that it has entered into after the beginning of the income year in which the election is made. | Detailed Reasoning - Financial Arrangement: Under the TOFA rules, it is necessary to first identify a “financial arrangement” of an entity for the purposes of Division 230. Under subsection 230-45(1), an arrangement is a ‘financial arrangement’ if under that arrangement there is: (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: (d) you also have under the arrangement one or more legal or equitable rights to receive something and/or one or more legal or equitable obligations to provide something; and (e) for one or more of the rights and/or obligations covered by paragraph (d): (i) the thing that you have the right to receive, or the obligation to provide, is not a financial benefit; or (ii) the right or obligation is not cash settlable; and (f) the one or more rights and/or obligations covered by paragraph (e) are not insignificant in comparison with the right, obligation or combination covered by paragraph (a), (b) or (c). The right obligation or combination covered by paragraph (a), (b) or (c) constitutes the financial arrangement. | Detailed Reasoning - Arrangement: An ‘arrangement’ is defined broadly in section 995-1 of the ITAA 1997 to mean “any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings”. | Detailed Reasoning - Application of the TOFA rules under Division 230: The loan was entered into prior to the introduction of the TOFA regime and is not subject to the TOFA rules in Division 230. Further, Company A has not made a transitional election to be subject to the TOFA rules. Therefore, Division 230 only applies to any financial arrangements Company A started to have from 1 January 2011, given its substituted accounting period of 31 December. The broad definition of “financial arrangement” means that Division 230 extends to a wide range of arrangements including loans. However, it is necessary to consider whether there have been any changes to the terms of the loan since its commencement, to determine whether the rights and obligations under the loan gave rise to a change in the financial arrangement which bring the loan into the TOFA regime. | Detailed Reasoning - Whether the rights and obligations under the loan form a single arrangement under subsection 230-55(4) of the ITAA 1997: Subsection 230-55(4) states that, whether a number of rights and/or obligations form an arrangement or are two or more separate arrangements is a question of fact and degree that to be determined having regard to the following: (a) the nature of the rights and/or obligations; (b) their terms and conditions (including those relating to any payment or other consideration for them); (c) the circumstances surrounding their creation and their proposed exercise or performance (including what can reasonably be seen as the purposes of one or more of the entities involved); (d) whether they can be dealt with separately or must be dealt with together; (e) normal commercial understandings and practices in relation to them (including whether they are regarded commercially as separate things or as a group or series that forms a whole); (f) The objects of Division 230. Taxation Ruling TR 2012/4 Income tax: the operation of subsection 230-55(4) of the Income Tax Assessment Act 1997 (ITAA 1997) in determining what is an 'arrangement' for the purposes of the taxation of financial arrangements under Division 230 of the ITAA 1997 discusses the operation of subsection 230-55(4) of the ITAA 1997 in determining whether a number of rights and/or obligations are themselves an arrangement or are 2 or more separate arrangements for the purposes of Division 230. Paragraphs 64 –121 of TR 2012/4 provide an example of how Division 230 applies in relation to lending facility agreements. The Commissioner considered that the advance of funds under a lending agreement and associated obligations to repay principal and capitalised interest should generally form a single financial arrangement under Division 230 where the rights and obligations are created under a single contractual arrangement and are directed toward a single commercial purpose. Having regard to the background and purpose of the Loan, it is considered that the rights and obligations under the Loan comprise one single financial arrangement. | Detailed Reasoning - Conclusion: Company B entered into the Loan prior to the commencement date of the TOFA rules, and the loan comprised one single financial arrangement; therefore Division 230 does not apply to any aspect of the arrangement. | Summary: To calculate the forex realisation gain or loss under Division 775 of the ITAA 1997 in respect of the Loan, the ‘proceeds for assuming an obligation to pay foreign currency’ include the opening balance of the principal loan amount. | Detailed Reasoning - Detailed reasoning: Section 775-95 defines the ‘proceeds of assuming an obligation to pay foreign currency’ as follows: 775-95 Proceeds of assuming an obligation to pay foreign currency For the purposes of this Division, the proceeds of assuming an obligation or a part of an obligation, to pay foreign currency are the total of: (a) the money you: (i) received; or (ii) are entitled to receive; or (iii) would be entitled to receive in the event of the exercise of an option; in return for incurring the obligation or the part of the obligation; and (b) the market value of any non-cash benefit you: (i) acquired or obtained; or (ii) are entitled to acquire or obtain; or (iii) would be entitled to acquire or obtain in the event of the exercise of an option; in return for incurring the obligation or the part of the obligation; reduced by any amounts that are included in assessable income under a provision of this Act other than this Division. | Detailed Reasoning - ‘Obligation’: The term 'obligation' was not defined for the purposes of section 775-55; however, it was intended by Parliament to have its ordinary legal meaning. Explanatory Memorandum to the New Business Tax System (Taxation of Financial Arrangements) Bill (No.1) 2003 (Cth) (which introduced Division 775 into the ITAA 1997) states at paragraph 2.108: “The term ‘obligation’ is intended to carry its ordinary legal meaning . It is not necessarily limited to those obligations that are recognised as liabilities for the purposes of the Australian Accounting Standards.” Section 775-140 extends the definition of the term obligation to pay foreign currency to include: (1) … an amount calculated by reference to a currency exchange rate effect, even if that amount is not an amount of foreign currency and (2) …an obligation to pay foreign currency, where the obligation is subject to a contingency. | Detailed Reasoning - ‘Foreign currency’: Section 995-1 provides that ‘foreign currency means a currency other than Australian currency’. The terms ‘currency’ and ‘Australian currency’ are not defined in the Assessment Acts and therefore take their ordinary meaning having regard to their context and the legislative purpose. In Taxation Determination (TD) 2014/25 Income tax: is bitcoin a 'foreign currency' for the purposes of Division 775 of the Income Tax Assessment Act 1997? at paragraph 32, the Commissioner considers that when defining ‘foreign currency’ as ‘a currency other than Australian currency’ in section 995-1, Parliament intended to use the term ‘currency’ in the same sense that ‘currency’ is used in the Currency Act – namely, a currency legally recognised and adopted under the laws of a country as the monetary unit and means of discharging monetary obligations for all transactions and payments in that country. Consistent with the Currency Act, this concept of currency is in turn divided into two types for the purposes of the ITAA 1997: ● Australian currency, and ● every currency that is recognised and adopted by the laws of any other sovereign State as the monetary unit and means of discharging monetary obligations for all transactions and payments in the respective sovereign state (that is, foreign currency). | Detailed Reasoning - Application of section 775-95: The opening balance of the Loan was the money company B received, when it was translated into Australian currency and recorded on the financial statements of Company B. In return for receiving this overseas currency, Company B incurred an obligation to repay the overseas currency to the related overseas Company. Although the Loan was not formally documented in a loan agreement, the agreement between Company B and the related overseas Company was noted in the audited financial statements of Company B, and was evidenced by the implied conduct of both parties. | Detailed Reasoning - Conclusion: To calculate the forex realisation loss under Division 775, the “proceeds for assuming an obligation to pay foreign currency” include the opening balance at inception of the loan. | Summary: Forex Realisation Event 4 (FRE 4) happened on repayment of the principal loan amount to the related overseas Company. | Detailed Reasoning - Division 775 – Foreign Currency Gains and Losses: Division 775 operates to recognise foreign currency gains and losses for income tax purposes and to quantify those gains or losses by reference to the change in the Australian dollar value of rights and obligations. Subsection 775-15(1) states: Your assessable income for an income year includes a forex realisation gain you make as a result of a forex realisation event that happens during that year. Similarly, subsection 775-30(1) states: You can deduct from your assessable income for an income year a forex realisation loss that you make as a result of a forex realisation event that happens during that year. “Forex realisation event” is defined in subsection 995-1(1) as: …any of the forex realisation events described in Division 775. | Detailed Reasoning - FRE 4: Subsection 775-55(1) states that FRE 4 happens if: (a) you cease to have an obligation, or part of an obligation, to pay foreign currency; and (b) any of the following applies: (i) … (ix) you incurred the obligation, or the part of the obligation in return for receiving an amount of Australian currency or foreign currency; Subsection 775-55(2) states that the time of the event is when you cease to have the obligation or part of the obligation. | Detailed Reasoning - Application of section 775-55: It has been established that Company B received the loan in return for incurring an obligation to pay foreign currency. Company B’s obligation to make repayments in foreign currency was incurred at the time that it received the overseas dollars. Company B discharged its obligations in full repayment of the Loan. At this time, any obligations it had assumed in return for receiving Australian currency or foreign currency in respect of the Loan ceased for the purposes of section 775-55. Therefore, the repayment of the principal loan amount was a Forex Realisation Event 4 as it satisfied subsection 775-55(1)(a) and (b)(ix). The time of the event was when the loan was repaid on 31 December 2015 (section 775-55(2)). | Detailed Reasoning - Conclusion: Forex realisation event 4 happened to Company A as Company B satisfied subsection 775-55(1)(a) and (b)(ix) in relation to the principal loan amount. | Summary: The carry forward loss position of Company A as at 31 December 2018 includes the deductible forex realisation loss incurred in accordance with section 775-30 of the ITAA 1997 on repayment of the loan . | Detailed Reasoning - Forex realisation loss: For each forex realisation event, a forex realisation loss is worked out in the way described in the event: subsection 995-1(1). In relation to FRE 4, section 775-55(5) ITAA 97 states that you make a forex realisation loss if: (a) the amount you paid in respect of the event happening exceeds 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 excess is attributable to a currency exchange rate effect. The amount of the forex realisation loss is so much of the excess as is attributable to a currency exchange rate effect. | Detailed Reasoning - Tax recognition time: Tax recognition time for FRE 4 is defined in section 775-55(7) according to the type of obligation: For the purposes of this section, the tax recognition time is worked out using the table: | Detailed Reasoning - the tax recognition time is...: 1 (a) the obligation, or the part of the obligation, is an expense or outgoing that you deduct; and the time when the expense or outgoing became deductible. (b) the obligation, or the part of the obligation, was not incurred: (i) in return for the acquisition of an item of *trading stock; or (ii) in return for your starting to hold a *depreciating asset; and (c) the obligation, or the part of the obligation, was not incurred as the second element of the cost of a depreciating asset 2 (a) the obligation, or the part of the obligation, is an expense or outgoing that you deduct; and the time when the item becomes part of your trading stock on hand. (b) the obligation, or the part of the obligation, was incurred in return for the acquisition of an item of *trading stock 3 the obligation, or the part of the obligation, is an element in the calculation of a net amount included in your assessable income (other than under this Division or Division 102 of this Act or Division 5 or 6 of Part III of the Income Tax Assessment Act 1936 ) the time of the determination of the exchange rate used to translate the element for the purpose of calculating the net amount. 4 the obligation, or the part of the obligation, is an element in the calculation of a net amount that is deductible (other than under Division 5 of Part III of the Income Tax Assessment Act 1936 ) the time of the determination of the exchange rate used to translate the element for the purpose of calculating the net amount. 5 (a) you incurred the obligation, or the part of the obligation: (i) in return for your starting to hold a *depreciating asset; or (ii) as the second element of the cost of a depreciating asset; and (a) in the case of the acquisition of a depreciating asset - when you began to hold the depreciating asset (worked out under Division 40); or (b) you deduct an amount under Division 40 or 328 for the depreciating asset (b) in the case of the second element of the cost of a depreciating asset - when you incurred the relevant expenditure. 6 you incurred the obligation, or the part of the obligation, as a *project amount the first time when any part of the amount became deductible. 7 the obligation, or the part of the obligation, is referred to in subsection 775-165(5) (which deals with extension of loans) the extension time referred to in that subsection. 8 you incurred the obligation, or the part of the obligation, in return for: the time when you received the currency. (a) receiving Australian currency or *foreign currency; or (b) the creation or acquisition of a right to receive an amount of Australian currency or foreign currency; where item 7 does not apply 9 (a) you incurred the obligation, or the part of the obligation, in return for the acquisition of a *CGT asset; and the time when you acquired the CGT asset (worked out under Division 109). (b) none of the above items apply 10 (a) you incurred the obligation, or the part of the obligation, as the second, third, fourth or fifth element of the *cost base of a CGT asset; and the time of the transaction under which you incurred the obligation. (b) none of the above items apply | Detailed Reasoning - Currency Exchange rate Effect: Section 775-105 states: (1) A currency exchange rate effect is: (a) any currency exchange rate fluctuations; or (b) a difference between: i. an expressly or implicitly agreed currency exchange rate for a future date or time; and ii. the applicable currency exchange rate at that date or time. (2) To work out whether there is a currency exchange rate effect and (if so), the extent of that effect, use whichever of the following translation rules is applicable to you: (a) the translation rules in section 960-50 (the standard rules); (b) the translation rules in section 960-80 (the functional currency rules). | Detailed Reasoning - Application: The proceeds of assuming the obligation is the opening balance of the loan under Section 775-95. The tax recognition time is when Company B received the loan: the applicable items in the table under subsection 775-55(7) are Item 8 for the principal of the loan. Company A did not make a transitional election under section 775-150 of the ITAA 1997, therefore Company A is required to apply the standard translations rules in section 960-50 of the ITAA 1997 (subsection 775-105(2)). Under item 1 of the table in subsection 960-50(6), the amount of an obligation is to be translated to Australian currency at the exchange rate applicable at the tax recognition time. Under subsection 960-50(7) however, the above is subject to any modifications made under the regulations, including where Company B relies upon the audited accounts method in regulation 1.1 of Schedule 2 of the ITAR 1997. For the purposes of Company B’s audited financial statements, foreign currency transactions were initially translated into Australian currency at the rate of exchange at the date of the transaction. It is therefore appropriate to calculate the foreign currency exchange rate effect using the spot rate at the time of each relevant event. | Detailed Reasoning - The deductibility of the forex realisation loss as at 31 December 2018: A forex realisation loss arising under FRE 4 is generally deductible in the year the event occurred (section 775-30(1)), except to the extent: ● it is a gain of a private or domestic nature (subsection 775-30(2)); or ● it is incurred in making exempt or NANE income and the obligations to which the FRE 4 relates do not give rise to a deduction (subsection 775-35(2)); or ● it is captured by one of the provisions in section 775-75 regarding certain short-term forex realisation losses. A tax loss of a corporate tax entity for a loss year can be carried forward to be deducted in a later income year according to section 36-17, and none of the above exclusions apply. The relevant forex realisation loss should therefore have been available to Company A under section 775-30 as a deduction for the 2015 income year. This has not been included in the tax return lodged by Company A for the income year ended 31 December 2015. Company A has been in a tax loss position as at 31 December 2015, 31 December 2016 and 31 December 2017. On the assumption that Company A satisfies the Continuity of Ownership test or Same Business Test as at 31 December 2018, the change to the carry forward losses for the income year ended 2015 as a result of the recognition of the forex realisation loss should be reflected in the income tax return and losses schedule of Company A for the income year ending 31 December 2018. | Detailed Reasoning - Conclusion: The carry forward loss position of Company A as at 31 December 2018 should include the deductible forex realisation loss incurred in accordance with section 775-30 of the ITAA 97 on repayment of the loan on 31 December 2015.