Private ruling: Capital loss and Foreign exchange gains or losses
Date of advice: 10 March 2017
Published: March 2018
Ruling period: Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2016

Ruling: Q1: Can you disregard the capital loss made on the disposal of your Australian private company shares under section 855-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Is the foreign exchange gains or losses made when you repay your loan to the Foreign Country X bank assessable or deductible in Australia? | A2: No

Relevant facts and circumstances: You are a resident of Australia for domestic income tax law purposes. You are a resident of the Foreign Country X for the purposes of the Double Tax Agreement between Australia and the Foreign Country X. You and your spouse jointly own a rural property Australia. The property is managed by your brother. It is held via a company. The Company was incorporated in Australia. The Company was unable to raise finance itself. You originally borrowed A$s from a bank in Australia (and later moved the loan to the other Australian bank), in order to on lend to the Company funds for working capital purposes. This on lending currently does not bear interest since that company is still loss making and cannot afford to pay interest. The company is also unable to pay a dividend. You borrowed money in the Foreign Country X to repay the above Australian loan. You had no expectation of receiving income as a result of making the loan. At the moment no assessable income is being earned by you from your loan to the Company. Regarding the repayment arrangements, there is no fixed termination date. The loan agreement provides that part repayments can be made at any time. The company may be wound up, if it can sell its land, some non-binding expressions of interest have been received. You are expecting to make a small Australian capital loss.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 Division 775 | Income Tax Assessment Act 1997 Division 855 | International Tax Agreements Act 1953

Reasons for decision: Summary: CGT event A1 occurs when you dispose of a CGT asset. You dispose of a CGT asset if a change in ownership occurs from you to another entity. A CGT asset is: a) any kind of property; or b) a legal or equitable right that is not property. In your case, your shares are property consequently they are a CGT asset. Therefore, when you disposed of the shares CGT event A1 occurred in accordance with section 104-10 of the ITAA 1997. Subsection 885-10(1) of the ITAA 1997 provides that you can disregard a capital gain or loss from a CGT event if: a) You are a foreign resident, or the trustee of a foreign trust for CGT purposes, just before the CGT event happens; and b) The CGT event happens in relation to a CGT asset that is not taxable Australian property. In your case, you are an Australia resident; while you are a resident of the Foreign Country X and not Australia for the purpose of the DTA that does not make you a foreign resident for any other purposes. Any capital gain or capital loss resulting from the disposal of the shares cannot be disregarded under subsection 855-10(1) of the ITAA 1997. The Foreign Exchange (Forex) gains or losses are covered by Division 775 of the ITAA 1997. The general principle is that Forex gains or losses have a revenue character rather than a capital nature. Forex gains or losses are assessable or deductible when they are realised. They are realised when a Forex realisation event happens. Forex realisation event 4 (FRE4) occurs when a taxpayer ceases to have an obligation, or part of an obligation to pay foreign currency – commonly when the foreign currency borrowing is repaid. The obligation, or part of the obligation, must cease, and be one of the following: ● obligations that represent an expense the taxpayer can deduct; ● obligation that are an element in the calculation of a net assessable or deductible amount; ● obligation incurred in return for the acquisition of a CGT asset; ● obligation that are incurred and form elements of the cost base of a CGT asset; or ● obligations incurred in return for receiving Australian or foreign currency, or the right to received such currency. Since the obligation to repay foreign currency was incurred in return for receiving Australian or foreign currency, FRE 4 will happen each time some or all of the foreign currency borrowings are repaid (paragraph 775-55(1)(a) and subparagraph 775-55(1)(b)(ix) of the ITAA 1997 apply). For most individual taxpayers, Forex gains or losses will generally be disregarded if the gain or loss is of a private or domestic nature as per subsection 775-15(2) and subsection 775-30(2) of the ITAA 1997, but where the gain or loss results from carrying on a business or a profit-making undertaking or plan, the gain or loss will be assessable income or an allowable deduction. In determining ability to Australian tax, it is necessary to consider not only the income tax laws, but also any applicable double tax agreement contained in the International Tax Agreements Act 1953 (Agreements Act). Section 4 of the Agreements Act incorporates that Act with the Income Tax Assessment Act 1936 (ITAA 1936) and the ITAA 1997 so that the Acts are read as one. Section 5 of the Agreements Act states that, subject to the provisions of the Agreements Act, any provision in an Agreement listed in section 5 has the force of law. The Foreign Country X Convention is listed in section 5 of the Agreements Act. The Foreign Country X Convention is located on the Austlii website (www.austlii.edu.au) in the Australian Treaties Series database. The Foreign Country X Convention operates to avoid the double taxation of income received by residents of Australia and the Foreign Country X. The different Articles of the Convention determine the respective taxing rights of the Foreign Country X and Australia in regard to various kinds of income. No Article in the Foreign Country X Convention specifically addresses Forex gains and losses. Article (Other Income) of the Foreign Country X Convention allocates taxing rights in relation to income not dealt with by the preceding Articles of the Convention. As you are a Foreign Country X resident for DTA purposes, Paragraph 1 of that article allocates a taxing right over the Forex gains to the Foreign Country X. However, paragraph 3 of that article also gives Australia a taxing right over the Forex gains if it is from Australian sources. Your loan and any corresponding gain or loss on repayment is sourced in the Foreign Country X and therefore only subject to taxation in the Foreign Country X. As explained above, your Forex gains or losses are not assessable or deductible in Australia.