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Does a non-resident taxpayer derive currency exchange gains or incur currency exchange losses under Division 3B of the Income Tax Assessment Act 1936 (ITAA 1936) when the whole or part of a foreign currency loan is repaid and both the principal and the repayments are in the same currency?

No. The taxpayer does not derive currency exchange gains nor incurs currency exchange losses under Division 3B of the ITAA 1936.

The taxpayer is a resident of a foreign country and owns an income producing rental property in Australia.

The taxpayer is not carrying on a business of buying and selling rental properties.

To purchase this property the taxpayer obtained finance from a wholly owned subsidiary of an Australian bank for an Australian dollar amount. The loan was then converted from Australian dollars to the currency of the foreign country and interest and loan repayments were denominated in that foreign currency.

Subsection 82U(1) of the ITAA 1936 states that Division 3B of the ITAA 1936 applies in relation to gains and losses only to the extent to which they are of a capital nature.

As the taxpayer is not carrying on the business of buying and selling rental properties, the repayments of principal will be of a capital nature and therefore subject to Division 3B of the ITAA 1936.

Currency exchange gains made by a taxpayer under an eligible contract will be included in assessable income under section 82Y of the ITAA 1936 and currency exchange losses incurred by a taxpayer under an eligible contract will be deductible under subsection 82Z(1) of the ITAA 1936.

An eligible contract is defined in subsection 82V(1) of the ITAA 1936 to include, 'a contract entered into by the taxpayer on or after the commencing day, other than a hedging contract'.

The contract entered into by the taxpayer was a loan contract and not a hedging contract and therefore is considered to be an eligible contract for the purposes of sections 82Y and 82Z of the ITAA 1936.

For either section 82Y or section 82Z of the ITAA 1936 to apply when the whole or part of a loan is repaid, there is still a prerequisite that a currency exchange gain or loss is realised in that income year.

Subsection 82V(1) of the ITAA 1936 defines currency exchange gains and losses as gains and losses to the extent that they are attributable to currency exchange fluctuations. In Federal Commissioner of Taxation v. Energy Resources of Australia (1996) 185 CLR 66; 96 ATC 4536; (1996) 33 ATR 52 the High Court commented that under a contract there needs to be a currency conversion before a gain or loss will be recognised for the purposes of Division 3B of the ITAA 1936.

The taxpayer's obligations under the loan contract are in a single currency. Consequently, any currency exchange fluctuations between the Australian and foreign currencies will not impact on the taxpayer's repayments under the contract and no foreign exchange gain or loss will arise under Division 3B of the ITAA 1936.