Issue
Does the mere re-exchange of the same amounts of currencies at the termination of a cross currency swap give rise to a currency exchange loss for the purposes of former Division 3B of Part III of the Income Tax Assessment Act 1936 (ITAA 1936)?
Decision
No. The mere re-exchange of the same amounts of currencies under a cross currency swap does not give rise to a currency exchange loss for the purposes of Division 3B of the ITAA 1936.
Facts
Aus Co (an Australian resident company) entered into a cross currency swap with a third party on 5 August 2002 to mitigate an exposure on capital account to movements in the Australian dollar (AUD)/United States dollar (USD) exchange rate.
Under the terms of the cross currency swap, Aus Co exchanged USD 50 million for AUD 90 million on 16 August 2002 and re-exchanged these same amounts on 16 August 2008.
The cross currency swap was an 'eligible contract' within the meaning of Division 3B of the ITAA 1936.
Aus Co did not make a transitional election under section 775-150 of the Income Tax Assessment Act 1997 (ITAA 1997). Aus Co has an applicable commencement date (within the meaning of section 775-155 of the ITAA 1997) of 1 July 2003.
Reasons for Decision
Division 3B of the ITAA 1936 was repealed by the New Business Tax System (Taxation of Financial Arrangements) Act (No 1 ) 2003. However, Division 3B continues to apply to eligible contracts (as defined in subsection 82V(1) of the ITAA 1936) entered into before the applicable commencement date. As the cross currency swap was entered into before Aus Co's applicable commencement date (being 1 July 2003), Division 3B applies to the swap.
Broadly, for a currency exchange loss to be deductible under Division 3B, the loss must be: • incurred under an eligible contract (subsection 82Z(1) of the ITAA 1936) • attributable to currency exchange rate fluctuations (subsection 82V(1) of the ITAA 1936); and • of a capital business nature (subsections 82U(1) and (2) of the ITAA 1936).
In Federal Commissioner of Taxation v. Energy Resources of Australia Limited (1996) 185 CLR 66 at 79; 96 ATC 4536 at 4542; (1996) 33 ATR 52 at 58-59 ( ERA ), the High Court of Australia commented that: Where a taxpayer borrows money on capital account in US dollars and repays the loan in US dollars, it makes no revenue profit or loss from the borrowing even though the exchange rate may be different at each date. Indeed, arguably it makes no profit or loss. If it converts the US dollars that it receives into Australian dollars and then converts Australian dollars into US dollars to repay the loan, it may make a profit or loss on the transaction. But the profit or loss results from the exchange transaction and not from the borrowing. Where there is no exchange transaction and the loan is on capital account, the taxpayer makes no loss or gain for the purpose of s 25 or s 51 of the Act simply because the rate of exchange has changed between the date of borrowing and the date of repayment.
In considering the application of Division 3B of the ITAA 1936 to the circumstances of that case, the High Court found, at CLR 81; ATC 4543; ATR 56: Furthermore, for the reasons that we have already given, the taxpayer made no currency exchange gain or loss. The unit of account and the unit of payment under the contract or contracts involved in this case were US dollars. The taxpayer made no gain or loss that was 'attributable to currency exchange rate fluctuations'.
The decision in ERA found that Division 3B of the ITAA 1936 neither required nor permitted a notional conversion of foreign currency to Australian dollars to calculate a gain or loss for the purposes of the Division where the borrowing and the repayment took place in the same foreign currency.
Aus Co exchanged USD 50 million for AUD 90 million at the start of the swap period. At the end of the swap period Aus Co re-exchanged the AUD 90 million and received back the USD 50 million. The initial exchange and the final exchange were for the same amounts and at the same AUD/USD currency exchange rate. Accordingly, for the purposes of Division 3B of the ITAA 1936, the mere re-exchange of the same amounts of USD and AUD could not give rise to a loss, under the eligible contract (the cross currency swap agreement), that was attributable to currency exchange rate fluctuations.