Functional currency choice: re-exchange of currency under a cross-currency interest rate swap agreement

Is the re-exchange of currency under a cross currency interest rate (CCIR) swap agreement which occurs after the effective date of a functional currency choice, subject to the two step translation under section 960-85 of the Income Tax Assessment Act 1997 (ITAA 1997), where the CCIR swap agreement was entered into before the effective date of the functional currency choice made under item 1 of subsection 960-60(1) of the ITAA 1997?

No, the re-exchange of currency under a CCIR swap agreement which occurs after the effective date of a functional currency choice, is not subject to the two step translation under section 960-85 of the ITAA 1997, where the CCIR swap agreement was entered into before the effective date of the functional currency choice.

AustCo is the head company of a consolidated group.

AustCo has been preparing its financial statements in USD and is intending to make a functional currency choice to use USD with effect from 1 July 2010 under item 1 of subsection 960-60(1) of the ITAA 1997.

AustCo has not previously chosen to use a non-AUD 'applicable functional currency'.

AustCoFinance, a member of the tax consolidation group, enters into a CCIR swap agreement with USCoHoldings, which is not a member of the tax consolidated group.

The initial exchange occurred on 20 June 2003 whereby AustCoFinance pays a USD amount and receives an AUD amount from USCoHoldings.

The re-exchange will occur on 31 December 2012 whereby AustCoFinance will pay back the AUD amount to USCoHoldings who will in turn repay the USD amount.

Section 960-85 of the ITAA 1997 states: Section 960-85 Special rule about translation - events that happened before the current choice took effect Australian resident required to prepare financial reports under section 292 of the Corporations Act 2001 960-85(1) If: (a) as the result of a choice (the current choice ) made by you under item 1 of the table in subsection 960-60(1), subsection 960-80(1) requires that an amount be translated to the *applicable functional currency; and (b) the amount is attributable to an event that happened, or a state of affairs that came into existence, at a time (the event time ) before the current choice took effect; the table has effect: Special rule about translation Item In this case ... this is the result ... 1 at the event time, no previous choice made by you under item 1 of the table in subsection 960-60(1) was in effect the amount is to be translated first to Australian currency at the exchange rate applicable at the event time, and then to the *applicable functional currency at the exchange rate applicable when the current choice took effect. ...

Special rule about translation

Item | In this case ... | this is the result ...

1 | at the event time, no previous choice made by you under item 1 of the table in subsection 960-60(1) was in effect | the amount is to be translated first to Australian currency at the exchange rate applicable at the event time, and then to the *applicable functional currency at the exchange rate applicable when the current choice took effect. ...

Taxation Ruling TR 2007/5 'Income tax: functional currency - when is an amount not in the "applicable functional currency"?' (TR 2007/5) states at paragraphs 26, 33 and 37 that: 26. The two step translation rule in section 960-85 applies only to relevant 'pre-choice' amounts - that is those 'pre-choice' amounts that are directly relevant to determining an entity's tax relevant net amount and so need to be translated into the 'applicable functional currency'.' 33. Section 960-85 is concerned with amounts which are 'attributable to an event that happened, or a state of affairs that came into existence in a prior year', (a 'prior year event'), being a year in which the use of the 'applicable functional currency' did not occur.. 37. A requirement for section 960-85 to apply is that an amount is 'attributable to' an event or a 'state of affairs' that predates the time the choice to use the 'applicable functional currency' takes effect.

TR 2007/5 emphasises that section 960-85 of the ITAA 1997 applies only to an event or state of affairs that took place in a year of income prior to the effective time of a functional currency choice. This is abundantly clear from the wording in the legislation. It is equally clear, therefore, that section 960-85 has no application to an event that happens or a state of affairs that comes into existence after a change to (or a change of) functional currency.

The entry into the CCIR swap agreement requires both parties to exchange currencies at two points in time, an initial exchange on 20 June 2003, with the exchange being reversed on 31 December 2012.

The re-exchange which occurs on 31 December 2012, whereby AustCoFinance will pay back the AUD amount to USCoHoldings who will in turn repay the USD amount, will not be subject to translation under section 960-85 of the ITAA 1997 as the events that arise on these transactions occur after the functional currency choice took effect.

The AUD denominated amount on re-exchange will, however, be subject to the single step translation contained in subsection 960-80(1) of the ITAA 1997, as it is not in the applicable functional currency.

Section 960-85 of the ITAA 1997 has no application to a 'post-choice' amount, event or state of affairs. The re-exchange between AustCoFinance and USCoHoldings is an event that occurs following the effective date of the functional currency choice and so gives rise to a post functional currency choice amount. As such, the amount is not subject to the two step translation under subsection 960-85(1) of the ITAA 1997.