Issue
Is a repayment of a principal amount, which occurs after the effective date of a functional currency choice, on a loan denominated in a non-AUD currency other than the one which later becomes the 'applicable functional currency', an amount that needs to be translated under the two step translation in section 960-85 of Subdivision 960-D of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
No, a repayment of a principal amount, which occurs after the effective date of a functional currency choice, on a loan denominated in a non-AUD currency other than the one which later becomes the 'applicable functional currency', is not an amount that needs to be translated under the two step translation in section 960-85 of Subsection 960-D of the ITAA 1997.
Facts
The taxpayer is the head company of a consolidated group.
The taxpayer has been preparing its financial statements in USD and is intending to make a functional currency choice under Item 1 of subsection 960-60(1) of the ITAA 1997 to use USD, with effect from 1 July 2010.
They have not previously chosen to use a non-AUD 'applicable functional currency'.
The taxpayer entered into various loan agreements prior to any functional currency choice under which it assumed various obligations.
Some of these loan agreements were denominated in CAD/Euro.
Reasons for Decision
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'?' states at paragraphs 26, 33, 37 and 108 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. Such an amount will be attributable in this sense where there is a sufficient causal connection between it and the relevant event or 'state of affairs'. 108. An amount that features, for the purposes of subsection 960-80(1), in the calculation of one of the annual net amounts to which the subsection refers, will not be affected by section 960-85 unless it is also 'attributable to' an 'event or a state of affairs' (the 'event time'), which has taken place before 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. Therefore, 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.
Section 960-85 of the ITAA 1997 is essentially targeting relevant amounts in existence, and events that have already happened, at the effective time of a functional currency choice. That is, elements in the calculation of post choice amounts of assessable income and allowable deductions, that are 'attributable to an event that happened, or a state of affairs that came into existence at a time before the current choice took effect', are the amounts that are targeted by section 960-85.
In effect, section 960-85 of the ITAA 1997 takes a 'snapshot' of these amounts at one point in time (the effective time of the functional currency choice) - being the date of transition to the 'applicable functional currency'. These amounts are then translated to the 'applicable functional currency' under the two step translation process. It is important to note that, after this point in time, section 960-85 has no further application - unless there is a subsequent change in the 'applicable functional currency'.
The amounts (elements) subject to translation under section 960-85 of the ITAA 1997 are generally either assets such as borrowing expenses (a prepaid expense for income tax purposes), depreciating assets, CGT assets, trading stock on hand, traditional securities, etcetera, or liabilities such as the amount of principal outstanding on a loan received.
Any repayments of principal made in CAD/Euro after the effective time of the functional currency choice to make USD the 'applicable functional currency', are all 'post-choice' events which give rise to post functional currency choice amounts. These repayments of principal are not attributable to a 'pre-choice' event or state of affairs in the sense required by section 960-85 of the ITAA 1997, as they were not made before the effective time of the functional currency choice.
As indicated above, the one point in time for the operation of section 960-85 of the ITAA 1997 has passed. The only translation rules that are relevant following the effective time of the functional currency choice are the translation rules contained in section 960-80 of the ITAA 1997. The repayments of principal in CAD/Euro made after the effective time of the functional currency choice will be subject to translation to USD under subsection 960-80(1) of the ITAA 1997, as these repayments (denominated in CAD/Euro) will be amounts that are not in the 'applicable functional currency' of USD.
In contrast, the principal loan balance in CAD/Euro outstanding at the effective time of the functional currency choice is an amount that is 'attributable to' an 'event that happened, or a state of affairs that came into existence' prior to the time of the effective functional currency choice - and so is subject to translation under section 960-85 of the ITAA 1997.
The principal loan balance outstanding in CAD/Euro may be 'attributable to' a number of events that have happened (that is, the taking out of the loan and the making of several principal repayments) and so is perhaps more appropriately described as a 'pre-choice state of affairs'. Either way, the principal loan balance outstanding in CAD/Euro is a 'pre-choice' amount which is subject to translation under section 960-85 of the ITAA 1997.
Conclusion
A repayment of a principal amount, which occurs after the effective date of a functional currency choice, on a loan in a non-AUD currency other than the one which later becomes the 'applicable functional currency', is not an amount that is attributable to a 'pre-choice' event or state of affairs for the purposes of the two step translation in section 960-85 of Subdivision 960-D of the ITAA 1997.