Pay as you go instalment income and foreign exchange realisation gains and losses

This Practice Statement clarifies when it is acceptable for pay as you go (PAYG) instalment payers to include a net foreign exchange (forex) realisation gain [1] in their PAYG instalment income, which generally includes gross rather than net income amounts. This Practice Statement takes effect from 1 July 2003.

For the purposes of determining its PAYG instalment income [2] for a particular period, an entity that uses the 'instalment rate x instalment income' method of calculating its PAYG instalment can include a net forex realisation gain as ordinary income derived during that period if: • the entity accounts for forex realisation gains and losses on a net basis in its books of account, and • this net basis of accounting is reflected in the manner in which the entity reported information about forex realisation gains and losses in the tax return (before reconciliation to taxable income) on which the instalment rate for that instalment period is based.

The net forex realisation gain referred to in paragraph 2 of this Practice Statement cannot include a forex realisation loss that is known, at the time of determining instalment income, to be material. [3]

This Practice Statement does not apply to: • individuals who do not derive income from a business, or • entities that pay PAYG instalments on the basis of gross domestic product adjusted notional tax.

All legislative references in this Practice Statement are to Schedule 1 to the Taxation Administration Act 1953, unless otherwise indicated.

The PAYG instalment provisions in Division 45 require an entity that uses the 'instalment rate ? instalment income' method of calculating their PAYG instalment to apply their instalment rate to their PAYG instalment income for the period. [4]

Subsection 45-120(1) states that an entity's PAYG instalment income for a period includes the entity's ordinary income derived during that period, but only to the extent that it is assessable income of the income year that is or includes that period. This does not include statutory income except for particular types of entities. [5] As stated in subsection 6-5(1) of the Income Tax Assessment Act 1997, ordinary income is income according to ordinary concepts. This generally means gross income before taking expenses into account.

Tax professional association representatives have advised us that it is common for entities to account for forex realisation gains and losses on a net basis rather than on a gross basis. That is, some accounting systems net off forex realisation gains and losses in one account rather than having separate accounts for gains and losses. Australian accounting standards do not require forex gains and losses to be disclosed separately unless they are material, that is, the payment summary or income statement may disclose a net forex gain or loss. [6] We recognise that an entity whose accounting system operates on a net basis for forex realisation gains and losses may need to undertake considerable reworking of accounts to determine gross forex realisation gains for an instalment period.

This Practice Statement confirms that entities that account for forex realisation gains and losses on a net basis in their books of account can include a net forex realisation gain (that is, after offsetting forex realisation losses) as ordinary income derived during an instalment period for the purposes of calculating the amount of their PAYG instalment income.

However, to maintain the integrity of the PAYG instalments base, where the amount of a PAYG instalment is calculated using the 'instalment rate × instalment income' method, there must be consistency between the basis on which: • forex realisation gains and losses are disclosed at the business income labels in the relevant tax return, and • forex realisation gains are included in the calculation of PAYG instalment income for the instalment period.

This is because the instalment rate that the entity uses to work out its PAYG instalment for a period (that is, the rate notified by us) is based on information provided in the entity's tax return. We work out an entity's instalment rate from information contained in the latest tax return from which an assessment has been made (or would have been made except that the entity had no taxable income). [7]

An entity reflects a net basis of accounting for forex realisation gains and losses in reporting information in its tax return by: • disclosing the net forex realisation gain at an income label [8] (and nothing at an expenses label except if a material forex realisation loss is shown at an expenses label) if it has a net forex realisation gain for the income year, or • disclosing the net forex realisation loss at an expenses label [9] (and nothing at an income label except if a material forex realisation gain is shown at an income label) if it has a net forex realisation loss for the income year.

An entity can include a net forex realisation gain in its PAYG instalment income for each instalment period for which the instalment rate is based on that tax return if the entity: • accounts for forex realisation gains and losses on a net basis in its books of account, and • reflects this net basis in the way that forex realisation gains and losses are shown in its tax return.

Where an entity has a forex realisation loss that is known at the time of working out instalment income for an instalment period to be material, this loss must be excluded for the purpose of working out the net forex realisation gain to be included in PAYG instalment income for that instalment period. It is recognised, however, that determining whether a forex realisation loss is material may not be known during the year when instalment income for an instalment period has to be worked out.

Where an entity has a net forex realisation loss for an instalment period, this loss cannot be offset against other income in the calculation of PAYG instalment income for the period. This is the case, regardless of the fact that the tax return on which the instalment rate was based reflected a net basis of accounting for forex realisation gains.

An entity reflects a gross basis of accounting for forex realisation gains and losses in reporting information in its tax return by: • disclosing gross forex realisation gains (that is, without offsetting forex realisation losses) at an income label, and • disclosing gross forex realisation losses at an expenses label.

An entity that has reported information about forex realisation gains and losses on a gross basis in its tax return cannot include a net forex realisation gain as ordinary income for the purpose of determining its PAYG instalment income for an instalment period for which the rate was based on that tax return.

Where an entity changes its accounting system from a gross to a net basis of accounting for forex realisation gains and losses, it will be necessary for the entity to take appropriate action to ensure the change to their systems still enables them to determine gross forex realisation gains for their instalment periods until such time as the entity's instalment rate is based on a tax return that reflects a net basis of accounting for forex realisation gains and losses.

This Practice Statement applies to entities that use the 'instalment rate ? instalment income' method of calculating their PAYG instalments, except for individuals who do not derive income from a business.

Individuals who do not derive income from a business must include their gross assessable forex realisation gains that are ordinary income [10] in PAYG instalment income when working out their PAYG instalment using the 'instalment rate x instalment income' method. This is because if these individuals have assessable forex realisation gains and deductible forex realisation losses, they do not have the option of disclosing a net forex realisation gain or a net forex realisation loss in their tax returns. They include any assessable forex realisation gains they derive at the appropriate income label and any deductible forex realisation losses at the appropriate deductions label.

This Practice Statement does not apply to entities that pay PAYG instalments on the basis of gross domestic product adjusted notional tax.

Where there is a shortfall in a PAYG instalment that results from a false or misleading statement about the amount of instalment income for the instalment period, an administrative penalty for the shortfall amount is payable under Division 284. Inclusion of a forex realisation gain determined on an inappropriate basis could constitute such a false or misleading statement. For example, it is inappropriate for an entity that accounts for its forex realisation gains and losses on a gross basis and reflects this basis in the information included in the relevant tax return, to include a net forex realisation gain rather than the gross forex realisation gains in instalment income.

We have a discretion to remit all or part of any penalties for shortfalls in PAYG instalment amounts. [11] Law Administration Practice Statement PS LA 2012/5 Administration of the false or misleading statement penalty – where there is a shortfall amount sets out guidelines for exercising this discretion.

XYZ Co accounts for forex realisation gains and losses on a net basis in its books of account. It includes a net forex realisation gain of $30,000 in 'Total income' in its 'Calculation of total profit or loss' at item 6 of its tax return for the 2003–04 income year.

XYZ Co is working out its PAYG instalment for the September 2005 to December 2005 quarter. The instalment rate that it applies to its PAYG instalment income for that quarter to work out its PAYG instalment amount is based on the information in the 2003–04 tax return. XYZ Co must include the net amount of its assessable forex realisation gains as ordinary income in its PAYG instalment income for the quarter.

If, on the other hand, XYZ Co includes gross forex realisation gains of $100,000 in 'Total income' and forex realisation losses of $70,000 in 'Total expenses' in its 'Calculation of total profit or loss' in its 2003–04 tax return, it is not appropriate for XYZ Co to include net forex realisation gains in its PAYG instalment income for the September 2005 to December 2005 quarter. It must include in its PAYG instalment income its gross assessable forex realisation gains as ordinary income (that is, without offsetting forex realisation losses). Failure to do so could lead to the instalment amount payable being lower than it would have been, resulting in a liability to shortfall penalty under Division 284.