Question 9 Derivative transactions

This question collects information about the transfer pricing risks associated with Australian taxpayers' derivative transactions with international related parties. Here you show the total amount for these transactions and an indication of the principal derivative transaction types undertaken.

The dollar amounts or values asked for in this question are all based on your accounting records.

Derivative takes on its ordinary meaning within the context of commercial and accounting practices.

Broadly, a derivative instrument is a contractual right that derives its value from the value of something else, such as a debt security, equity, commodity or specific index. The most common derivative instruments are forwards, options, swaps and credit derivatives. Unlike traditional debt and equity securities, these instruments generally do not involve a return on an initial investment.

The disposal or the acquisition of a derivative would constitute a derivative transaction.

All your derivative transactions with international related parties should be shown at this question, including derivatives entered into for trading, hedging, speculation or arbitrage purposes.

You should not include exchange traded options or exchange traded futures in this question. However, where exchange traded options or futures are not separated from other options or futures in your records they may be included.

Where you use mark-to-market or fair value accounting for financial accounting purposes you may use this method for determining amounts included for derivatives at this question. This will include the net change in fair value of the derivative recorded as a gain or loss in your financial statements for the relevant income year.

For many derivatives (for example, interest rate swaps), the parties to the contract will make payments at regular intervals under the contract. These gross payments should be recorded at this question as captured for accounting purposes. If under the derivative instrument, net cash flows are exchanged at certain specified times during the term of the contract, and only net cash flows are captured for accounting purposes, then the amounts should be included at this question on a net cash flow basis. Principal or notional principal amounts exchanged under the derivatives should not be included.

The net settlement amounts exchanged to close out a forward rate agreement or cross currency swap agreement would be included at this question, but not a principal amount delivered under the agreement.

The amounts payable or derived as option premiums would also be included at this question.

The amounts reported at this question may be reported in financial statements as revenue and gains or expenses and losses, depending on the accounting treatment of your derivatives (and this includes amounts relating to derivatives entered into that are part of a hedging purpose).

Therefore for the purposes of this question, the terms:

• expenditure and losses are interchangeable
• revenue and gains are interchangeable.

To evaluate the information provided at items 9a or 9b we need to know whether the Australian taxpayer is conducting derivative trading globally through a trading structure such that profits from the activities are shared with international related parties. Where this is the case there is a transfer pricing risk due to the need to determine the appropriate allocation of profits between the relevant parties. This is the focus of item 9c.

Global trading of financial instruments, including derivatives, is defined by reference to the fact that some part of the business is conducted in more than one tax jurisdiction. This concept of trading derivatives globally is based on the OECD's definition of global trading of financial instruments.

For information about what might constitute global trading, see paragraphs 9 to 11 of the introduction of OECD Document – The Taxation of Global Trading of Financial Instruments (1998). You can buy a copy at OECD iLibraryExternal Link

To complete this question:

• identify the derivative transactions undertaken with international related parties
• total the expenditure incurred and the revenue earned in respect of these derivative transactions with international related parties
• determine the principal arm's length pricing method used to set or review consideration in respect of these derivative transactions.

If you had derivative transactions with international related parties during 2020–21, answer Yes at A item 9 and complete the following:

• At C of item 9a, write the total amount of expenditure incurred in respect of your derivatives with international related parties.
• At D of item 9a, write the total amount of revenue earned or derived in respect of your derivatives with international related parties.
• At E of item 9a, write the Appendix 5 code for the principal arm's length pricing method used to set or review consideration in respect of your derivatives with international related parties.
• At F of item 9a, write the Appendix 9 code for the percentage of your international related party dealings involving derivatives with international related parties for which you have documentation.
  
  Percentage of dealings with documentation refers to the aggregate dollar amount of transactions reported at this question for which you have relevant documentation expressed as a percentage of total dollar value of transactions reported at this question.
• At G1, G2 and G3 of item 9b, write the Appendix 6 code for the three types of derivative transactions you entered into with international related parties that have the highest dollar value.
• Answer Yes or No at H of item 9c depending on whether you engaged in the trading of derivatives globally through a trading structure (irrespective of the type of trading model used) such that you share global profits from these activities with international related parties.