House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 7 The elective foreign exchange retranslation method

Outline of chapter

7.1 This chapter outlines how the elective foreign exchange retranslation election (retranslation method) rules operate. The chapter explains:

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when the retranslation method may be applied;

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the effect of the retranslation method;

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the difference between a general retranslation election and an election in relation to qualifying forex accounts; and

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the interaction of the retranslation method with the other elective methods under Division 230.

Overview of the foreign exchange retranslation method

Application of the retranslation method

7.2 Taxpayers who prepare audited financial reports in accordance with Australian accounting standards or comparable foreign accounting standards may make:

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an election to apply the retranslation method to all 'financial arrangements' under Division 230 and those arrangements subject to Subdivision 775-F of the Income Tax Assessment Act 1997 (ITAA 1997) (general retranslation election); or

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an election to only apply the foreign exchange retranslation method to one or more of their financial arrangements that meet the definition of a 'qualifying forex account' (qualifying forex account election).

7.3 Once made, an election is irrevocable.

7.4 Where the retranslation method applies, any gain or loss due to changes in currency exchange rates will be generally determined by the amount which is required under Australian Accounting Standard AASB 121 The Effects of Changes in Foreign Exchange Rates (AASB 121) (or a comparable foreign accounting standard) to be recognised in profit or loss in the financial reports.

7.5 Broadly, where a general retranslation election is made, all gains and losses attributable to changes in currency exchange rates arising from financial arrangements will be brought to account under Subdivision 230-D.

7.6 The retranslation method is similar to the fair value method in recognising unrealised gains and losses in the period in which they occur. However, the retranslation method only recognises gains and losses that are attributable to movements in foreign currency exchange rates. Fair value, on the other hand, recognises gains and losses attributable to changes in other variables such as interest rates and creditworthiness in addition to any gains and losses that are attributable to movements in foreign currency exchange rates.

7.7 The retranslation method will not apply to a financial arrangement if any of the following elections have been made in relation to that financial arrangement:

•

a fair value election under Subdivision 230-C;

•

a financial reports election under Subdivision 230-F; or

•

a hedging financial arrangement election under Subdivision 230-E to the extent it applies to that financial arrangement.

7.8 Where the retranslation method applies to a financial arrangement, any gains and losses not attributable to changes in currency exchange rates will be brought to account under the accruals and/or realisation methods.

7.9 If none of the elective tax-timing methods (including the retranslation method) apply to a financial arrangement, gains and losses including those attributable to changes in currency exchange rates will be brought to account under the accruals and/or realisation methods.

7.10 A qualifying forex account election can only be made where a general retranslation election has not already been made.

Context of amendments

7.11 The retranslation method measures the gain or the loss arising from different prevailing exchange rates at different points in time, on translating a given number of units of one currency into another currency.The retranslation tax-timing method will only be relevant to those taxpayers with arrangements denominated in, or determined by reference to, a foreign currency or, in the case of taxpayers who have made an election under Subdivision 960-D of the ITAA 1997, a non-functional currency.

7.12 The scope of the retranslation method is determined by the two foreign exchange retranslation elections available. A taxpayer can make either:

•

a general election to use the retranslation method, the scope of which is determined by the amounts required by AASB 121 to be recognised in the profit or loss statement in a taxpayer's set of financial reports. A general election is made in respect of all financial arrangements and other arrangements where those amounts have not previously been recognised in the taxpayer's set of financial reports; or

•

a qualifying forex account election to use the retranslation method only in respect of one or more financial arrangements that meet the definition of a 'qualifying forex account'. A qualifying forex account is defined in the ITAA 1997 as an account denominated in foreign currency which is used for the primary purpose of facilitating transactions or is a credit card account.

7.13 Under AASB 121, certain annual gains and losses attributable to changes in foreign exchange rates are required to be recognised in profit or loss in an entity's financial reports. The retranslation method is intended to apply only to these gains and losses.

7.14 These gains and losses, referred to in AASB 121 as exchange differences , are the differences resulting from translating a given number of units of one currency into another currency at different exchange rates. An initial translation is made when the relevant item is first recognised for financial accounting purposes. At subsequent reporting dates, another translation, sometimes referred to as 'retranslation', is made. The difference between these amounts is recognised for accounting purpose in profit or loss, despite typically being unrealised.

7.15 Gains and losses attributable to changes in currency exchange rates may also arise under AASB 121 on the settlement or maturity of the relevant item.

7.16 Where the retranslation method applies it may result in the recognition of unrealised gains and losses attributable to changes in currency exchange rates. If an entity continues to hold a financial arrangement under Division 230 or an arrangement subject to Subdivision 775-F of the ITAA 1997, the taxation of any unrealised foreign exchange gains or losses as a result of applying the retranslation method may, like the fair value tax-timing method, cause volatility in an entity's taxable income. Taxpayers will need to determine whether this method is suitable for determining these gains and losses for tax purposes.

7.17 For some taxpayers, recognising gains and losses in a manner consistent with what is required under AASB 121 may be beneficial from a compliance perspective. Their foreign exchange exposures are likely to be such that the retranslation method in AASB 121 does not impose significant volatility in earnings, and therefore alignment between the financial accounting and tax outcomes would also not impose any significant volatility in taxable income.

7.18 Other taxpayers may see benefits in recognising for tax purposes foreign exchange gains and losses as determined under AASB 121 only in respect of one or more of their 'qualifying forex accounts'.

7.19 To a limited extent, the election to use the retranslation method for qualifying forex accounts is similar to the retranslation election currently available under Subdivision 775-E of the ITAA 1997. Under Subdivision 775-E, a retranslation election that operates to imitate the retranslation method in AASB 121 is available for certain transactional foreign currency denominated accounts maintained with a bank or similar financial institution.

7.20 Retranslation is different to fair value in that it only recognises gains and losses attributable to movements in foreign currency exchange rates. Fair value, on the other hand, recognises gains and losses attributable to changes in other variables such as interest rates and creditworthiness in addition to any gains or losses attributable to movements in foreign currency exchange rates. Consistent with the approach relating to the fair value tax rules, Division 230 does not mandate retranslation tax treatment.

Summary of new law

7.21 Where audited financial reports are prepared in accordance with Australian accounting standards or comparable foreign accounting standards, a taxpayer may elect to use the retranslation method to determine gains and losses from financial arrangements to the extent they are attributable to changes in currency exchange rates.

7.22 If made, the general retranslation election will also bring to account gains and losses attributable to changes in currency exchange rates made from arrangements which are subject to Subdivision 775-F of the ITAA 1997.

7.23 The general retranslation election will apply to all relevant arrangements which are first held in the income year in which the election is made. In subsequent income years, it will apply to all arrangements in respect of which the relevant accounting standards recognise in profit or loss, an amount attributable to foreign currency exchange rate changes. This includes intra-group transactions that are financial arrangements which would not normally be recognised by the Australian Accounting Standard AASB 127 Consolidated and Separate Financial Statements (AASB 127), or a comparable foreign accounting standard.

7.24 The head company of a consolidated group may choose that the general retranslation election will not apply to the financial arrangements or arrangements subject to Subdivision 775-F of the ITAA 1997 in relation to the life insurance business of the head company of a consolidated group or a MEC group. Regulations may also be made to allow the head company of a consolidated or MEC group to choose to elect to exclude these financial arrangements in relation to other businesses of the group.

7.25 Taxpayers who do not make a general retranslation election may make an election in respect of one or more of their qualifying forex accounts, essentially any transactional account. In certain circumstances they will be able to elect their qualifying forex accounts with effect from 1 July 2003.

7.26 The gain or loss recognised for an income year under the retranslation method will generally be the same as that which is required to be recognised under AASB 121 or its foreign equivalent in an entity's profit or loss. However, the retranslation method will not recognise an amount in an entity's profit or loss if that amount has previously been recognised in equity.

7.27 Both the general retranslation election and the qualifying forex account election are irrevocable.

7.28 Where the requirements for making either election cease to be satisfied, the election ceases to have effect and a balancing adjustment is required to be made.

Comparison of key features of new law and current law

Detailed explanation of new law

When can the foreign exchange method be used?

7.29 The retranslation method will only apply in respect of an arrangement if a foreign exchange retranslation election validly applies to that arrangement.

7.30 A foreign exchange retranslation election may apply in two circumstances:

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at the taxpayer's election, to all relevant arrangements, where the specified accounting and auditing requirements are satisfied (general retranslation election) [ Schedule 1, item 1, subsections 230-255(1) and (2), item 6, section 775-295 ]; or

•

to financial arrangements that are qualifying forex accounts, in respect of which an election has been made (qualifying forex account election) [ Schedule 1, item 1, subsections 230-255(3) and (4 )].

General retranslation election

Election requirements

7.31 Only taxpayers whose financial reports are prepared and audited in accordance with Australian accounting and auditing standards or comparable foreign accounting and auditing standards can make the general retranslation election. This includes taxpayers whose results are properly reflected in a set of audited financial reports of a connected entity. [ Schedule 1, item 1, subsection 230-255(2 )]

7.32 Chapter 5 explains what is meant by financial reports, financial reporting requirements, accounting standards and auditing standards (including comparable foreign accounting and auditing standards).

Scope of general retranslation election

7.33 If the general retranslation election is made, the retranslation method will apply to determine all gains and losses attributable to currency exchange rate changes which arise from all arrangements to which the election applies.

7.34 A general retranslation election will apply to all arrangements:

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that the taxpayer starts to have in the income year in which the election is made or in a later income year [ Schedule 1, item 1, paragraph 230-265(1)(d), item 6, paragraph 775-295(1)(a )];

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that are recognised in a financial report in respect of which the accounting and auditing requirements are satisfied [ Schedule 1, item 1, paragraph 230-265(1)(b), item 6, paragraph 775-295(1)(b )];

•

in respect of which an amount attributable to changes in currency exchange rates is required to be recognised in profit or loss in the financial reports pursuant to AASB 121 (or another standard prescribed in the regulations) or a comparable foreign accounting standard [ Schedule 1, item 1, paragraph 230-265(1)(c), item 6, paragraph 775-295(1)(c )];

•

where the amount attributable to changes in currency exchange rates is recognised in profit or loss in the taxpayer's financial reports and which has not previously been recognised in the equity reserves in the taxpayer's financial reports [ Schedule 1, item 6, subsection 775-305(4 )]; and

•

including intra group transactions that are financial arrangements which have not been recognised in the financial reports because they have been disregarded for financial accounting purposes under AASB 127 or a comparable foreign accounting standard [ Schedule 1, item 1, subsection 230-265(2 )].

7.35 Under AASB 121 (or comparable foreign accounting standards) certain gains and losses attributable to changes in currency exchange rates are recognised in profit or loss in an entity's financial reports. For the general retranslation election to apply to an arrangement, AASB 121 or a comparable foreign accounting standard must require the recognition in profit or loss of gains and losses (if any) from the arrangement in the year in which the gain or loss arises. The requirement that a gain or loss must be recognised in profit or loss will not be satisfied where it has earlier been recognised in equity.

7.36 In respect of this requirement, the regulations may prescribe that gains and losses attributable to changes in currency exchange rate fluctuations may be required to be recognised under accounting standards other than AASB 121. For example, if AASB 121 is replaced subsequent to the enactment of Division 230, and the replacement standard provides for retranslation, such a replacement standard would be expected to be prescribed by the regulations as being a relevant accounting standard. Gains and losses attributable to changes in currency exchange rates which arise from relevant arrangements will be required to be recognised under such a replacement standard. To the extent to which comparable foreign accounting standards require these gains and losses from financial arrangements to be recognised in profit or loss, and those amounts have not previously been recognised in an equity reserve, this requirement will also be satisfied.

7.37 Where a general retranslation election applies to an arrangement, gains and losses from that arrangement which are attributable to changes in currency exchange rates will be recognised under either Subdivision 230-D or 775-F of the ITAA 1997.

7.38 Whilst Division 775 of the ITAA 1997 could potentially apply whenever there is a cessation of an obligation to pay or receive foreign currency (or right to receive or pay foreign currency), subsection 230-20(2) has the effect of disregarding gains and losses arising under Division 775 to the extent they are, or will be, included in assessable income or allowable as a deduction under Division 230. A note, following subsections 775-15(4) and 775-30(4), clarifies this point. [ Schedule 1, items 2 and 3 ]

Division 230 retranslation arrangements

7.39 Where a general retranslation election applies to a financial arrangement, its gains and losses attributable to currency exchange rate changes will be subject to Division 230 unless:

•

the financial arrangement is subject to an exception that provides that its gains and losses are not subject to Division 230 (discussed in Chapter 2); or

•

the financial arrangement is specifically excluded by subsection 230-270(3) or (4), from having the general retranslation method under Division 230 apply to it.

7.40 Where a general retranslation election applies to a relevant financial arrangement, the amount taken to be a gain or loss for the purposes of Division 230 is determined by AASB 121 or a comparable foreign accounting standard. That gain or loss is the amount which AASB 121 or a comparable foreign accounting standard requires to be recognised in profit or loss for that financial arrangement. [ Schedule 1, item 1, subsection 230-280(1 )]

Retranslation method under Division 775 of the ITAA 1997

7.41 An arrangement to which the general retranslation election applies will have those gains and losses attributable to currency exchange rate changes subject to Subdivision 775-F of the ITAA 1997 if it is:

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a financial arrangement whose gains and losses are not subject to Division 230 (as set out in Subdivision 230-H and explained in Chapter 2); or

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an arrangement, which constitutes a right and/or an obligation to receive or provide foreign currency, which is not a financial arrangement.

[ Schedule 1, item 6, Subdivision 775-F ]

7.42 Where Subdivision 775-F of the ITAA 1997 applies to an arrangement to which the general retranslation election applies, the amount taken to be a forex realisation gain or loss for the purposes of that Division is also determined by AASB 121 or a comparable foreign accounting standard. The gain or loss taken to be made is the amount attributable to changes in currency exchange rates in respect of that arrangement which is required by AASB 121 (or a comparable foreign accounting standard) to be recognised in profit or loss for that arrangement. This gain or loss will be recognised under new forex realisation event 9 contained in Subdivision 775-F of the ITAA 1997. [ Schedule 1, item 6, section 775-305 ]

The general retranslation election ceases to apply

Cease to meet eligibility requirements

7.43 The general retranslation election ceases to have effect in respect of all relevant arrangements from the start of any income year during which the taxpayer ceases to be eligible under subsection 230-220(2) to make the election. This may occur if, for example, the taxpayer no longer prepares its reports in accordance with the relevant accounting standards, or it no longer satisfies the requirement that the reports are audited (see Chapter 5). [ Schedule 1, item 1, subsection 230-285(1 )]

7.44 The cessation of the general retranslation election in these circumstances does not prevent a fresh election being made should the eligibility requirements once again be satisfied. However, a subsequent general retranslation election will apply only to those relevant arrangements the taxpayer starts to have in the year the election is remade, or in subsequent income years. [ Schedule 1, item 1, subsection 230-285(2 )]

Cease to meet recognition requirements

7.45 The general retranslation election will cease to apply to a particular arrangement from the start of any income year where:

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the arrangement is no longer recognised in financial reports that meet the relevant accounting and auditing requirements discussed in Chapter 5; or

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in relation to the arrangement, amounts attributable to changes in currency exchange rates are no longer required by the relevant accounting standard to be recognised in profit or loss in the financial reports.

[ Schedule 1, item 1, subsection 230-285(3), item 6, subsection 775-310(1 )]

7.46 Where the general retranslation election ceases to apply to an arrangement, the election cannot subsequently reapply to such an arrangement, even where the arrangement later satisfies the relevant recognition requirements. [ Schedule 1, item 1, subsection 230-285(4), item 6, subsection 775-310(2 )]

Example 7.1 : A financial arrangement ceases to be recognised in a relevant financial report

Yvee Imports Ltd (Yvee) is a large Australian company that imports forensic tools and equipment from various foreign sources for law enforcement organisations. Yvee prepares accounts in accordance with Australian accounting standards, and has its accounts audited in accordance with the Australian auditing standards.

Yvee has various foreign currency denominated financial arrangements in respect of which it is required to recognise amounts in profit or loss in its financial reports, in accordance with AASB 121.

Over time, an arrangement that has previously had amounts in respect of currency exchange changes recognised under AASB 121 diminished in value such that it was no longer recognised in the financial reports, under the accounting practice regarding materiality.

From the start of the income year in which the financial arrangement was no longer recognised in the financial reports, the elective retranslation method ceased to apply to this particular arrangement of Yvee. Although the retranslation method no longer applies to this arrangement, any gains and losses attributable to currency exchange rate changes will be recognised under the accruals or realisation methods.

Note: Yvee will continue to apply the retranslation method to the remainder of its arrangements that satisfy the relevant criteria.

Balancing adjustment under Division 230 where the general retranslation election ceases to apply

7.47 When the general retranslation election ceases to apply to a Division 230 financial arrangement, a balancing adjustment is required to be made in respect of that financial arrangement. [ Schedule 1, item 1, subsections 230-290(1) and (3 )]

7.48 The balancing adjustment is to be made in accordance with the balancing adjustment requirements set out in Subdivision 230-G (see Chapter 10). The balancing adjustment is:

•

calculated on the assumption that the financial arrangement is disposed of when the general retranslation method ceases to apply (at the start of the income year in which the relevant requirements are failed) for its fair value at that time; and

•

is limited to the extent to which the balancing adjustment so calculated is reasonably attributable to a 'currency exchange rate effect'.

[ Schedule 1, item 1, subsections 230-290(2) and (4 )]

7.49 The relevant financial arrangement is taken to be reacquired for its fair value at the time the election ceased to apply. [ Schedule 1, item 1, subsection 230-290(5 )]

7.50 A currency exchange rate effect is defined in the ITAA 1997 to mean any currency exchange rate fluctuations or the difference between an agreed currency exchange rate for a future time and the applicable currency exchange rate at that time. This ensures that only gains and losses attributable to changes in currency exchange rates are taken into account at the time of the deemed disposal when the general retranslation election ceases to apply to the relevant financial arrangement.

7.51 As the retranslation method will no longer apply to such a financial arrangement, the other tax-timing methods need to be considered in respect of that arrangement.

Consequences under Division 775 of the ITAA 1997 where the general retranslation method ceases to apply

7.52 When the general retranslation method ceases to apply to an arrangement that is being retranslated under Subdivision 775-F of the ITAA 1997, the taxpayer will be taken to have:

•

disposed of the relevant arrangement immediately prior to the time the general retranslation election is taken to cease to have effect or ceases to apply to that arrangement for its fair value at that time; and

•

reacquired the arrangement immediately after the time the general retranslation election is taken to cease to have effect or ceases to apply to it for that same value.

[ Schedule 1, item 6, section 775-315 ]

7.53 Any difference between the retranslated value of the arrangement at the time it was last retranslated and the time immediately prior to the election ceasing, will be recognised as a gain or a loss under 'forex realisation event 9'. [ Schedule 1, item 6, sections 775-305 and 775-315 ]

7.54 For the purposes of Division 775 of the ITAA 1997, any future forex realisation gains or losses arising from the reacquired arrangement will be determined under the general provisions of Division 775.

Qualifying forex account election

Election requirements

7.55 Instead of making a general retranslation election, a taxpayer may elect to apply the retranslation method to one or more of its financial arrangements that meet the definition of a qualifying forex account. This qualifying forex account election can only be made where a general retranslation election does not apply to that financial arrangement. [ Schedule 1, item 1, subsection 230-255(3 )]

7.56 Existing elections that apply to qualifying forex accounts under Subdivision 775-E of the ITAA 1997 will cease to apply to any account to which a general retranslation election or a qualifying forex account election applies. [ Schedule 1, item 5, subsection 775-270(1A )]

Qualifying forex account

7.57 A qualifying forex account is a foreign currency denominated account which has the primary purpose of facilitating transactions or is a credit card account. [ Schedule 1, item 112, definition of ' qualifying forex account' in subsection 995-1(1 )]

7.58 The current restriction which limits 'qualifying forex accounts' to accounts held with an 'ADI' (authorised deposit-taking institution) as defined in the ITAA 1997 will be removed [ Schedule 1, item 112, definition of ' qualifying forex account' in subsection 995-1(1 )]. In a general sense, the limitation in the existing law has meant that only accounts held with banks and financial institutions were able to be retranslated under Subdivision 775-E of the ITAA 1997.

7.59 The effect of this change, which is to have effect (in certain circumstances) from 1 July 2003, is to broaden the category of accounts which may be subject to foreign exchange retranslation treatment under Subdivision 775-E of the ITAA 1997 and under the new provisions contained in Subdivision 230-D. Refer to Chapter 11 for more detail on the changed application of the retranslation election under Division 775.

The scope of the qualifying forex account election

7.60 Where a qualifying forex account election is made in respect of a financial arrangement that is a 'qualifying forex account', it will apply to determine all gains and losses attributable to changes in currency exchange rates from that account.

7.61 If a taxpayer makes a qualifying forex account election before they start to have the financial arrangement that is a qualifying forex account, then the retranslation method applies from the time the taxpayer starts to hold that account. [ Schedule 1, item 1, paragraph 230-255(4)(a )]

7.62 If the taxpayer already held the financial arrangement prior to making the election, the retranslation method will apply from the start of the year in which the taxpayer made that election [ Schedule 1, item 1, paragraph 230-255(4)(b )]. In these circumstances, the taxpayer will be required to make a balancing adjustment in accordance with Subdivision 230-G calculated as if the taxpayer had ceased to have the arrangement for its fair value at the time when the election started to apply to the arrangement. However, the balancing adjustment will only recognise an amount to the extent it is reasonably attributable to a currency exchange rate effect [ Schedule 1, item 1, section 230-275 ].

Qualifying forex accounts which are held prior to the commencement of Division 230

7.63 Until the lodgment date of the first income year in which Division 230 first applies, a taxpayer can elect to have Division 230 apply to all existing financial arrangements. For more information on this refer to Chapter 13. [ Schedule 1, Part 3, subitem 104(2 )]

7.64 A balancing adjustment is required for all existing financial arrangements where this transactional election is made. This includes existing financial arrangements which meet the definition of a qualifying forex account. [ Schedule 1, Part 3, subitem 104(12 )]

7.65 Generally, there will be only a small (if any) balancing adjustment required for most taxpayers already retranslating their existing qualifying forex accounts under Subdivision 775-E of the ITAA 1997. [0]This is because the retranslation calculation under Subdivision 775-E should have already brought to account gains and losses attributable to changes in currency exchange rates arising from the account up until the end of the immediately preceding income year.

7.66 A balancing adjustment for an existing qualifying forex account that has not been subject to the retranslation election under Subdivision 775-E of the ITAA 1997 may consist of an amount which is due to currency exchange rate changes as these gains and losses may not have been previously recognised under Division 775 of the ITAA 1997. [ Schedule 1, Part 3, subitem 104(12 )]

When a qualifying forex account election will cease to apply

7.67 A qualifying forex account election will cease to apply to a financial arrangement from the start of an income year during which:

•

the financial arrangement stops being a qualifying forex account; or

•

the taxpayer makes a general retranslation election under subsection 230-255(1) that applies to that account.

[ Schedule 1, item 1, subsection 230-285(5 )]

7.68 Where a qualifying forex account election ceases to apply to a particular financial arrangement, it cannot subsequently reapply to that arrangement even if the relevant requirements begin to be satisfied once more in relation to that arrangement. (Refer to Chapter 5 for further discussion of this point.) [ Schedule 1, item 1, subsection 230-285(6 )]

A balancing adjustment under Division 230 where the qualifying forex account election ceases to apply

7.69 When a qualifying forex account election ceases to apply, a balancing adjustment is required to be made in the same manner and with the same consequences as for those financial arrangements for which a general retranslation election ceases to apply under Division 230 (see paragraphs 7.47 to 7.51). [ Schedule 1, item 1, subsections 230-290(3) to (5 )]

Foreign exchange retranslation elections are irrevocable

7.70 A general retranslation election or qualifying forex account election cannot be revoked. [ Schedule 1, item 1, subsection 230-255(5 )]

7.71 However, a general retranslation election may cease to apply (as discussed in paragraphs 7.43 and 7.46). Where this happens, a taxpayer may make a new election when the conditions for making a general retranslation election are subsequently satisfied. The new election will only apply to those arrangements the taxpayer starts to have in, or after, the year in which the election is remade that were not previously subject to such an election (see Chapter 5). [ Schedule 1, item 1, subsection 230-285(2 )]

7.72 Once a qualifying forex account election ceases to apply to a financial arrangement, it cannot subsequently reapply to that arrangement.

Interaction with other tax-timing methods in Division 230

7.73 If a financial arrangement is subject to a fair value election, any gains or losses attributable to changes in currency exchange rates will be brought to account under that method [ Schedule 1, item 1, paragraph 230-40(6)(a )]. The retranslation method will not apply (despite any election that has been made) because the fair value method recognises changes in fair value between two points in time. Any changes attributable to currency exchange rate movements are also recognised under the fair value method.

7.74 To the extent to which a hedging financial arrangement election applies to a financial arrangement (see Chapter 8), the retranslation method has no application [ Schedule 1, item 1, paragraph 230-40(6)(b )]. Gains and losses from that financial arrangement will be determined under the hedging financial arrangements method.

7.75 If an election to rely on financial reports applies to a financial arrangement, the retranslation method does not apply [ Schedule 1, item 1, paragraph 230-40(6)(c )]. The financial reports method broadly recognises gains and losses from financial arrangements based on the method used in an entity's financial reports to recognise those amounts. To the extent to which AASB 121 applies to a financial arrangement, gains and losses required to be recognised under that standard will be recognised under the financial reports method. As a result the retranslation method will have no application.

7.76 In a hierarchical sense, these are the most fundamental exclusions from the retranslation method, other than the exceptions specified within the method itself which have been detailed above.

7.77 In the absence of any elective tax-timing method (including the retranslation method) applying to a financial arrangement, any gain or loss attributable to changes in currency exchange rates will be brought to account under the accruals or realisation methods. This result will be achieved through the combined operation of the accruals and realisation rules in Division 230, and the translation rules in Subdivisions 960-C and 960-D of the ITAA 1997.

7.78 Where the accruals method applies, financial benefits provided or received under a financial arrangement which are denominated in a particular foreign currency are not translated into Australian currency before calculating the sufficiently certain overall gain or loss from the arrangement. This is because the rule that ordinarily requires elements in a calculation to be first translated to Australian currency (or the relevant functional currency) before the calculation is conducted (in subsections 960-50(4) and 960-80(4) of the ITAA 1997), does not apply to amounts worked out under the accruals method in Division 230. Therefore, any amounts attributable to changes in currency exchange rates will be included in the running balance adjustment under section 230-175 or the balancing adjustment under section 230-445. For further discussion see Chapter 11. [ Schedule 1, item 28, definition of ' special accrual amount' in subsection 995-1(1 )]

7.79 The retranslation method is intended to work in tandem with the accruals and realisation methods. The retranslation method operates to recognise gains and losses attributable to changes in currency exchange rates. The accruals and realisation methods will apply to recognise those gains and losses that may arise from the financial arrangement which are not due to currency exchange rate fluctuations. See Examples 7.2 and 7.3.

Example 7.2 : No foreign exchange retranslation election

A Co acquires a US dollar (US$) denominated promissory note with a face value of US$100,000 for a cost of US$98,550. Assume the note is acquired on the first day of A Co's income year and that the promissory note matures in three years time.

A Co has not made a foreign exchange retranslation election, hedging financial arrangement election, fair value election or election to rely on financial reports under Division 230 in relation to the promissory note. A Co has also not made a functional currency election under Subdivision 960-D of the ITAA 1997.

The provisions in Subdivision 960-C of the ITAA 1997 which require foreign currency amounts to be translated into Australian dollars will apply for the US$ denominated amounts.

The relevant US$/A$ exchange rate prevailing:

•

at the time the promissory note is acquired, is 0.75;

•

at the end of year 1, is 0.73;

•

at the end of year 2, is 0.76; and

•

at the end of year 3, is 0.78.

The promissory note is a financial arrangement, as the only rights and obligations A Co has under the promissory note is its right to receive US$100,000, thus satisfying the test for a cash-settlable financial arrangement (section 230-45).

A Co pays the US$98,550 when the promissory note is acquired.

The discount to the face value of the promissory note will be brought to account under the accrual rules in Subdivision 230-B. The accrual calculation undertaken to determine the amount of the relevant gain or loss on the financial arrangement to be accrued each year, is to be undertaken in the relevant foreign currency (definition of 'special accrual amount' in subsection 995-1(1) of the ITAA 1997).

The gain to be accrued is the US$1,450 discount, as this is a sufficiently certain overall gain or loss from the financial arrangement (the promissory note) that is known at the start time (subsections 230-100(2) and 230-105(1)). The period over which this gain is to be spread, on a compounding accruals basis, is the three-year period from when A Co acquired the promissory note, to when it matures (subsection 230-130(1) and section 230-135).

Over this three-year arrangement the internal rate of return calculates to 0.488 per cent. This means the gain taken to be made from the financial arrangement in each year under the accrual rules (subsection 230-140(1)) is as follows:

•

year 1 - US$481;

•

year 2 - US$483; and

•

year 3 - US$486.

These gains are included in the assessable income of A Co (subsection 230-15(1)). A Co must translate these assessable amounts into Australian currency, using the translation rules in Subdivision 960-C of the ITAA 1997. Assuming A Co does not choose to use any alternate translation rules allowed in Schedule 2 to the ITAA 1997, (such as a relevant average exchange rate), these amounts translate to:

•

A$659 in year 1 (US$481/0.73);

•

A$636 in year 2 (US$483/0.76); and

•

A$623 in year 3 (US$486/0.78).

However, as the arrangement has come to an end in year 3 (as on receipt of the US$100,000, all of A Co's rights and obligations under the financial arrangement have ceased), a balancing adjustment is made (paragraph 230-435(1)(b)).

The balancing adjustment broadly involves comparing the financial benefits and consideration received and paid under the financial arrangement, with the gains and losses from the financial arrangement assessable or allowable as deductions (subsection 230-445(1)).

Even though the US$98,550 A Co paid, not being an obligation persisting when the promissory note is acquired, is not part of the financial arrangement, it plays an integral role in determining whether A Co has a gain or loss from the arrangement and therefore is considered to be a financial benefit A Co provided under the financial arrangement (subsection 230-60(1)).

As such, under the balancing adjustment, A Co compares (in Australian dollar terms, pursuant to subsection 960-50(4) of the ITAA 1997), the US$100,000 received ( step 1 ), with the US$98,550 paid plus any assessable gains made from the financial arrangement, (ie, the accrual amounts) ( step 2 ) (subsection 230-445(1)).

Balancing adjustment (section 230-445 )	US $	Exchange rate US$/A $	A $
step 1	Financial benefit received under arrangement (face value of note).	100,000	0.78	128,205
step 2	Financial benefit taken to be provided under arrangement (cost of note)	98,550	0.75	131,400
	plus assessable gains from arrangement (accrual gains)
	year 1			659
	year 2			636
				132,695
step 3	Excess of step 2 over step 1 is a loss made from the financial arrangement.			(4,490)

This loss of A$4,490, calculated under the balancing adjustment, is taken to be a loss made from the financial arrangement, and deductible in year 3 (subsections 230-445(1) and 230-15(2)).

Accordingly, the tax treatment of A Co's gains and losses from its promissory note in total is:

•

year 1 - A$659 assessable gain;

•

year 2 - A$636 assessable gain;

•

year 3 - A$4,490 allowable deduction;

comprised of:

A$623 assessable gain and A$5,113 allowable deduction.

•

NET - A$3,195 deductible loss.

A Co's net position is a deductible loss of A$3,195. This is equal to the difference, in Australian dollar terms, of the amount paid for the promissory note (A$131,400), and the amount received on its maturity (A$128,205).

Example 7.3 : Foreign exchange retranslation election

Assume the facts are the same as for Example 7.2, but that A Co has made a valid retranslation election.

The calculation of the gain or loss to be accrued will be the same.

In addition, any foreign exchange gains and losses will be calculated each year under the retranslation method. Under AASB 121, the carrying amount of A Co's promissory note will be translated into Australian dollar currency at the date it was acquired, and at subsequent recording dates, with any exchange differences required to be recognised in profit or loss. Under the retranslation method, these amounts will be taken to be gains or losses made from the financial arrangement (subsection 230-280(1)).

It is assumed that A Co has been discounting its promissory note for financial accounting purposes using the effective interest rate method, on the same basis as the accrual calculations discussed in Example 7.2.

In the relevant years, the amount required by AASB 121 to be recognised in profit or loss is therefore:

Year	Carrying value (US $)	Foreign exchange retranslation gain / ( loss ) ( A $) ( difference between carrying value at closing and opening rates )
1	98,550	3,600 (US$98,550 x (1/0.73 - 1/0.75))
2	99,031 (98,550 plus 481 accrual gain from year 1 - see Example 7.2)	(5,355) (US$99,031 x (1/0.76 - 1/0.73))
3	99,514 (99,031 plus 483 accrual gain from year 2 - see Example 7.2)	(3,357) (US$99,514 x (1/0.78 - 1/0.76))

Therefore, under the retranslation method, a gain of A$3,600 will be assessable in year 1, and losses of A$5,355 and A$3,357 will be deductible in years 2 and 3 respectively (subsections 230-280(1) and 230-15(1) and (2)).

In addition, as with Example 7.2, a balancing adjustment is required in year 3, as at the end of year 3 the financial arrangement is realised. Under the balancing adjustment, compare (in Australian dollar terms, pursuant to subsection 960-50(4) of the ITAA 1997), the US$100,000 received plus any deductible losses made from the financial arrangement (ie, any foreign exchange retranslation losses) ( step 1 ), with the US$98,550 paid plus any assessable gains made from the financial arrangement, (ie, any accrual gains plus any foreign exchange retranslation gains) ( step 2 ) (subsection 230-445(1)).

Step	Balancing adjustment (section 230-445 )	US $	Exchange rate US $/ A $	A $
step 1	Financial benefit received under arrangement (face value of note)	100,000	0.78	128,205
	plus
	Deductible losses from arrangement:
	year 2 retranslation loss			5,355
	Total of step 1			133,560
step 2	Financial benefit taken to be provided under arrangement (cost of note)	98,550	0.75	131,400
	plus
	Assessable gains from arrangement
	year 1 retranslation gain			3600
	year 1 accrual gain (per Example 7.2)			659
	year 2 accrual gain (per Example 7.2)			636
	Total of step 2			136,295
step 3	Excess of step 2 over step 1 is a loss made from the arrangement			(2,735)

The A$2,735 is deductible to A Co in year 3 (subsections 230-445(1) and 15(2)).

The combined effect for A Co of an application of both the accrual and retranslation methodologies, and the balancing adjustment is that the total gain or loss calculated in the relevant years from the promissory note is:

•

year 1 - A$4,259 gain

•

(comprised of a A$3600 retranslation gain, plus A$659 accrual gain, per Example 7.2);

•

year 2 - A$4,719 loss

•

(comprised of a A$5,355 retranslation loss, plus A$636 accrual gain, per Example 7.2);

•

year 3 - A$2,735 loss

•

(comprised of a A$3,357 notional retranslation loss, plus A$623 notional accrual gain, per Example 7.2, plus A$1 balancing adjustment loss);

•

NET - A$3,195 deductible loss.

As in Example 7.2, A Co's net position is a deductible loss of A$3,195.