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Foreign exchange (forex):
functional currency –
accounting and reporting
This document is current at December 2003. Subsequent editions
will be published on our website and will provide details on end of
year tax reporting, including the completion of tax returns.
This fact sheet provides an overview of the new functional
currency rules1, including eligibility requirements. Eligible
taxpayers who keep their accounts solely or predominantly in a
particular foreign currency can now use that functional currency as
their unit of account to calculate taxable income. Transactions in
the applicable functional currency that go into working out a
taxpayer’s taxable income or tax loss need not be translated into
Australian dollars ($A); only the net amount of taxable income
needs to be translated into $A.
Capital Gains Tax (CGT)
Company tax and
imputation
Consolidation
This fact sheet is for Australian residents, and non-residents with a
permanent establishment in Australia. It does not cover:

income from overseas permanent establishments of
resident taxpayers, or

income attributable to offshore banking units, controlled
foreign companies or transferor trusts.
Demergers
Excise and fuel schemes
Fringe Benefits Tax (FBT)
General Value Shifting
Regime (GVSR)
GST
Integrity measures
International financial
reporting standards
International tax
Petroleum resource rent
tax
Research & development
tax concession
Taxation of financial
arrangements
Taxation of life insurance
companies
Venture capital franking
rebate
How do the functional currency rules affect
tax accounting?
Once a taxpayer chooses to use a non-$A functional currency, it
must use that currency as the unit of account in its day-to-day
income tax accounting.
Non-functional currency amounts received
or paid
All elements of the financial accounts that make up taxable
income must be measured in the functional currency. Therefore,
any amounts received or paid in another currency, including $A
amounts, must be translated into the functional currency.
The translation rules, including applicable exchange rates, follow
the core rules for translation of foreign income to $A2 except that
in this case,

$A is treated as a foreign currency for functional currency
taxpayers, and

the taxpayer’s applicable functional currency is not a
foreign currency for the purposes of working out taxable
income or tax loss.3
Important: A forex realisation gain or loss may arise for certain
amounts if there is a discrepancy in prevailing exchange rates at
relevant times, for example between an amount being incurred
and paid. For a functional currency taxpayer, changes in the value
of the $A against the applicable functional currency can bring
about a forex gain or loss. (See “Example 1” below).
Example 1: Trigger of foreign currency loss
Stellar Rex Inc. (Stellar Rex), a USA company with a branch in
Australia, chooses to account for the taxable income of its
Australian branch in a functional currency. For Stellar Rex’s
purposes, US$ is the applicable functional currency and $A is a
foreign currency.
Stellar Rex contracts to purchase a depreciating asset from an
Australian company in $A, as follows:
Year 1
Stellar Rex contracts to purchase the asset for $A10,000. Stellar
Rex holds the asset from the date of contract.
At the time, $A1.00 = $US 0.50. Therefore the cost in functional
currency is $US 5,000.
Year 2
13 months after beginning to hold the asset, Stellar Rex pays $A
10,000 for the asset.
At this time, $A1.00 = $US 0.55, so the $A10, 000 Stellar Rex
pays is equivalent to $US 5,500.
As the payment was made more than 12 months after first holding
the asset, the loss is not a short-term forex realisation loss
(section 775-75 of ITAA 97). Therefore, Stellar Rex makes a forex
realisation loss of US$500 under Foreign Realisation Event 44.
This loss will be taken into account in calculating its taxable
income. Taxable income will be calculated in $US and converted
into $A.
Events before the choice takes place
The measure includes translation rules5 to cover taxable activities
that took place prior to a choice to use a non-$A functional
currency.
Where the taxpayer has not previously made a choice, translate
the amount:
1. first, into $A, at the exchange rate in effect at the time of the
transaction or event, and;
2. second, into the applicable functional currency at the exchange
rate in effect at the time the choice took effect.
Where the taxpayer has previously chosen to use a different
functional currency, translate the amount:
1. first, into the previous functional currency at the rate in
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effect at the time of the transaction or event, and;
2. second, into the new functional currency at the
exchange rate in effect when the current choice took
effect.
Example 2: Sale of assets acquired prior to a functional
currency choice
FION Inc (FION), a non-resident corporation, operates through a
permanent establishment in Australia. FION conducts its business
predominantly in Yen.
In the year ended 30 June Year 1 it chooses to use Yen (¥) as its
functional currency. The choice applies for the year commencing 1
July Year 2.
In the year ended 30 June Year 3, FION sells a tourist resort for
¥600 million, which it had purchased prior to Year 1 for ¥500
million.
As FION’s functional currency is ¥ the capital gain or capital loss
will be calculated in ¥. However, as ¥ was not the functional
currency at the time the asset was acquired, the ¥ cost is
converted to $A at the exchange rate prevailing at the time the
cost was incurred. The $A amount is then converted to ¥ at the
exchange rate prevailing at the time the choice to use ¥ as the
functional currency took effect.
Assume the exchange rates were:
At the time of purchase of the asset:
$A1.00: ¥68.50
At the time the choice took effect:
$A1.00: ¥62.00
The cost base for the purposes of calculating the capital gain or
loss on the disposal of the asset is:
¥500,000,000
X 62.00
68.50
= $A7,299,270 X 62.00
= ¥452,554,744
The capital gain, calculated in FION’s functional currency, is:
Sale proceeds:
¥600,000,000
Less cost base:
¥452,554,744
Gain:
¥147,445,256
How do the functional currency rules affect
tax reporting?
Detailed information on year end tax reporting will be
published in a later web version of this document.
The functional currency rules permit taxpayers to work out their
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taxable income or loss in their applicable functional currency. All
tax reporting is still to be expressed in $A. When reporting on the
income tax return or activity statement, taxpayers work out the
reported amounts in the functional currency and then translate the
amounts into $A.
For label amounts other than the taxable income amount where a
translation is needed, an entity uses the same translation rate as
the taxable income translation rate. If the entity does not have a
taxable income amount in a given income year (for example, if it
has a tax loss), it uses the same rate that it would have used to
translate a taxable income amount.
How to treat different amounts
Amount type
Treatment
Amounts used in
working out taxable
income or tax loss
denominated in the
functional currency
(FC), including
amounts of foreign
income6.
Include in the taxable income calculation
in FC before translating taxable income
from FC into $A.
Amounts used in
working out taxable
income or tax loss in
another currency
including $A
amounts, amounts of
foreign income and
the gross up amount
in respect of a
franked dividend.7
Translate into the FC using the
applicable rate for that amount. Include
the FC value in the taxable income
calculation before translating taxable
income from FC into $A. (See Example 3
and Example 4)
Carry-forward losses
Carry forward losses are allowable
deductions that reduce taxable income.
Identify the carry forward loss amount in
FC from previous income year.
Include these amounts in the taxable
income calculation in FC before
translating taxable income from FC into
$A.
When reporting the value of a tax loss,
translate it into $A.
Tax exempt amounts Tax exempt amounts that reduce carry
that reduce carry
forward losses are translated into
forward losses
functional currency generally upon being
derived and then used to absorb the loss
to the extent of their value.
When reporting the value of a tax exempt
amount, translate it into $A.
Foreign tax credits
(FTC)8
The value of foreign tax credit amounts
are not used in working out taxable
income (except for the calculation of
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attributable income of a Controlled
Foreign Company or transferor trust).
The core rules apply and the value of
foreign tax paid used to calculate foreign
tax credits is translated into $A when the
foreign tax is paid. (See Example 3)
Franking credits
The value of franking credits is not used
in working out taxable income. Franking
credits are a tax off-set.9 Add $A value of
franking credits to franking account
without translation into FC. (See Example
4)
Tax offsets and
rebates
Tax rebates and off-sets are not used to
work out taxable income or tax loss. The
core translation rules apply.
If the amount is already in $A, no
translation takes place.
If the amount is in a non-$A currency,
translate the amount into $A. Do not first
translate into FC.
Values expressed in
law.10
Translate these amounts to FC at the
applicable rate. (See Example 5)
Example 3: Foreign tax credits
Taxpayer chooses $US functional currency.
¥115 = 1.00 $US = 2.00 $A.
¥11,500 derived by taxpayer consisting of:
¥10,350 cash and
¥ 1,150 tax withheld in Japan.
To work out taxable income, translate ¥11,500 into $US as
follows:
¥11,500 = 100 $US added to assessable income.
Taxable income, including the ¥ receipt, is translated into $A at
end of year. If, between the time the income is derived and the
time it is reported at year end, the value of the $US-$A pair
changes, this change will be reflected in the amount of assessable
income the taxpayer eventually will need to bring to account. In
this example of at year end 1.00$US = $1.75$A then the taxpayer
will report A$175 assessable income from the receipt.
FTC calculation:
¥1,150 tax withheld is translated into $A upon being paid as
follows:
¥1,150 = $A20.
$A20 is used in calculating the amount of the foreign tax credit
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being the lesser of the amount of the foreign tax paid or the
Australian tax payable on the foreign income ($A200) and other
foreign income of that class.
Example 4 Franking credits
$US 1.00 = $A 2.00

XYZ Corporation (XYZ) is an Australian resident
company who chooses to employ $US as its applicable
functional currency. XYZ derives a fully franked dividend
as follows:
$A 70 cash
$A 30 gross-up amount (franking credit value)11.
Assessable income calculation

Taxpayer translates $A100 ($70 +$30) into $US as
follows:
$A 100 x 0.5 = $US 50
At tax year end $US 50 (and other taxable income values) are
translated into $A at regulation rate.
Franking Account Balance
Add $A 30.00 to franking account balance. No translation takes
place.
Example 5: Application of translation rule to a monetary limit
Exact Ltd (Exact), has made a valid choice to use as its applicable
functional currency the $US. In year 1, Exact purchases a car for
$US 40,000. At the time, the price is equivalent to $A72,700.
If the car limit under section 40-230 of the ITAA 1997 was
$A60,000 in year 1, Exact would apply that provision by converting
the limit to $US 33,012. The first element of the $US cost of a car
is therefore reduced to that amount.
Reporting during the year: activity
statements
When completing an activity statement:
1. calculate instalment income in functional currency,
2. translate into $A at the appropriate rate, and
3. fill in Label T1 of the activity statement accordingly.
Further information
For more information you can:
View more foreign exchange (forex) documents.
Phone:
13 28 61
for personal tax enquiries
6
13 28 66
for business tax enquiries
If you do not speak English well and want to talk to a tax
officer, phone the Translating and Interpreting Service
(TIS) on 13 14 50 for help with your call.
If you have a hearing or speech impairment and have
access to appropriate TTY or modem equipment, phone
13 36 77.
If you do not have access to TTY or modem equipment,
phone the Speech to Speech Relay Service on 1300 555
727.
NAT 10472
1 New Sub-Div 960-D, Income Tax Assessment Act (ITAA) 1997
2 See Sub-Div 960-C ITAA 1997. More information on the core
translation rules is available at www.ato.gov.au - search under
`translation' or select 'Business' then 'Large Corporates &
Multinationals' and then 'Taxation of Financial Arrangements'.
3 Section 960-80 ITAA 1997
4 More information on Forex Realisation Event 4 is available at
www.ato.gov.au - select `Business' then 'Large Corporates &
Multinationals' and then 'Taxation of Financial Arrangements'.
Section 960-80 ITAA 1997
5 Section 960-85 ITAA 1997
6 Sections 6AB and 6AC Income Tax Assessment Act 1936
7 Subsection 207-20(1) ITAA 1997.
8 Foreign tax credits in relation to the attributable income of a CFC
are not dealt with in this fact sheet.
9 Subsection 207-20(2) ITAA 1997
10 Paragraph 960-80(2)(i) ITAA 1997.
11 Subsection 207-20(1) ITAA 1997
Last Modified: Tuesday, 28 June 2005
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