Issued
2015

Approval - income tax - currency conversion for branches

Determination covers foreign currency conversion methods approved by the CIR for branches – published 2015.

All legislative references are to the Income Tax Act 2007 unless otherwise stated.

Summary

  1. The Act requires foreign currency amounts to be converted to New Zealand dollars to calculate a taxpayer's New Zealand income tax liability.
  2. In some cases, the Act may prescribe a currency conversion method or foreign exchange rate source to use, but in most cases it does not.  Section YF 1(2) applies where the Act does not provide a specific currency conversion method or exchange rate source to use.  It requires taxpayers to convert foreign currency amounts to New Zealand dollars by applying the close of trading spot exchange rate on the date the amount is required to be measured or calculated.
  1. However, the Act gives the Commissioner the power to approve alternative currency conversion methods and foreign exchange rate sources.  The following currency conversion methods have been approved by the Commissioner for branches:
    • Entities that prepare financial statements that comply with International Financial Reporting Standards (IFRS) (as defined in s YA 1) may use the currency conversion method and rates adopted under IFRS to convert their branch's foreign currency amounts to New Zealand dollars (the IFRS method).
    • Non-IFRS taxpayers may use:
      • the average mid-month exchange rate method;
      • the average end-of-month exchange rate method;
      • the mid-month exchange rate method;
      • the end-of-month exchange rate method; or
      • the monthly average exchange rate method.
  1. Use of the annual and monthly methods is subject to certain conditions and thresholds that are discussed later in this item. 
  2. Entities using one of the approved currency conversion methods may need to make tax adjustments.  Where relevant, entities using the IFRS method should use the actual amounts, as already converted to New Zealand dollars, in their financial statements (see para [13]).  When making tax adjustments under an annual or monthly method, the adjustments should be consistent with the nature of the item being adjusted (see para [25]). 
  1. The Commissioner also approves the following alternative foreign exchange rate sources for branches under ss YF 1(5) and YF 2(2), subject to conditions outlined at [34] to [42]:
    • Read the foreign exchange rates.
    • The foreign exchange rates published on the Reserve Bank of New Zealand website: www.rbnz.govt.nz.
    • Foreign exchange rates from one of New Zealand's registered banks.
    • Any reputable externally-sourced exchange rate that is appropriate given the nature of the branch's business.
  1. All of the methods and exchange rate sources are approved for a foreign branch of a New Zealand entity's business or a New Zealand branch of a foreign entity's business. 
  2. This Approval does not apply to financial arrangements.  Financial arrangements must be converted to New Zealand dollars using the methods and rates prescribed under the financial arrangements rules.
  3. If a taxpayer is using, or would like to use, a method or rate source not outlined in this Approval, the taxpayer may apply to the Commissioner under ss YF 1(5), YF 1(6) or YF 2(2) for approval to use that method or rate source.  (Applications can be emailed to: fxconversions@ird.govt.nz.)
  4. This Approval updates and replaces "Tax effects of exchange alterations on 21 November 1967" Public Information Bulletin No 44 (February/March 1968), and "How revaluation affects tax" Public Information Bulletin No 75 (November 1973).

Interpretation

  1. Unless the context otherwise requires, these terms have the following meanings:
    • "Annual method" means the average mid-month exchange rate method or the average end-of-month exchange rate method.
    • "Branch" means a division of an entity's business located somewhere other than the head office.  A branch is not a separate legal entity.
    • "Currency conversion method" means an "annual method", a "monthly method" or the "IFRS method".
    • "Foreign currency amount" means an amount denominated in a currency other than New Zealand dollars.
    • "IFRS method" is the method set out at [12]. 
    • "Monthly method" means the mid-month exchange rate method, the end-of-month exchange rate method, or the monthly average exchange rate method.

IFRS method

  1. Entities that prepare financial statements that comply with IFRS (as defined in s YA 1) may use the currency conversion method and rates adopted under IFRS to convert their branch's foreign currency amounts to New Zealand dollars.  When separate financial statements are not prepared for the branch, the IFRS method can be used when the entity (of which the branch is a part) prepares IFRS financial statements that include the branch. 
  2. When making tax adjustments, where relevant, entities should use the actual amounts (as already converted to New Zealand dollars) in those financial statements.
  3. For fixed assets, tax depreciation should be calculated in New Zealand dollars on the New Zealand dollar cost, determined under subpart EW (if applicable), using the cost in New Zealand dollars as per the Statement of Financial Position, or determined using the spot rate on the date of acquisition. 

Annual methods

  1. The Commissioner has approved two annual currency conversion methods.  These are the average mid-month exchange rate method and the average end-of-month exchange rate method.  The essential difference between the two methods is the rate used to convert the foreign currency amounts to New Zealand dollars. 
  2. The annual methods can only be used by a branch where the New Zealand group (ie, the branch and any associated New Zealand entities) has an annual turnover of less than NZD$10,000,000.  The threshold has been imposed because the annual methods are a significant departure from the close of trading spot exchange rate (the default position under the Act).  Therefore, the Commissioner has only approved the annual methods for smaller taxpayers.  This should help reduce compliance costs for those taxpayers in circumstances where the variances between the methods are likely to be less significant.

Average mid-month exchange rate method

  1. The average mid-month exchange rate method converts foreign currency amounts using the average mid-month exchange rate.  This means that instead of converting foreign currency amounts on a daily basis, a branch's income and expenditure can be separately aggregated and converted at the end of the income year. 
  2. The average mid-month exchange rate for the currency conversion is calculated by adding together the exchange rates for the 15th day of each month in the relevant period (usually 12 months) and then dividing that total by the number of months in the relevant period (usually 12) to arrive at a single annual exchange rate.  This exchange rate is then applied to the aggregated foreign currency amounts. 

Average end-of-month exchange rate method

  1. The average end-of-month exchange rate method converts foreign currency amounts using the average end-of-month exchange rate.  This means that instead of converting foreign currency amounts on a daily basis, a branch's income and expenditure can be separately aggregated and converted at the end of the income year. 
  2. The exchange rate for the currency conversion is calculated by adding together the exchange rates for the last day of each month in the relevant period (usually 12 months) and then dividing that total by the number of months in the relevant period (usually 12) to arrive at a single annual exchange rate.  This exchange rate is then applied to the aggregated foreign currency amounts. 

Monthly methods

  1. The Commissioner has approved three monthly currency conversion methods.  These are the mid-month exchange rate method, the end-of-month exchange rate method, and the monthly average exchange rate method.  The essential difference between the three methods is the rate used to convert the foreign currency amounts to New Zealand dollars.

Mid-month exchange rate method

  1. The mid-month exchange rate method converts foreign currency amounts using the exchange rate for the 15th day of the month.  This means that instead of converting foreign currency amounts on a daily basis, a branch's income and expenditure can be separately aggregated and converted at the end of each month using the exchange rate for the 15th day of the month. 

End-of-month exchange rate method

  1. The end-of-month exchange rate method converts foreign currency amounts using the exchange rate for the last day of the month.  This means that instead of converting foreign currency amounts on a daily basis, a branch's income and expenditure can be separately aggregated and converted at the end of each month using the exchange rate

Monthly average exchange rate method

  1. The monthly average exchange rate method converts foreign currency amounts using the average exchange rate for the month.  This means that instead of converting foreign currency amounts on a daily basis, a branch's income and expenditure can be separately aggregated and converted at the end of each month using the average daily exchange rate for the month. 

Annual tax adjustments under the annual and monthly methods

  1. When using an annual method or a monthly method, entities may need to make tax adjustments.  The adjustments should be consistent with the nature of the item being adjusted.  Items could be adjusted in one of the following ways:
    • An item could be adjusted using the actual amount converted during the period (eg, reversing out non-deductible legal fees using the New Zealand dollar amount already converted in the Statement of Financial Performance).
    • An item could be adjusted using the daily rate on the last day of the period for adjustments to items in the Statement of Financial Position (eg, adjustments reversing/including the opening and closing balances of provisions or reserves).
    • An item could be adjusted using an average annual rate for adjustments that occur throughout the period.
    • For fixed assets, tax depreciation should be calculated in New Zealand dollars on the New Zealand dollar cost, determined under subpart EW (if applicable), using the cost in New Zealand dollars as per the Statement of Financial Position, or determined using the spot rate on the date of acquisition.

Conditions for use of currency conversion methods 

  1. If a branch is part of a company that is part of a consolidated tax group (subpart FM of the Act), all companies in the group must also use the chosen currency conversion method to convert their branches' foreign currency amounts.
  2. Where the Act specifies a method to be used for a particular transaction or arrangement, an entity will not be able to use an annual method or a monthly method for that transaction or arrangement.  For example, s EX 57 specifies methods for calculating income or loss for foreign investment funds.  Similarly, any financial arrangements will need to be converted under the financial arrangements rules.
  3. Where a branch has paid foreign income tax, the entity must convert the tax payments to New Zealand dollars at the exchange rate on the date the foreign income tax was paid.  This is because foreign tax credits are allowed under subpart LJ when foreign tax is paid.  

Notification requirements for currency conversion methods

  1. An entity does not need to notify the Commissioner that it will be using a currency conversion method approved in this item to convert its branch's foreign currency amounts to New Zealand dollars.  However, once an entity decides to use that method, it must use that method consistently for all future income years. 
  2. If an entity wishes to change to a different method, it will need to apply to the Commissioner for approval to do so.  (Applications can be emailed to: fxconversions@ird.govt.nz.)
  1. If a branch becomes unable to satisfy the annual method threshold conditions outlined at [16] above, the entity has four options:
    • It could convert its branch's foreign currency amounts to New Zealand dollars using the close of trading spot exchange rate (s YF 1(2)).
    • It could convert its branch's foreign currency amounts to New Zealand dollars using one of the monthly methods set out in this Approval.
    • It could apply to the Commissioner, under s YF 1(6), seeking approval to continue to convert its branch's foreign currency amounts to New Zealand dollars using the annual method.
    • It could apply to the Commissioner under s YF 1(6), seeking approval to convert its branch's foreign currency amounts to New Zealand dollars using an alternative currency conversion method. 

Foreign exchange rate sources for branches

Approval of alternative foreign exchange rate sources for branches

  1. The Act gives the Commissioner the power to approve alternative foreign exchange rate sources.  Section YF 1(5) permits the Commissioner to approve alternative foreign exchange rate sources in circumstances where the Act has failed to specify a rate.  Section YF 2(2) permits the Commissioner to do the same in circumstances where the Act has specified a foreign exchange rate source. 
  1. The Commissioner has approved the following foreign exchange rate sources for use by branches under ss YF 1(5) and YF 2(2):
    • Read the foreign exchange rates
    • The foreign exchange rates published on the Reserve Bank of New Zealand website: www.rbnz.govt.nz  (daily or monthly average exchange rates are available).
    • Foreign exchange rates from one of New Zealand's registered banks (a list of registered banks is available on the Reserve Bank of New Zealand's website at www.rbnz.govt.nz/regulation_and_supervision/banks/register/).
    • Any reputable externally-sourced exchange rate.
  1. A foreign exchange rate obtained from a registered bank or a reputable external source will need to be appropriate, given the nature of the business carried on by the entity and branch.  For example, depending on the nature of the business, a wholesale rate may be more appropriate than a retail rate.
  2. These foreign exchange rate sources are approved for a foreign branch of a New Zealand entity's business or a New Zealand branch of a foreign entity's business.
  3. The foreign exchange rate sources can be used even where the Act specifies a foreign exchange rate source to use.  However, they cannot be used where the financial arrangements rules specify that a particular foreign exchange rate source must be used (see [37] below).

Conditions

  1. The approved exchange rate sources cannot be used where the financial arrangements rules specify that a particular foreign exchange rate source must be used.  For example, Determination G6D specifies the foreign exchange rate sources that must be used to determine foreign exchange rates for financial arrangements.  
  2. Some of the foreign exchange rate sources listed may only provide rates for trading days.  If the relevant date is not a trading day, an entity should use the foreign exchange rate on the preceding trading day. 
  3. Entities are reminded of their obligation to keep sufficient records in case they later need to verify the foreign exchange rates used.  This is especially important where the source of rates is not published or readily available.  Further, where an entity uses a registered bank rate or a reputable externally-sourced exchange rate, the entity must be able to show that the rate is appropriate for its business.
  4. The rates must be applied consistently.  This means that a branch must use the same exchange rate source for all foreign currency amounts derived in a particular year, and that the same exchange rate source must be used from year to year. 

Notification

  1. An entity does not need to notify the Commissioner that it will be using one of the approved foreign exchange rate sources to convert its branch's foreign currency amounts to New Zealand dollars.  However, once an entity decides to use an approved foreign exchange rate source, it must use that source consistently throughout the income year and for future income years.
  2. If, in a later income year, an entity wants to use a foreign exchange rate from another source to convert its branch's foreign currency amounts to New Zealand dollars, the entity will need to seek approval from the Commissioner to do so. (Applications can be emailed to: fxconversions@ird.govt.nz.)

Examples

Example 1 - average end-of-month exchange rate method  

Pink Enterprises is a New Zealand company with an Australian branch.  Pink Enterprises has an annual New Zealand group turnover of NZD$6,000,000 and a balance date of 31 March.  The branch transacts in Australian dollars.  For New Zealand tax purposes, Pink Enterprises must convert its branch's foreign currency amounts to New Zealand dollars.  For the 2016 income year, Pink Enterprises decides to use an annual method to convert its branch's foreign currency amounts.  It chooses the average end-of-month exchange rate method.

Pink Enterprises does not need to notify the Commissioner of this change. 

For the purposes of this example, assume that the branch has income of AUD$5,000,000 and expenditure of AUD$3,000,000 earned/incurred over the 2016 income year.  These amounts must be converted using the average exchange rate for the last day of each complete month in the relevant period (in this case, 12 months):

Income: AUD$5,000,000 divided by 0.9509* = NZD$5,258,176.40.  This amount is included in Pink Enterprises' gross income from a foreign branch.

Expenditure: AUD$3,000,000 divided by 0.9509* = NZD$3,154,905.80.  This amount is included in Pink Enterprises' expenditure from a foreign branch. 

(* For the purposes of this example, the assumed AUD$ average exchange rate for the last day of each complete month in the 2016 income year.)

During the year the branch makes two Australian tax payments - on 1 August 2015 and on 1 December 2015.  These amounts must be converted using the daily exchange rate that applied on the date the tax payments were made.

 

Example 2 - threshold exceeded  

For the last four years, Purple Enterprises has used the average mid-month exchange rate method to convert its branch's foreign currency amounts to New Zealand dollars.  In 2018, Purple Enterprises' annual New Zealand group turnover increases to NZD$15,000,000.  The branch is no longer able to use an annual method.  Purple Enterprises has four options:

  • It could convert its branch's foreign currency amounts to New Zealand dollars using the close of trading spot exchange rate (s YF 1(2)).
  • It could convert its branch's foreign currency amounts to New Zealand dollars using one of the monthly methods set out in this Approval.
  • It could apply to the Commissioner, under s YF 1(6), seeking approval to continue to convert its branch's foreign currency amounts to New Zealand dollars using the average mid-month exchange rate method.
  • It could apply to the Commissioner, under s YF 1(6), seeking approval to convert its branch's foreign currency amounts to New Zealand dollars using an alternative currency conversion method. 

 

Example 3 - mid-month exchange rate method  

Maroon Enterprises is a New Zealand company with an Australian branch.  Maroon Enterprises has a balance date of 31 March.  The branch transacts in Australian dollars.  For New Zealand tax purposes, Maroon Enterprises must convert its branch's foreign currency amounts to New Zealand dollars.  For the 2016 income year, Maroon Enterprises decides to use the mid-month exchange rate method to convert its branch's foreign currency amounts. 

Maroon Enterprises does not need to notify the Commissioner of this change. 

For the purpose of this example, assume that the branch has income of AUD$400,000 and expenditure of AUD$300,000 earned/incurred in June 2016.  These amounts must be converted using the exchange rate for the 15th day of June:

Income: AUD$400,000  divided by 0.9509* = NZD$420,654.11.  This amount is included in Maroon Enterprises' gross income from a foreign branch for the month of June.

Expenditure: AUD$300,000 divided by  0.9509* = NZD$315,490.58.  This amount is included in Maroon Enterprises' expenditure from a foreign branch for the month of June. 

(* For the purpose of this example, the assumed AUD$ average exchange rate for the 15th day of June 2016.)
On 1 June 2016 the branch makes an Australian tax payment.  This amount must be converted using the daily exchange rate that applied on the date the tax payment was made. 

References

Subject references
Branch
Currency conversion
Foreign currency amount
Exchange rate

Legislative references
Income Tax Act 2007, ss YA 1, YF 1, YF 2