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TOFA accruals is like High School English

TOFA accruals are like High School English

Julian Humphrey dives into the options available to taxpayers when calculating TOFA accruals.

Julian Humphrey

Partner, Corporate Tax

KPMG Australia


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TOFA accruals are like High School English – there is no single correct answer. Rather, the default Taxation of Financial Arrangements (TOFA) accruals rules provide taxpayers with a number of choices and options when it comes to accruing gains and losses on financial arrangements. Whilst the overall amount of a gain or loss from a financial arrangement might be determinable, the amount of that gain or loss to be included in an income year can vary depending on the approach taken.

The basic approach to a TOFA compounding accruals calculation is:

  • Determine the amount of the gain or loss to be accrued
  • Determine a period over which the gain or loss is to be spread
  • Divide the period into intervals of 12 months or less and, with the exception of the first and last interval, of the same length
  • For each interval, determine a rate of return and an amount to which to apply that rate of return and use these amounts to calculate the amount of the gain or loss to be allocated to that interval
  • And finally, if the interval does not fall wholly within an income year, allocate the gain or loss for the interval between the two income years on a reasonable basis

The choice of interval period will affect the calculation of the rate of return as well as the amount for any interval that will straddle income years and can be allocated on a reasonable basis. And this is before various concessions and choices available for particular accruals calculations, including the use of the effective interest rate method used for accounting purposes and the treatment of portfolio fees, premiums and discounts.

So in the ordinary course, there is usually sufficient flexibility in the TOFA accruals method to match most accounting approaches, which makes all the above an interesting academic exercise to justify adopting accounting calculations for tax purposes. However, there are a number of cases where the outcome is not so intuitive nor does it necessarily follow accounting.

Capital indexed bonds are one such example. Whilst long term capital indexed bonds will typically be priced and accrued using an assumption as to the long term index growth expectation, the TOFA accruals rules require an assumption that the current rate of change of the relevant index remains constant. As a result, seasonal and one-off changes in quarterly or annual consumer price index (CPI) numbers can have a significant impact on the periodic TOFA accrual calculations for these long term arrangements.

Another example is a particular gain or loss that forms part of broader financial arrangement that doesn’t itself have a principal amount, such as an establishment fee for a loan. Where the establishment fee is treated as a particular gain or loss and to be spread over the period of the borrowing the accruals calculation is less intuitive. Taxation Ruling TR 2016/2 on TOFA and swaps provides some insight to such calculations. Footnote 28 to that ruling contains an explanation as to how $1,833 is to be accrued over the life of the swap “by solving the mathematical equation X-$1,833=X/1.062” to give the notional principal amount to which the rate of return is applied.

Indeed TR 2016/2 provides a number of calculations of the TOFA accruals method which will interest those seeking that academic challenge of applying the TOFA accruals method.

So whilst we await further TOFA simplification, we must embrace the existing flexibility whilst dealing with the complexities associated with particular types of financial arrangements.

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