Circular letter on the use of functional currency for tax purposes
Since the company law allows the preparation of commercial accounts in a currency other than the euro, many companies have chosen to adopt the currency of their foreign parent company. For tax purposes however, such companies had to convert the assets and liabilities expressed in the foreign currency in euros, in accordance with the valuation rules set forth by article 23 of the Income Tax Law, within a tax balance sheet.
The tax authorities have acknowledged that this method may lead to the recognition of exchange gains and losses, appearing solely in this tax balance sheet, that do not reflect the economic reality of a company’s business. As a consequence, they have issued Circular letter L.G.-A n°60 dated 16 June 2014 providing a framework of rules for companies drawing their annual accounts in a foreign currency and wishing to declare their commercial result, as well as their taxable income, by converting the amounts determined in such foreign currency into euros (functional currency method).
Since the use of a functional currency has an impact on the taxable income, it has been necessary to foresee some safeguards preventing a possible abuse. As a consequence, the Circular letter provides for a written request for applying the functional currency to be introduced at the latest three months before the end of the accounting year for which the first application is requested. For companies incorporated in the course of the accounting year, the delay for filing the request is extended to the end of such first accounting year. Furthermore, the Circular letter states that the choice to apply the functional currency is irrevocable and must mandatorily be applied as long as the commercial accounts of the company are expressed in such foreign currency. The conversion into euros must be made by using the closing foreign exchange rate or the average foreign exchange rate for the period covered by the tax return as published by the European Central Bank. Again, the choice for the one or the other foreign exchange rate is irrevocable. Tax assessments will however continue to be issued in euros and the tax will have to be paid in euros. Tax forms will be adapted to reflect the election for functional currency. In the meantime, taxpayers wishing to apply the functional currency have to establish an appendix to the tax return allowing tracing the origin of such amounts converted into euros that may have an impact on the taxable income or fortune of a given year or of forthcoming years. Finally, all companies being part of a tax consolidation are obliged to declare their taxable income in the same currency as from the first year for which the tax consolidation applies.
The foreign exchange rate applies, both for corporate income and municipal business tax, to the amounts of the current year (i.e., commercial result of the year, including amounts to be added or deducted, or sum of the balance sheet used to calculate the minimum corporate income tax) as well as to amounts relating to a prior tax year (i.e., losses carried forward, donations, recapture). This means that such amounts will be reported in the functional currency and converted into euros at the foreign exchange rate applicable for the year in which they are used. Tax credits (e.g., tax credit for investments or for the hiring of unemployed persons) are determined in the foreign currency and converted into euros using the foreign exchange rate as described above. However, the carry forward of such tax credits will be computed in euros.
As regards net wealth tax, the latter will be calculated on the unitary value determined by applying the foreign exchange rate of the closing day of the last financial yearpreceding the key date for unitary value. For some determined assets (participations in corporations), the value for net wealth tax purposes needs to be determined as at 31 December, even if the closing of the financial year is set at another date. To determine if a participation qualifies for the net wealth tax exemption, the amount in foreign currency is converted into euros at the historical foreign exchange rate(unless of course the 10% threshold is met). Net wealth tax reduction (as foreseen by paragraph 8a of the net wealth tax law) for a given year corresponds to one fifth of the special reserve built in foreign currency, converted into euros at the foreign exchange rate of the closing day of the last balance sheet preceding the key date of determination of net wealth tax.
Finally, the Circular letter also provides some guidance as regards the transition from a euro-denominated tax balance sheet to the functional currency method. In particular, it is foreseen that the companies wishing to apply the functional currency method will have to draw a tax balance sheet in euros for the transition year in order to ascertain that the valuation rules set forth by the tax law are respected. The Circular letter furthermore gives some more details as regards the valuation of specific balance sheet items upon conversion into the functional currency.
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