Corporate Income Tax
Alignment of taxation of foreign exchange gains & losses with accounting By Sean Kleynhans
The treatment of foreign exchange (forex) gains and losses is dealt with in terms of section 24I of the Act. Over time, through various amendments, section 24I has developed into quite a complicated set of rules. In many instances the tax treatment of exchange items differs markedly from the treatment for accounting purposes. It is National Treasury’s intention that section 24I be more aligned with IFRS. There are essentially three parts of section 24I legislation in respect of which changes are proposed, namely:
- to the connected person rules (section 24I(7A) and 24I(10));
- in respect of assets purchased and sold in foreign currency (section 24I(11) and paragraph 43(1) and (4); and
- to the deferral in respect of assets not yet brought into use (section 24I(7).
We discuss each of these in turn.
The connected person rules
In terms of section 24I(7A) pre 8 November 2005 currency gains and losses are deferred in respect of loans and advances of a capital nature, loans and advances between companies that are connected persons and loans and advances that are not hedged by a related or matching FEC. These items are spread over 10 years (i.e. until 2015).
Post 8 November 2005, exchange differences (and not just debt related items) in respect of related company loans are deferred until realised. This applies to exchange items between resident and connected person in relation to a resident, a resident and a CFC and a CFC and another CFC.
It is proposed going forward that the only instance where exchange differences will be deferred will be where entities form part of the same group for IFRS purposes, and then only in respect of debt between group companies where settlement is neither planned nor likely to occur in the foreseeable future (in terms of IFRS), or for FEC’s and currency option contracts which are designated as an effective hedge of foreign investments for IFRS. In all other instances the tax treatment, it is proposed, will follow the accounting treatment.
Assets purchased and sold in foreign currency
The capital gains tax (CGT) system ignores currency gains and losses when an asset is acquired and disposed of in the same foreign currency. This rule applies for non-monetary assets and excludes foreign equity and SA sourced assets. A CGT gain or loss is calculated on a simplified basis in the foreign currency firstly, which gain or loss is then translated into rands at the average rate in the year of disposal. It is proposed that this simplified approach should no longer apply for companies and trading trusts. If applicable, the acquisition price will be translated into local currency in the year of acquisition, and the disposal price translated into local currency in the year of disposal. The currency differences will give rise to a capital gain or loss.
As a separate point, currency gains and losses in respect of loans used to acquire non-monetary assets (and hedges) are generally ignored. Treasury is of the view that disregarding currency gains and losses in respect of non-monetary assets is hard to justify. It is proposed that the matching of monetary to non-monetary items be removed from the mark to market system of currency taxation applicable to companies and trading trusts.
Deferral for assets not yet brought into use
Forex differences are generally realised for tax purposes on an annual basis irrespective of realisation. Annual currency recognition is deferred if monetary items are linked to non-monetary depreciable or amortisable assets which will only be brought into use at a later stage. This essentially relates to forex differences relating to foreign currency loans that are used to acquire, install, erect or construct tangible property or devise develop, create, produce, acquire or restore intangible property.
It is proposed by treasury that the recognition of currency gains and losses should follow financial accounting on the basis that IFRS does not link monetary items with non-monetary items (e.g. loans with assets). The current tax deferral rule, for currency exchange items in order to finance pre-production assets, is without foundation.
Timing of the changes
It is proposed that the changes will apply to all years of assessment commencing after 1 January 2013. All currency gains and losses deferred at that date will be triggered at the close date before the effective date.
The final format of these amendments remains to be seen in the revised bill (due at the end of this month). It is important in anticipation thereof to review the current foreign exchange items in place and consider the impact if the legislation stays in the format it is proposed.
