Foreign Exchange Gains or Losses
Business activities have expanded significantly and foreign exchange and international trading has become a part of businesses, both small and large. The foreign currency gains and losses need to be recognised in the financial reporting on the company. But for tax purposes, the currency recognition and translation may not be the same as that used for financial reporting. The Income Tax Act requires that amounts expressed in a foreign currency be translated into Rand for income tax purposes.
For income tax purposes, the nature and taxpayer type will determine what provision of the law will apply. The starting point will be section 24I of the Income Tax Act, which applies to the general tax treatment of foreign exchange gains or losses. Section 24I (3) expressly provides that all gains and losses on foreign exchange transactions, whether realised or not, whether of a capital nature or not, be included in or deducted from income.
Also, such transactions will be recognised at the transaction, translation, and realisation dates, while recognising local currency and functional currency.
In addition to section 24I, there are several other sections that may apply, and for this reason the recognition of foreign exchange gains or losses is complex. This article is not aimed at describing all the transactions and taxing provisions, but is intended to assist in understanding which sections should be applied.
When the taxpayer is an individual, the first question is whether the taxpayer is holding the exchange item as trading stock. If yes, then section 24I will apply. If no, the Eight Schedule (CGT) will apply (paragraph 84 – 96 for cash and paragraph 43 for assets other than cash).
When the taxpayer is a trust, the first question is whether the trust is carrying on a trade. If yes, section 24I will apply. If no, the Eight Schedule (CGT) will apply (paragraph 84 – 96 for cash and paragraph 43 for assets other than cash).
All South African companies and foreign companies to the extent that such is in relation to a permanent establishment in South Africa or controlled foreign companies in terms of section 9D, will apply section 24I. One should be careful in identifying when to use spot rates, forwards rates, or average exchange rates. In general, average exchange rates (as published on SARS website and updated from time-to-time) will not apply to section 24I.
The following sections generally provide for the currency translation to be done with application of average exchange rates: Section 6 quat(4) – foreign tax credits Section 9D(6) – controlled foreign company Section 9G – disposal of foreign equity instrument which constitutes trading stock Section25D(2) – foreign permanent establishments of a resident Section 25D(3) – natural person or trust that has made an election to apply average exchange rates as a method of translation Eight Schedule (CGT) – some paragraphs have specific provisions regarding average exchange rates, and other paragraphs has unique translation rules specific to those paragraphs.
For income tax purposes, the nature and taxpayer type will determine what provision of the law will apply.
Source: SAIPA (Tax Committee)