Capital gains tax on foreign currency assets

Professor Alta Koekemoer Center for Accounting University of the Free State,

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When dealing with assets acquired or disposed of in a foreign currency, it is necessary to determine the capital gain or loss in rand in order to complete your tax return.

Paragraph 43 of the Eighth Schedule contains the rules dealing with gains and losses on assets acquired or disposed of in a foreign currency. It provides the rules for converting the various components making up the capital gain or loss into rand (expenditure, proceeds and where applicable, market value) the timing of the conversion, and the appropriate exchange rate to be used. This paragraph of the Eighth Schedule only deals with non-monetary assets acquired or disposed of in a foreign currency. Monetary foreign currency assets and liabilities as well as hedging contracts are dealt with in the main act, under s 24I.[1]

 

Paragraph 43 of the Eighth Schedule prescribes two different translation methods for specific situations: The first translation method[2] is prescribed for natural persons and non-trading trusts where the asset is acquired and disposed of in the same foreign currency. The second translation method[3] must be used in all other instances, meaning where the first translation method is not prescribed. In other words the second translation method must be used, firstly for natural persons and non-trading trusts where the asset is acquired in one currency and disposed of in a different currency. This would be the case where

  • -base cost is denominated in local currency and proceeds in a foreign currency;
  • -base cost is denominated in a foreign currency and proceeds in a local currency; and
  • -base cost is denominated in one foreign currency and proceeds in another foreign currency.

Secondly, as the first translation method is prescribed only for natural persons and non-trading trusts it follows that the second situation should be used for all other persons like companies and trading trust regardless of whether assets are acquired and disposed of in the same or in different currencies.

 

In terms of the first translation method the capital gain or loss on the disposal of the asset is determined in the foreign currency that the asset was acquired and disposed of. It is thereafter translated into rand by applying either the average exchange rate for the year of assessment in which that asset was disposed of or by applying the spot rate on the date of disposal of that asset.

 

For example, Mr. X acquires an asset for a base cost of US$100 000 when the spot rate is R7 to the dollar, and then eventually disposes of the asset for US$120 000 when the spot rate is R9 to the dollar. In this example the first translation method is prescribed as the person is a natural person and both base cost and proceeds are denominated in the same foreign currency.

 

According to the first translation method[4] Mr. X would first have to determine the capital gain or loss in dollars and then translate it into Rand. The capital gain expressed in dollars would be US$20 000 (proceeds of US$120 000 less base cost of US$100 000). The capital gain expressed in dollars is then translated to Rand using either the spot rate on the date of disposal of that asset (given as R9/US$) or the average exchange rate for the year of assessment in which that asset was disposed of (not given in this example). Mr. X’s capital gain would, therefore, be R180 000 (US$20 000 x R9/US$).

 

If one assumes that the taxpayer in this is example was not Mr. X, a natural person, but X. Ltd, a company, then the second translation method[5] must be used. The second translation method requires that the capital gain or loss must be determined in rand (not foreign currency). In order to calculate the capital gain in rand the base cost and the proceeds must first be converted to rand. The base cost of U$100 000 is translated to rand either at the spot rate on the date the expenditure was incurred (R7/US$) or the average rate in the year the expenditure was incurred (not given in this example). The proceeds of US$120 000 is translated to rand at spot rate on date of disposal (R9/US$) or average rate in the year of disposal (not given in this example). According to the second translation method X Ltd.’s capital gain would be R380 000 (proceeds of R1 080 000 (US$120 000 × R9/US$) less base cost of R700 000 ($100 000 × R7/US$))[6]. In terms of the first translation method the capital gain is only calculated on the real gain of R180 000 and not on the foreign currency gain. In this instance (using the second translation method) the capital gain is calculated on both the real gain of R180 000 and on the foreign currency gain due to the devaluation of the rand of R200 000 ($100 000 × (R9/US$ less R7/US$)). The first method is therefore simpler and easier to apply as the taxpayer need not keep record of the exchange rates when expenditure is incurred, only of the exchange rate on disposal of the asset.

 

In terms of paragraph 43 all taxpayers have a choice to translate into local currency using either spot rate or average rate[7]. This seems to contradict the main act, section 25D, whereby a company or trading trust may only translate income and expenditure into local currency using spot rate. The intention of the legislator, when introducing the amended translation methods in terms of paragraph 43, was to simplify the calculation for natural persons and non-trading trusts where the asset is acquired and disposed of in the same foreign currency[8]. The second translation method was provided as alternative in all other situations, in other words also where the taxpayer is a company or trading trust. It is therefore unclear whether it was actually the intention of the legislator to provide for a choice between spot rate and average rate in the case of companies or trading trusts. It nonetheless seems from the letter of the act that this option is currently available to all companies and trading trusts for purposes of calculating the capital gain when disposing of non-monetary assets in foreign currency.

[1] Only if s 24I is applicable. Part XIII of the Eight Schedule that dealt with capital gains and losses on foreign monetary assets was repealed effective for years of assessment commencing from 1 March 2011.

[2] Par 43(1) of the Eighth Schedule.

[3] Par 43(1A) of the Eighth Schedule.

[4] Par 43(1) of the Eighth Schedule.

[5] Par 43(1A) of the Eighth Schedule.

[6] Although the taxpayer has a choice to translate into local currency either at spot rate or average rate, only spot rates were provided in this example.

[7] Applicable to all disposals after 1 March 2013.

[8] According to the explanatory memorandums of the 2012 and 2013 Tax Laws Amendment Acts.