An exchange difference (a gain or a loss) made in respect of an exchange item (a debt, a unit of currency, a foreign option contract or a forward exchange contract) must be added to or deducted from the income of a person in terms of section 24I of the Income Tax Act. The exchange difference must be calculated on the translation date of that exchange item (if the exchange item did not realise during the year of assessment) or on the realisation date of that exchange item if the exchange item realised during that year of assessment.
However, in certain cases the calculated exchange difference should not be taken into account in the taxable income of the person in that particular year of assessment. The inclusion in or deduction from income of such exchange differences should be deferred to a subsequent year of assessment.
Section 24I(10A)(a) defers exchange gains and losses if, at the end of the year of assessment the person who incurred the debt, or to whom the debt is payable, and the other party to the contractual provisions of that exchange item, form part of the same group of companies, or are connected persons in relation to each other. The inclusion or deduction of exchange differences is deferred until realisation or until the provisions of this deferral section no longer applies.
If the above requirements are met, but a forward exchange contract or foreign currency option contract has been entered into by that person to serve as a hedge in respect of that foreign debt incurred by or payable to the person, the exchange difference should not be deferred but should be recognised (s 24I(10A)(i)).
Furthermore, if the debt is funded directly or indirectly by any debt owed to any person who is not part of the same group of companies as, or is not a connected person in relation to that person or the other party to the contractual provisions of that exchange item, the exchange difference in respect of the debt should not be deferred (s 24I(10A)(a)(ii)).
A further requirement that should be met before the exchange difference must be deferred is that such debt (i.e the exchange item) or any portion thereof should not represent, for that person, a current asset or a current liability for the purposes of financial reporting in accordance with the International Financial Reporting Standards issued by the International Accounting Standards Board (IFRS) (s 24I(10A)(a)(ii)).
The subsection will therefore only defer exchange differences in respect of a long-term debt. However, in terms of IFRS, a portion of a long-term debt is recognised annually as a current liability if the debt or part of the debt is repayable within 12 months after year-end. It appears from the wording of the Act that the entire exchange gain or loss should be recognised (and not deferred) if any portion is moved to current assets or current liabilities for purposes of IFRS. It is doubted as to whether this was really the intention of the legislature since it appears from the Explanatory memorandum on the Taxation Laws Amended Bill 2014 (clause 40) that the intention was for the deferral of the exchange differences to apply to the entire loan, provided a portion of the loan is classified as a long-term loan. The exchange difference on the entire loan should then only be recognised once the entire loan is realised. This is, however, in contradiction with the current wording of the Act. The current wording of the provision may therefore have adverse cash flow implications as the tax on the cumulative exchange differences over the duration of a loan may become payable before the actual cash flow related to the loan realises.
It is suggested that the wording of the Act for this requirement should be amended to state that ‘the exchange item or any portion thereof represent a non-current asset or a non-current liability for the purposes of financial reporting pursuant to IFRS’.
Mrs Annelize Oosthuizen (CA(SA))
Senior lecturer in Taxation
School of Accountancy
University of the Free State