In the field of international taxation, the question of foreign exchange fluctuations is of particular importance because of the variety of currencies used worldwide and the requirements by local tax authorities generally to use the domestic currency for tax reporting in the home country.
Section 24I of the Income Tax Act 1962, (Act No 58 of 1962) (“the Act”) contains explicit and comprehensive rules designed to deal with the tax consequences of foreign-exchange issues. The Taxation Laws Amendment Bill 2012 proposes that part of the rules contained in section 24I be amended to ensure that currency gains or losses in respect of debt, and the effective hedge, between related entities will be deferred until realisation. If enacted, the new regime will replace the current system for taxing currency gains and losses arising in the case of related companies which is divided into two sets of rules that depend on different effective dates.
Financing transactions are particularly affected by foreign exchange fluctuations as the foreign exchange component, coupled with the financing transaction’s potentially long period, can significantly influence whether such transactions generate an overall profit or loss. Although the foreign exchange component of a global gain or loss will always remain second to the overall amount, the effects of increased volatility in the currency markets and the quantitative easing measures recently taken in several jurisdictions to alleviate the effects of the recent liquidity crisis should not be underestimated.
The new regime will, as is the case with most fiscal provisions, be subject to a number of requirements, conditions and limiting factors. The first requirement tests the relationship between the entities which must be ‘related’ to each other. Entities that form part of the same group of entities for International Financial Reporting Statements (IFRS) purposes will be considered related. It should be noted that an IFRS group is broader than a group as defined under the Act. In particular, an IFRS group requires a more than 50 per cent threshold as opposed to the ITA’s 70 per cent threshold. It is not necessary that the related entities present consolidated financial statements for them to form part of the same group of entities.
Once the entity test is met, the next requirement tests the nature of the instrument between the related entities. The new regime is limited to debt between group entities where the debt is a claim for which settlement is neither planned nor likely to occur in the foreseeable future as contemplated in IFRS thereby excluding short-term and trade receivables / payables, or in respect of a forward exchange contract or a foreign option currency contract which is designated as an effective hedge under IFRS.
The new regime will apply in respect of any year of assessment commencing on or after 1 January 2013. Therefore under the new system that will be implemented in terms of the TLAB, all remaining suspended currency gains and losses that occurred in years of assessments on or before 8 November 2005 will be triggered for realisation on the date the new system is implemented. All exchange item transactions that occurred post 8 November 2005 will be deemed to be realised at the end of the year of assessment preceding the effective date.