Section 24I of the Income Tax Act (“the Act”) governs the income tax treatment of exchange gains or losses made in respect of both realised and unrealised foreign exchange transactions.
Unrealised exchange differences on foreign denominated debts between connected persons have been subject to an array of income tax treatments over the past few years. Realisation of the exchange difference is triggered to the extent that the related debts have been repaid, setoff or settled in any other manner.
Previous tax treatment of unrealised exchange differences
Unrealised exchange differences that arose in respect of foreign denominated capital loans and advances between connected persons, before November 2005, are included, or deducted from the taxpayer’s taxable income over a maximum ten year period.
For foreign denominated loans and advances between connected persons made in tax years after November 2005, the tax treatment of unrealised exchange differences is different:
- Firstly, unrealised exchange differences on all loans and advances, including trade receivables and trade payables, are deferred for income tax purposes.
- Secondly, only when exchange differences are realised are these amounts included in, or deducted from, taxable income.
Because of these provisions, South African tax resident companies may have significant unrealised exchange gains or losses that have not yet been subject to income tax adjustments.
Further changes to the treatment of unrealised exchange differences
A new regime, introduced by section 24I(10A), now regulates the income tax treatment of unrealised exchange differences on loans between connected persons. This new regime seeks to align the income tax and IFRS treatment of unrealised exchange differences, unless a good reason exists for these differing treatments.
The intention behind this new section is that these previous and future unrealised exchange differences must continue to be excluded or not be deducted from taxable income, only if all of the following conditions are applicable:
- The loan or advance is not a current asset or a current liability under IFRS;
- The loan is not funded directly, or indirectly, by persons forming part of the same group of companies as the debtor or creditor;
- The loan is not funded directly, or indirectly, by persons who are connected persons in relation to the debtor or creditor; and
- No forward exchange contract or a foreign currency option contract has been entered into to hedge against exchange differences arising on the loan.
In other words, if any of these conditions do not apply, then the unrealised exchange differences must be included in or deducted from taxable income.
Section 24I(10A) of the Act is effective for years of assessment commencing on or after 1 January 2013.
Consider the changes to the treatment of unrealised exchange differences between connected persons:
Taxpayers are advised to consider the implications of unrealised exchange differences relating to loans between connected persons. These considerations include:
- Is there an unrealised exchange gain that should be included when determining provisional tax to be paid?
- Is there an unrealised exchange loss that can significantly decrease a company’s taxable income allowing for a reduced provisional tax assessment?
- In preparing financial statements, are there any unrealised exchange gains or losses that must no longer be recognised in deferred tax?