n Business Tax and Company Law Quarterly - Weak currency and the taxation of foreign exchange gains

Volume 7 Number 1
  • ISSN : 2219-1585


Foreign exchange gains and losses in respect of debt, units of currency, forward exchange contracts ('FECs') and foreign currency option contracts ('FCOCs') denominated in foreign currency (defined as 'exchange items') are taxed within the provisions of section 24I of the Income Tax Act 58 of 1962. The depreciating rand against other international currencies has shed light on the tax consequences of exchange items, in particular where exchange items in the form of debt is due to a taxpayer but because of liquidity constraints, the debtor is unable to pay. This aspect was highlighted in the recent 2016 Budget Proposals. For foreign loans and claims receivable that are irrecoverable, the spot rate at year-end is applied to determine the foreign exchange gain or loss. With the depreciating rand, a taxable gain will arise if the foreign loans and claims are denominated in a foreign currency. On the face of it the irrecoverable nature of the claim is ignored for tax purposes, and it is only upon waiver or write-off of the loan ('realisation') that the spot rate at the time is applied to the foreign currency amount resulting in a taxable gain. The legislative change foreshadowed in the Budget Proposals are to be welcomed and will likely deal with matters such as debtor irrecoverability and the taxation of attendant foreign exchange gains. The depreciating rand will diminish the market value of the FEC contracts which will result in foreign exchange losses at year-end and upon settlement of the FEC. These losses are likely to offset taxable foreign exchange gains on foreign claims that are hedged.The tax treatment of FCOCs at year-end and upon realisation (i e exercise or expiration) is determined with reference to the market value of the option at that point in time. Market value is deemed to have regard to the value applied for accounting purposes or the 'intrinsic value', being the difference between the strike price of the option and spot rate at the time of the exercise of the option. The depreciating rand will reduce the value of an option contract. This means that options completely out-of-the-money will result in a zero gain/loss for the option holder at year-end or upon close out of the option. It seems apparent that the tax treatment in a depreciating rand environment has been favourably legislated for exchange items other than foreign debt. Legislative change is required to govern the latter, however, caution is suggested in dealing with the respective tax consequences.

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