Forex frolics

Fluctuating exchange rates can complicate the tax obligations of SA companies operating abroad.

Forex frolics
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If a person from one country sells goods or services in another country without operating through an establishment there, the income generated will generally be taxable only in that person’s country of residence. If the person begins to deal in that country through a permanent establishment there, however, the profits generated will be taxable in the other country.

READ:Dealing with clogged losses

So far, so straightforward. But when you consider that most transactions elsewhere in Africa are done in dollars, for instance, tax complications arise when there’s a delay or time lag between delivery and payment, because the rand/dollar exchange rate changes regularly.

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Consider the following example:

  • Businessman X sells apples to a foreign buyer. The contract is in US dollars. On the delivery date, which is also the invoice date, the rate of exchange is such that the dollar is very strong. X records the event in rands because he’s based in SA. Our businessman doesn’t get many rands for each US dollar.
  • X receives the telegraphic transfer of funds in US dollars a week later. The rate has now changed and the dollar is much weaker than the rand. X again has to record the receipt in rands. 
  • This time he receives far more rands per dollar, and has, in fact, made a forex gain, which is taxable. (If the situation is reversed, he would have made a forex loss.)

Although the tax consequences of multi-jurisdictional transactions within Africa are most often subject to Double Tax Avoidance Agreements, these don’t cover the effects of a volatile exchange rate. In the SA Income Tax Act, the effects of forex gains/losses are regulated under Section 24I and Section 25D.

Complex rules
The rules involved are extremely complex, but the underlying principles are fairly simple. In the Appeal Court case Caltex Oil (SA) Ltd v Secretary of Inland Revenue, where judgment was delivered in 1975, an SA company had to pay for goods in pounds sterling. The pound lost value before the date of discharge of the obligation, and the question concerned the date of valuation of the obligation, as a time difference affected the amount that could be deducted in terms of the SA Income Tax Act. The court held that, firstly, tax is an annual event.

This is a very important. It means that only the transactions that relate to the year in question are recognised in that year, even if incomplete. Stock on hand at the year end, if in US dollars, for instance, is recognised in rand terms on the last day of the year.

Date of completion
The court also held that when a tax event takes place in a foreign currency, the ruling exchange rate on the date of completion – that is, the time when an amount accrues to the taxpayer or a liability becomes payable – is used for converting the amount into rands. SARS has also published a helpful practice note, Note 4 of 1999, that deals with forex gains and losses. Any businessperson who operates offshore and is liable for tax in SA would do well to be familiar with it.

Peter O’Halloran is head of tax at BDO, Gaborone. Contact him on 00267 390 2779 or at [email protected]. Please state ‘Tax’ in the subject line of your email.