79 Foreign currency: computation of income and chargeable gains

Summary

This section ensures that both exchange differences on long-term borrowings and the matching exchange differences on hedging contracts are brought into the computation of a trading company’s profits on the same basis for tax purposes. This means that foreign exchange gains/losses which balance each other and leave the company unaffected for commercial purposes also balance out after tax.

Exchange gains/losses are brought into the computation of the company’s trading income for tax purposes as they accrue in the audited accounts of the company. This reliance on the company’s accounts provides an accessible tax treatment of exchange gains/losses which overrides distinctions between long-term and short- term borrowings and between realised and unrealised exchange gains/losses. The accounts-based approach is even-handed in charging gains on the same basis as it allows losses.

Details

(1)(a) "profit and loss account" is defined by reference to companies which are resident in the State and also by reference to the activities in the State of companies which are not resident in the State but who carry on a trade in the State through a branch or agency. The use of "business" in the case of such a non-resident company is intended to distinguish, where necessary, that part of a trade attributable to an Irish branch from the entirety of the trade which is partly carried on through the branch. "Business" is also used because the branch account might address non-trading aspects of the company’s activity through or from the branch.

A number of companies, trading in the State through branches, are incorporated in countries outside the European Union which have no provision in their law which corresponds to Chapter 18 of Part 6 of the Companies Act, 2014 (that section provides for the appointment of auditors to companies). This is because there is no statutory audit requirement in respect of companies incorporated in these countries. Under Part III of the European Communities (Branch Disclosures) Regulations, 1993, such non-resident companies incorporated outside the European Union are required to prepare and deliver to the Companies Registration Office audited accounts of the Irish branch operations. Unless an inspector becomes aware that the treatment of exchange gains/losses in those accounts does not conform to a recognised accounting standard or has been inconsistent from year to year, such accounts are to be treated as being within the definition of "profit and loss account".

"rate of exchange" is "a" rate at which 2 currencies might be exchanged. The form of words used acknowledges that there could be more than one rate applicable at any time. However, the rate must be agreed between parties acting at arm’s length. The reason for this is that non-arm’s length exchange rates could be advantageous to a group of companies where the circumstances of the member companies differed so as to allow the value of the relief for a loss to exceed the cost of the charge on a gain (for example, where one company was entitled to manufacturing relief and another was not).

"relevant contract" is any hedging instruments such as swaps and forward rate agreements. A foreign currency deposit could be used to hedge an amount payable in that foreign currency and accordingly the currency deposit would be a "relevant contract" if the liability were trade-related. If a company hedges the net exposure created by a number of trading amounts, the hedging instruments are treated as relevant contracts so long as the net exposure hedged arises wholly from trade- related items.

"relevant tax contract" is a contract entered into to hedge against exchange rate risk on a tax liability which arises from a change in the rate of exchange between the functional currency and Euro.

"relevant monetary item" includes cash held and amounts payable in the course of a trade. Money "receivable" is not included. The requirement that a "relevant monetary item" be money held or payable "for the purposes of a trade" is central to the restriction of the scope of the section to trade-related exchange gains/losses. The "purposes of the trade" test works throughout the definition of a "relevant contract" which addresses the possibility of a loss being incurred on a relevant monetary item. The reference to "trading income" in subsection (2) reflects the fact that the gains/losses addressed by that subsection derive from "trading" items whether relevant monetary items or relevant contracts.

(1)(b) The purposes of requiring the treatment of contracts as relevant contracts to be disregarded except for the purposes of this section is to pre-empt the following argument being made:

• A company is due to make a second and final payment in US Dollars in 6 months time for plant. In order to eliminate the risk of loss from an adverse movement in the $/€ exchange rate, the company places an amount of US Dollars equal to the payment due on deposit. The exchange gain or loss on the value of the US Dollar deposit will be brought into account in computing the trading income of the company. The "trading" treatment of the exchange difference to the US Dollar deposit could be cited as grounds for arguing that the deposit interest should also be treated as a trading receipt.

(1)(c) Gains/losses resulting from the introduction of the euro are treated as gains/losses resulting from a change in a rate of exchange.

(2) Subsection (2) applies notwithstanding section 76. Section 76 provides for the application of income tax principles to computations for the purposes of corporation tax. The application of "income tax principles" or "income tax law and practice" as provided by section 76 requires a capital/revenue distinction to be made as respects the treatment of foreign exchange gains/losses in corporation tax computations. To the extent that the treatment of foreign exchange gains/losses for corporation tax purposes provided for by this subsection conflicts with income tax principles, such as the capital/revenue distinction, this subsection takes precedence.

The tax treatment of foreign exchange differences follows the accounting treatment but only "for the purposes of corporation tax". The treatment bringing foreign exchange differences on trade-related "capital" liabilities into account applies to "any gain or loss". Since it is intended that not only should trade-related "capital" foreign exchange losses be allowed but also that trade-related "capital" foreign exchange gains should be charged, it is essential that the treatment of foreign exchange differences in accordance with accounting practice should be comprehensive and consistent. In addition, whether a foreign exchange difference is "realised or unrealised" is not one of the criteria which determines the treatment of exchange differences. The criteria which determines the treatment of exchange differences are that —

• the gains/losses be referable to trade-related amounts payable and cash, or to hedging in respect of such amounts,
• the gains/losses are foreign exchange gains/losses (that is, they must result "directly" from a change in a rate of exchange – for example, if a revaluation of currency A against currency B results in a decrease of sales by a distribution company X to customers in country B, leading company X to sell a warehouse at a loss, that loss is not treated as resulting "directly from a change in a rate of exchange"), and
• the gains/losses be reflected in an audited profit and loss account whether of the company or, in the case of a company which is not resident in the State, of the Irish branch. The gains/losses, however, must be "properly" reflected in those accounts – that is, debited and credited in accordance with the applicable standard accounting practice. Where a company makes up its accounts in a currency other than the euro, in accordance with the applicable standard accounting practice, foreign exchange differences are computed by reference to that currency rather than the euro.

(3)(a) Foreign exchange gains/losses taken into account in computing trading income of a company by virtue of this section should not be extracted from the amount of "the company’s income for the relevant accounting period from the sale in the course of the trade mentioned in subsection (3) of section 448 of goods and merchandise" for the purposes of computing manufacturing relief.

Exchange differences which are brought into account in computing trading income of a company by virtue of subsection (2) (that is, trade-related "capital" exchange differences) are not also brought into the computation of chargeable gains (and allowable losses) of the company. Sections 551 and 554 would ensure the exclusion of the exchange differences in question from the computation of chargeable gains and allowable losses without the confirmation of subsection (3). Thus, subsection (3) has been inserted only to ensure that the position is as clear as possible.

Subsection (3) applies "for the purposes of corporation tax". Section 78(5) applies capital gains tax principles to computations of chargeable gains and allowable losses for the purposes of corporation tax. Given that subsection (3) essentially confirms the provisions of sections 551 and 554, the phrase "Notwithstanding section 78" is arguably unnecessary. However, there may be exceptional instances where subsection (3) would do more than simply confirm the position under the Capital Gains Tax Acts. For example, where a loss on a long-term trade liability is covered by a gain on a forward rate agreement, there might be no credit or debit taken to the profit and loss account of the company. The appropriate treatment of the forward rate agreement gain would not be beyond doubt given that it would not have been explicitly brought into account in computing trading income of the company. The wording of the subsection effectively removes any such doubt and ensures that the gain is excluded from the computation of the chargeable gains of the company.

Although this provision addresses gains/losses on hedging contracts it could also be relevant to a disposal of foreign currency which a company had contracted to acquire under the terms of a swap agreement. The separate treatment of the currency transaction component of a swap will not result in the gain/loss in question being treated as a chargeable gain or an allowable loss. The currency received on the unwinding of a swap in relation to a trade-related borrowing would be "money held" by the company for the purposes of the trade notwithstanding its immediate application in repayment of the borrowing.

The gain/loss referred to in subsection (3) must result "directly" from a change in an exchange rate.

(3)(b) The subsection does not prevent foreign exchange gains being treated as chargeable gains when received by life assurance companies carrying on life business which are not charged to corporation tax in respect of that business under Case I of Schedule D (that is, life assurance companies chargeable on the "investment income minus management expenses basis"). It should be noted, however, that since this provision only governs subsection (3), subsection (2) is still relevant to a life assurance company’s notional Case I computation. Section 551 ensures that, in the case of a life assurance company, the same foreign exchange differences are taken into account in the "notional Case I" computation and also in the computation of chargeable gains for the "investment income minus management expenses" computation.

(4) Exchange rate gains/losses on hedging instruments are, subject to conditions, not to be treated as a chargeable gain or an allowable loss. The conditions are —

• the gain/loss must be attributable to a contract entered into for the purposes of eliminating an exchange rate risk in relation to a corporation tax liability,
• the gain/loss must result directly from exchange rate fluctuations,
• a gain may only be ignored to the extent that it does not exceed the exchange rate loss on the corresponding tax liability, and
• a loss may only be ignored to the extent that it does not exceed the exchange rate gain on the corresponding tax liability.

Relevant Date: Finance Act 2021