Taxation of foreign exchange gains and losses

The Uganda tax law requires businesses operating in Uganda to prepare their accounts in accordance with the generally accepted accounting principles also commonly referred to as GAAP. In the case of Uganda, the GAAP is the International Financial Reporting Standards which are commonly referred to by accountants as IFRS.

In addition to the requirement to prepare accounts according to GAAP, businesses in Uganda are also required to compute their income chargeable to tax in Uganda Shillings. Where a business or taxpayer prepares their accounts in a foreign currency such as US Dollars, Euros, Ksh etc, the tax law requires that business or taxpayer to convert the foreign currency amounts in their books of accounts to Uganda Shillings for purposes of computing the business’ tax payable in Uganda.

The amounts must be converted into Uganda Shillings using the Bank of Uganda mid exchange rate applying between the foreign currency and the Uganda Shilling on the date that the amounts were derived, incurred or taken into account for tax purposes.

This means that at the date of the transaction, each asset, revenue, liability or expense item arising from a foreign currency transaction should be translated in Shs at the exchange rate in effect at the transaction date, unless the transaction is hedged. At each balance sheet date, monetary items reflected in foreign currency should be translated into Shs using the prevailing exchange rate in effect at the balance sheet date. This will create an exchange gain or loss on the difference between the exchange rate on the date the transaction took place and the exchange rate on the balance sheet date. This difference has to be reported in the company’s income statement.

The translation of foreign currency denominated items into Shs often gives rise to either a realised or unrealised foreign exchange gain or loss.

For example if a company makes a sale of $1,000 on credit to its customer, on January 1, 2010 when the exchange rate was Shs2,200 to the $, the transaction would be recorded in the company’s books at Shs2,2 million.

The company’s books will reflect a sale of Shs2,2 million and a debtor or receivable of Shs2,2 million. If by the end of the year, the receivable has not been collected yet, the company will close its books on January 31, 2010 with a debtor reflecting the fact the receivable has not been collected yet.

Assuming the exchange rate on December 31, 2010 is Shs2,000 to the $, the company will be required to reflect the receivable as Shs2 million in its books as opposed to the Shs2.2 million which was the equivalent of the $1,000, the amount receivable when the sale was made. The difference of Shs200,000 between the two figures will have to be recorded in the company’s income statement as a foreign exchange loss. This loss appears as an expense in the company’s profit and loss account.

According to the tax law, this kind of foreign currency loss that is simply arising as a result of translation gains is not considered to be a realised foreign currency loss. As a result it is not tax deductible. The same applies to an unrealised foreign exchange gain, that is the gain would not be taxable on the company as income.

This tax treatment of non realised foreign exchange gains and losses is a major issue for companies that transact mainly in foreign currency. For example in the above illustration, if the outstanding receivable was $1m, the unrealised foreign exchange loss would be Shs 200m.

This loss would reduce the company’s profits but it would not be a tax deductible cost. The effect of this would be the company having to report lower profits as a result of this loss, yet at the same time paying an additional Shs60 million in taxes as a result of the Shs200 million unrealised foreign exchange loss not being tax deductible. However, with very good, pro-active and innovative tax planning this situation can be avoided.

The writer is the PricewaterhouseCoopers Uganda Country Senior Partner. francis.kamulegeya@ug.pwc.com