In today's globalized economy, businesses and individuals often engage in international transactions, leading to exposure to foreign exchange fluctuations. In Bangalore, a prominent hub for businesses in India, understanding the tax treatment of foreign exchange gains and losses is crucial for both companies and individuals engaged in cross-border activities. This article aims to provide insights into the taxation framework governing foreign exchange gains and losses in Bangalore.

General

Some terms that need clarification are as follows:

Closing rate - The closing rate is the spot exchange rate at the end of the reporting period, viz. the reporting date or balance sheet date.

Exchange rate - The spot exchange rate is the exchange rate for immediate delivery. It is the current price level in the market to directly exchange one currency for another.

Exchange difference - Exchange difference is the difference resulting from translating/converting/exchanging a given number of units of one currency into another currency at different exchange rates.

The exchange rate is the ratio of exchange for two currencies.

1) Functional currency is the currency of the primary economic environment in which the entity operates.

2) Presentation currency is the currency in which the financial statements are presented.

Monetary items are units of currency held, as well as assets and liabilities to be received or paid in a fixed or determinable number of units of currency, e.g. trade receivables, trade payables, cash, deposits, and bank balances.

Non-monetary items are those such as PPE, intangible assets, investments in associates, and others that have no rights to receive or obligation to pay a fixed or determinable number of units of currency.

Comprehensive income consists of 2 sections: income statement and other comprehensive income. Unrealized gains and losses are included in the other comprehensive income by the larger corporations.

Accounting treatment

At the end of each reporting period

1. Foreign currency monetary items shall be translated using the closing rate.
2. Non-monetary items that are measured at historical cost in a foreign currency shall be translated using the exchange rate at the date of transaction. Subsequently, no recalculation is needed.
3. Non-monetary items that are measured at fair value in a foreign currency shall be translated using the exchange rates at the date when the fair value was measured.

Reporting foreign currency transactions

A foreign currency transaction is a transaction that is denominated in or requires settlement in a foreign currency, including transactions arising when an entity:

1. buys or sells goods or services whose price is denominated in a foreign currency;
2. borrows or lends funds when the amounts payable or receivable are denominated in a foreign currency; or
3. otherwise acquires or disposes of assets, or incurs or settles liabilities, denominated in a foreign currency.

Recognition of foreign exchange gains or losses

1. When the entity translates the balances in the foreign currency of monetary items into the presentation currency at the reporting date; or
2. When the entity makes a settlement of monetary items in a foreign currency, and there is a change in the exchange rates on the transaction date and on the date of settlement.
3. Gains or losses arising on translating monetary items or on the settlement of monetary items shall be recognized in profit or loss in the period in which they arise.

Realized and Unrealised gains or losses

• Realized gains or losses are the gains or losses on foreign exchange transactions that have been completed as of the reporting date. In clearer terms, this means that the payment has been made or received prior to the close of the accounting period.
• Unrealized gains or losses are the gains or losses on transactions that have not been completed as of the reporting date. This would mean that the payment has not been made or received prior to the close of the accounting period.

Tax treatment

Taxability and deductibility of foreign exchange gains and losses

Foreign exchange gains and losses are taxable and deductible respectively if the gains and losses are:

1. arising from revenue transactions;
2. realised;
3. arising from a trade.

Foreign exchange gains and losses are not taxable and deductible respectively, if the gains or losses are:

1. arising from capital transactions;
2. unrealised;
3. arising from a non-trade activity/transaction;
4. arising from the translation of foreign currency into presentation currency at the reporting date.

Revenue transactions

Revenue transactions are transactions relating to the normal operating cycle of an entity such as sales, purchases, trading, etc.

Capital transactions

Capital transactions are transactions relating to assets, such as the purchase of property, plant and equipment, investments, speculations outside the normal operating cycle of an entity, etc.

Trade and non-trade activities

Trade generally refers to activities involving sales of goods and services, whereas non-trade activities refer to activities that are not related to the selling of goods or the provision of services.

Borrowing cost

If an entity has foreign currency borrowings that are used in the ordinary course of business operations, any foreign exchange gain or loss on repayment of the borrowings would be considered revenue transactions.

Similarly, if foreign currency borrowings are used to purchase capital assets, any foreign exchange gain or loss on repayment of the borrowings would be considered capital transactions.

 

Created & Posted by Pooja

Income Tax Expert at TAXAJ

 

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