SARS releases rules for comment

The draft interpretation note sets out SARS' views on how these rules should be applied. The rules are essentially contained in section 25D of the Income Tax Act. The rules applicable for capital gains tax purposes do not fall within the ambit of the draft interpretation note.

The draft interpretation notes deals with two broad situations in which the rules may become relevant. The first is when a taxpayer directly enters into transactions denominated in a foreign currency. The second is when a taxpayer carries on operations through a foreign subsidiary (i.e. a controlled foreign company or CFC) or a foreign branch (i.e. a permanent establishment or PE).

Spot rate

The starting point in section 25D is that amounts denominated in foreign currencies must be translated into Rand at the applicable spot rate. It goes on, however, to provide that, in the case of a PE, the average exchange rate for the relevant year of assessment becomes applicable. SARS envisages a separate tax calculation being performed in a PE's reporting currency.

The resulting taxable income can then be translated into rands at the relevant average rate. A similar approach is set out for CFCs, in section 9D of the Income Tax Act. There are also specific rules for PEs and CFCs operating in hyperinflationary environments.

There are no legislative provisions to deal with the situation where a PE or a CFC concludes transactions in a foreign currency other than its reporting currency (i.e. a third currency, other than Rand or its reporting currency). The draft interpretation note sets out SARS' view that taxpayers should then follow generally accepted accounting practice, as set out in IAS 21 (a spot rate approach).

Individual taxpayers

A taxpayer that is an individual or a non-trading trust may elect to use average exchange rates for a year of assessment, rather than spot rates. That election will then apply to all foreign currency denominated transactions during that year of assessment. This is considered a simpler approach for such taxpayers. SARS quotes a range of average exchange rates on its website. Taxpayers may use those rates or, alternatively, calculate their own rates.

The draft interpretation note also deals with the tax treatment of foreign equity instruments, blocked foreign funds (where deferral relief is available) and the translation of foreign taxes to Rand (for purposes of tax credit relief).