TAX IMPLICATIONS RELATED TO THE …

1 Draft for comments The Malaysian Institute of Certified Public Accountants TAX IMPLICATIONS RELATED TO THE implementation OF FRS 121: THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES Prepared by: Joint Tax Working Group on FRS Draft for comments Tax IMPLICATIONS RELATED to the implementation of FRS 121: The Effects of Changes in Foreign Exchange Rates Contents Page No. 1 Introduction 1 Background of FRS 121 Rationale Scope of FRS 121 Definition of essential terms Effective date 1 1 1 1 2 Scope of the comments 1 3 Changes introduced by the FRS regime 2 The MASB Regime (MASB 6) 2 Foreign Currency Transactions 2 Financial Statements of Foreign Operations 2 The FRS Regime (FRS 121)

2 2 Foreign Currency Transactions 2 4 Tax treatment before FRS implementation 3 5 Tax issues arising from FRS 121 implementation 3 Claim of capital allowances 3 Translation of functional currency to presentation currency 4 Valuation of inventories 5 Comparison of FRS conversion and actual RM figure 6 Computation of interest restriction 8 6 International tax practices 8 Singapore 8 Hong Kong 8 7 Proposals/ Recommendations of tax treatments 9 Draft for Comments Tax IMPLICATIONS RELATED to the implementation of FRS 121: The Effects of Changes in Foreign Exchange Rates 1 1.

3 INTRODUCTION BACKGROUND OF FRS 121 Rationale FRS 121 was issued to stipulate the accounting principles underlying the recognition of foreign currency transactions and the translation of foreign currency financial statements into the local currency as presented in the financial statements. Scope of FRS 121 FRS 121 shall be applied: a. In accounting for transactions and balances in foreign currencies, except for those derivative transactions and balances that are within the scope of FRS 139; b.

4 In translating the results and financial position of foreign operations that are included in the financial statements of the entity by consolidation, proportionate consolidation or the equity method; and c. In translating an entity s results and financial position in a presentation currency. Definition of essential terms a. Closing rate is the spot exchange rate at the balance sheet date; b. Foreign currency is a currency other than the functional currency of the entity; c. Functional currency is the currency of the primary economic environment in which the entity operates; d.

5 Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency; and e. Presentation currency is the currency in which the financial statements are presented. Effective date Annual periods beginning on or after 1 January 2006 2. SCOPE OF COMMENTS This paper covers the effects of two stages translation of currency, as introduced by the FRS 121, where the presentation currency is not the functional currency. Draft for Comments Tax IMPLICATIONS RELATED to the implementation of FRS 121: The Effects of Changes in Foreign Exchange Rates 2 3.

6 CHANGES INTRODUCED BY THE FRS REGIME THE MASB REGIME (MASB 6) Foreign Currency Transactions Foreign currency transactions are recorded, on initial recognition, at the spot rate. At each balance sheet date: a. Foreign currency monetary items are reported at closing rate, unless there are RELATED or matching forward contracts in respect of trading transactions, in which case, the contract rates are used; b. Non-monetary items which are carried at historical cost are reported using the exchange rate at the date of the transaction; and c.

7 Non-monetary items which are carried at fair value are reported using the exchange rates at the date when the values were determined. Exchange differences at this juncture are recognised in the income statement. Financial Statements of Foreign Operations If the foreign operations are integral to the operations of the reporting enterprise, the financial statements of the foreign operations are translated as in above. Otherwise, the reporting enterprise uses the following procedures: a. The assets and liabilities, both monetary and non-monetary, of the foreign entity are translated at the closing rate; b.

8 Income and expense items of the foreign entity are translated at the exchange rates at the dates of the transaction; and c. All resulting exchange differences are recognised in equity. THE FRS REGIME (FRS 121) Foreign Currency Transactions Stage 1 Translation to Functional Currency Foreign currency transactions are recorded, on initial recognition, at the spot rate. At each balance sheet date, translation from foreign currency to functional currency is done as follows: a. Foreign currency monetary items are reported at closing rate; b.

9 Non-monetary items which are carried at historical cost are reported using the exchange rate at the date of the transaction; and c. Non-monetary items which are carried at fair value are reported using the exchange rates at the date when the values were determined. Exchange differences at this juncture are recognised in the income statement. Draft for Comments Tax IMPLICATIONS RELATED to the implementation of FRS 121: The Effects of Changes in Foreign Exchange Rates 3 Stage 2 Translate to the Presentation Currency The results and financial position of the entity are translated from the functional currency to the presentation currency as follows: a.

10 Assets and liabilities for each balance sheet presented are translated at the closing rate; b. Income and expenses for each income statement are translated at exchange rates at the dates of the transactions; and c. All resulting exchange differences are recognised as a separate component of equity. 4. TAX TREATMENT BEFORE FRS implementation There are no specific provisions in the Income Tax Act, 1967 on exchange profits and losses. Generally, for income tax purposes, profits or losses have not arisen until they are realised.