1. Currency Rules National Treasury

2. Complex Web Of Currency Law 1.The foreign currency rules represent one of the most complex features of the Income Tax Act simply by virtue of the subject matter involved. 2.The foreign currency rules tend to be all-encompassing because foreign currency gains and losses involve all forms of foreign related transactions. 3.The foreign currency rules, like the reorganisations rules, also represent “a system on top of a system.”

3. Types of Foreign Currency Gains 1.All foreign denominated income/loss must be translated into Rands: -Basic translations are covered under section 25D (directly earned income0 and section 9D(6) (CFC income); and -Capital Gains are covered under paragraph 43 of the 8th Schedule. 2.The currency gain on the corpus from foreign liquid investments must similarly be taxed: -Foreign cash and debt are covered under section 24I (companies) and Part XIII of the 8th schedule; and -Foreign Shares are covered under section 9G and 43 of the 8th Schedule.

4. Translations of Directly Earned Foreign Income 1.The proposed Bill attempts to rationalise the currency rules by including foreign denominated income into one basic system (section 25D). 2.Under the proposed system, all foreign denominated income is translated into Rands at the “average exchange rate” for the taxable year. 3.Taxpayers with branches must now fully rely on the financial reporting currency of that branch.

5. Translations of CFC Income 1.All CFC income is translated into Rands based on the CFC’s currency of financial reporting, just like branches (Section 9D(6)). 2.Each shareholder with CFC income translates that CFC income using the “average exchange rate” for that shareholder’s year of assessment. 3Note: Some have suggested that the “average exchange rate” should be based the CFC’s year.

6. Average Exchange Rate 1.Translation occurs at the average exchange rate for the year, not the spot rate on the transaction date (Section 1). 2.The average exchange rate system is the most neutral economic result and eliminates unusual currency spikes from the system. 3.The average exchange rate can be the 365-day simple average or a daily weighted average (based on net income or net loss). 4.Comments are requested on the practical viability of this method for taxpayers.

7. Basic Capital Gains for Foreign Assets 1.Taxpayers that purchase and sell foreign assets with the same foreign currency determine all gains and losses in that currency and then translate those gains and losses at the “average exchange rate” (Section 43(1)). 2.Special rules for conversion were needed when a taxpayer purchases an asset in one foreign currency and sells in another (Section 43(2)). 3.Special effective date rules were needed for 1 October 2001 foreign assets and the tax-free carryover of foreign assets (in a share-for-share reorganisation for example).

8. Foreign Cash and Debt (1): Companies 1.Under current law (Section 24I), the corpus of foreign cash and debt (plus currency forwards and option contracts) are all taxed on a mark-to-market system if held by-- -Companies -Trusts carrying on trade -Natural persons with foreign currency items held as trading stock (clarified by the Bill). 2.Under the mark-to-market system, all foreign currency items are deemed sold annually at ordinary rates; this rule is premised on the presumed liquidity of the foreign instruments involved.

9. Foreign Cash and Debt (2): Companies 1.Under current law (Section 24I(10), taxpayers cannot claim 24I losses for loans to certain CFCs. 2.The Bill also exempts gains as well as losses. 3.However, a taxable event will occur upon repayment of loan principal or sale of the loan. 4.This rule eliminates income for South African companies that have made illiquid foreign denominated loans to their CFCs.

10. Foreign Cash and Debt (3): Companies 1.Under current law (Section 24I(11), taxpayers disregard all foreign currency losses/gains on loans to the extent those loan proceeds are used to acquire foreign assets that do not carry any corresponding currency gains/losses (i.e., that are not foreign liquid investments). 2.The inadvertent flaw in the current rule was removed. The inadvertent flaw essentially rendered the rule null and void, thereby freely allowing taxpayers to claim currency losses on debts used to acquire foreign assets, the latter of which carried no corresponding currency gains.

11. Foreign Cash and Debt (4): Companies 1.The current section 24I regime is based solely on spot rates. 2.Although this spot rate system dates back to 1993, this system is now inconsistent with other currency systems. Query, should the average exchange rate be used instead? 3.Taxpayers would benefit by an “average exchange rate system” because this system could effectively ignore mid- year currency changes.

12. Foreign Cash and Debt (1): Individuals 1.Under current law, the corpus of all foreign cash and debt (plus currency forwards and option contracts) are all taxed on a a “pooling system”if held by-- -Individuals that do not hold foreign currency as trading stock; and -Trusts that do not carry on any trade. 2.Under the pooling system, currency gains and losses are only triggered for currency items converted out of the pool into a different currency (when shifting from U.K. pounds into dollars for example); transfers within the same currency are ignored. 3.These rules were previously in regulatory form and revised to reflect taxpayer comments.

13. Foreign Cash and Debt (2): Individuals 1.The rules eliminate foreign currency gain/loss for all-- -Domestic or private expenses (other than for immovable property such as homes); -Traveling or maintenance expenses; and -Involuntary disposals (such as theft). 2.The rules also eliminate foreign currency gain/loss for one personal checking account of the taxpayer’s choice.

14. Foreign Cash and Debt (3): Individuals 1.The averaging system for measuring currency gains fully applies to the “pooling method.” 2.A LIFO system is being considered for the pooling regime so all mid-year currency gains/losses completely fall outside the system (only long-term currency gains/losses would be accounted for). 3.All these rules will apply prospectively. Taxpayers have been concerned that the regulatory pooling rules would apply from 1 October 2001.

15. Liquid Foreign Equity Shares 1.The currency gain/loss on the corpus for all liquid foreign equity shares remain full taxable, regardless of whether the shares are held as capital assets or as trading stock. 2.The definition of foreign equity shares was clarified to include shares on-- -any listed exchange, regardless of whether that exchange is national, regional or local; - any interdealer quotation system.

16. South African Sourced Assets 1.The foreign currency gain/loss on all foreign denominated assets from South African sources is fully picked-up under the proposed Bill (such as South African located transport containers). 2.The source rules are based on the same OECD guidelines as described previously. 3.This coverage was intended under current law but the mechanism utilised was inherently flawed.