The Federal Inland Revenue Service (FIRS) has released a clarification on the necessary adjustments that may be required to determine the tax position from foreign currency (FCY) transactions.

This clarification is provided in an information circular to taxpayers, tax practitioners, tax officials, and the general public, outlining the appropriate tax treatment of FCY transactions in accordance with the relevant tax laws.

The service acknowledges that the International Financial Reporting Standards (IFRS) dictate the treatment of FCY transactions in an entity’s financial statements for accounting purposes.

The IFRS treatment may be suitable for accounting purposes, but it may not align with existing tax regulations, requiring adjustments when calculating tax liabilities.

The tax authority emphasized that only expenses that are wholly, exclusively, necessarily, and reasonably incurred in generating taxable income can be deducted to determine assessable profits for the relevant assessment year, in accordance with specific sections of the Companies Income Tax Act (CITA), Personal Income Tax Act (PITA), and Petroleum Profits Tax Act (PPTA).

It clarified that Foreign Exchange (FX) differences occur when the booking rate for a foreign-currency transaction differs from the rate used on a subsequent reporting or settlement date. The FIRS highlighted that exchange differences on monetary items are treated as taxable income or deductible expenses for income tax purposes.It further stated that FX differences arising from hedging transactions are not taxable income or deductible expenses until the hedged item is realised.

Exchange differences arise when a foreign currency transaction is settled at a rate different from the initial booking rate, leading to the payment or receipt of a revalued amount.

The company clarified that unrealized exchange differences have no impact on tax liability and should be disregarded when calculating assessable profits.

The statement indicated that unrealised exchange losses are not tax deductible, and unrealised gains are not considered taxable income. Realised exchange differences, on the other hand, will affect the tax due, either increasing it in the case of a gain or decreasing it in the event of a loss, as they are factored into the computation of assessable profits.

Additionally, the service offered a template for the taxation of both monetary and non-monetary items, specifying that exchange differences on the settlement or recovery of a monetary item are considered realised exchange differences.

“Exchange differences on foreign currency cash balances are realised upon conversion to another currency or another class of monetary or non-monetary.”

The Federal Inland Revenue Service (FIRS) has clarified that unrealized exchange differences recognized for accounting purposes will not be adjusted when calculating the National Agency for Science and Engineering Infrastructure (NASENI) levy of 0.25% of Profit Before Tax (PBT) for eligible companies.

Similarly, the National Information Technology Development Agency (NITDA) Levy of 1% of PBT payable by companies specified in the NITDA Act, as well as the minimum tax payable under section 33(2) of the Companies Income Tax Act (CITA) at the rate of 0.5% of gross turnover as defined under section 105 of CITA (less franked investment income) where applicable, will not be subject to adjustments based on unrealized exchange differences.

With regard to tax-exempt items, the service indicated that exchange rate differences resulting from an item exempt from tax are not subject to taxation in the event of a gain, nor are they deductible in the event of a loss.

It was stated that, "As an example, any exchange gain or loss from the sale of Federal Government of Nigeria's (FGN) Eurobonds will not be considered taxable income or deductible expense for income tax purposes, regardless of the taxpayer's business nature.

"Please be aware that income and expenses associated with tax-exempt items must be detailed in the tax computation statement or schedule, and must be categorized by type.

"For instance, expenses linked to FGN Naira Bonds and FGN Eurobonds should be presented separately."

Regarding documentation and refunds, it is emphasized that companies are required to maintain detailed records of all foreign currency transactions, including dates, amounts, counterparties, and applicable exchange rates.

Additionally, companies must reconcile exchange differences recognized in financial statements and provide associated deferred tax analysis.

The tax authority also highlighted the need to make necessary adjustments to tax due if it is determined that a taxpayer is artificially realizing or deferring foreign exchange gains and losses for the purpose of tax avoidance, especially in related party transactions.

Furthermore, commissions, fees, and other charges related to foreign exchange transactions, as well as FX hedging or the use of unofficial exchange rates, are subject to the WREN test to determine tax deductibility.

It was stated that any income generated, including consequential realized exchange gains, shall be subject to taxation regardless of the circumstances unless the income is exempt from tax.

Additionally, peer-to-peer exchange rates agreed upon for transactions between related parties shall be subject to transfer pricing regulations, the service further stated.

Furthermore, it was mentioned that the offsetting of exchange gains or losses shall be segregated by business line and tax regimes.

“For example, exchange gains arising from a taxable item or business operation should not be offset against the loss from an item or a business operation that is exempt from tax.”