The Federal Inland Revenue Service Nigeria (FIRS) has issued a circular to provide information and guidance to the public, taxpayers, tax practitioners, and tax officials regarding the proper tax treatment of foreign exchange transactions in accordance with relevant tax laws. This circular supersedes Information Circular No. 2024/3, which the Service previously issued on June 14th, 2024.
Introduction
The International Financial Reporting Standards (IFRS) prescribe the treatment of foreign currency transactions in an entity’s financial statements for accounting purposes. The FIRS notes that the treatment prescribed by the IFRS may be sufficient for accounting purposes. However, such treatments may not be in accordance with extant tax rules, which would necessitate making relevant adjustments when computing tax payable.
This Information Circular aims to clarify the relevant adjustments that may be required to determine the tax position from such transactions.
Legal Framework
Generally, only expenses that are wholly, exclusively, necessarily and reasonably incurred in the production of a taxable income may be deducted in order to ascertain the assessable profits for the relevant year of assessment, in line with Sections 24(1) & 27 of the Companies Income Tax Act (CITA), Sections 20 & 21 of the Personal Income Tax Act (PITA) and Sections 10 & 13 of the Petroleum Profits Tax Act (PPTA).
Foreign Exchange Difference
Foreign exchange difference arises where the foreign exchange rate used in booking a foreign-currency transaction differs from the rate used on a subsequent reporting or settlement date.
Illustration 1
Assume that Needy Ltd borrowed US$1m through a Nigerian bank on a date when the exchange rate was N500/US$1. The loan must be repaid in the same currency at the end of 24 months.
The loan would be recorded in the books of Needy Ltd on the transaction date as N500m (US$1m x 500). At the accounting year-end, if the exchange rate has moved to N600/US$1, the loan amount due in naira would be N600m (US$1m x 600). A difference of N100m has arisen due to an increase in the exchange rate from N500/US$1 to N600/US$1.
Foreign exchange rates can rise or fall. Where the exchange rate rises, i.e., goes up as in the previous illustration, the resulting exchange difference is a loss to the paying party (Needy Ltd). On the other hand, if the exchange rate falls i.e., comes down, a gain accrues to the paying party.
Illustration 2
Using the Needy Ltd illustration, assume that on the date Needy Ltd repays the loan, the exchange rate fell to N560/US$1, which means that the bank will only debit its account with N560m ($1m x 560). This will result in an exchange difference (gain) of N40m (N600m – N560m) between the last booking date and the payment date. Taking the transactions from the date the loan was granted to the date of loan repayment, there is a net exchange difference (loss) of N60m, i.e., N500m (loan received) – N560m (repayment).
Realised and Unrealised Exchange Differences
Foreign exchange differences are further classified as “realised” or “unrealised”.
Unrealised exchange differences occur when the revaluation of a foreign currency transaction arose from mere accounting (reporting) purposes and did not result in payment or receipt of the revalued sum.
Using the illustration in paragraph 2, the N100m exchange difference occurring in the first reporting year was unrealised as it was only for reporting purposes.
Realised exchange differences occur when a foreign-currency transaction is closed at an exchange rate different from the booking rate, resulting in payment or receipt of the revalued sum.
Going back to the illustration in paragraph 2, Needy Ltd liquidated the loan of US$1m at N560/US$1 compared to the receipt of US$1m loan at N500/US$1. While the company received N500m into its bank account upon the disbursement of the loan, it paid out N560m to liquidate the loan. This resulted in a net difference (loss) of N60m, which was realised.
Unrealised exchange differences do not increase or decrease the tax liability as they must be ignored in the computation of the assessable profits. Where unrealised exchange loss is charged to the statement of comprehensive income account (i.e., Profit and Loss Account), such unrealised losses are not tax-deductible, while unrealised gains are equally not taxable income.
However, realised exchange differences will increase (in the case of a gain) or decrease (in the event of a loss) tax due as they are included in the computation of the assessable profits.
Monetary and Non-monetary Items
For monetary and non-monetary items, exchange differences will be treated as follows:
- Exchange differences on the settlement or recovery of a monetary item are realised exchange differences.
- Exchange differences on foreign currency cash balances are realised upon conversion to another currency or class of monetary or non-monetary item.
- Exchange differences on any monetary item are treated as taxable income or deductible expense for income tax purposes
Hedging Transactions
Foreign exchange differences arising from hedging transactions are not taxable income or deductible expenses until the hedged item is realised.
Tertiary Education Tax (TET)
The tax treatment of exchange currency transactions and translations also applies to TET. This means exchange differences, taxable income, or deductible expenses for Companies Income Tax (CIT) purposes shall be similarly treated when arriving at assessable profits for TET purposes.
Other Taxes
Unrealised exchange differences recognised for accounting purposes shall not be adjusted in computing the following taxes:
- National Agency for Science and Engineering Infrastructure (NASENI) levy at 0.25% of the Profit Before Tax for eligible companies.
- National Information Technology Development Agency (NITDA) Levy at 1% of Profit Before Tax payable by companies specified in the NITDA Act.
- Minimum tax payable under section 33(2) of CITA at 0.5% of gross turnover as defined under section 105 of CITA (less franked investment income) where applicable.
Tax Exempt Items
Exchange differences arising from an item exempt from tax are not taxable in the case of a gain and not deductible in the case of a loss. For instance, any exchange gain or loss on the disposal of the Federal Government of Nigeria’s (FGN) Eurobonds will not be a taxable income or deductible expense for income tax purposes, regardless of the nature of the taxpayer’s business.
Note that income and expenses relating to tax-exempt items shall be disclosed in the tax computation statement or schedule and segregated by type. For example, expenses relating to FGN Naira Bonds and FGN Eurobonds shall be shown separately.
Documentation and Returns
A company must keep detailed records of all foreign currency transactions stating the dates, amounts, counterparty, and applicable exchange rates. Furthermore, every company must provide a reconciliation of exchange differences recognised in the income statement, a statement of comprehensive income or equity, and associated deferred tax analysis.
Artificial Transactions
Where the Service determines that a taxpayer is artificially realising or deferring the realisation of foreign exchange gains and losses with the principal purpose of tax avoidance, especially in a related party transaction, necessary adjustments shall be made to the tax due.
Other Matters
- Commissions, fees and other charges associated with foreign exchange transactions, including a split or second invoice (where applicable), foreign exchange hedging or the application of unofficial exchange rates shall be subject to the wholly, reasonably, exclusively and necessarily (WREN) test to determine tax deductibility.
- Any income earned, including consequential realised exchange gains, shall be taxed irrespective of the circumstances unless the income is exempt from tax.
- Peer-to-peer exchange rates agreed for transactions between related parties shall be subject to transfer pricing rules.
- Offsetting exchange gains or losses shall be segregated by line of business and tax regimes. For instance, exchange gains arising from a taxable item or business operation shall not be offset against the loss from an item or a business operation exempt from tax.
Amendment or Revision of the Circular
The Service may, at any time, withdraw or replace this Circular or publish an amended or updated version
