The Federal Inland Revenue Service (FIRS) has released new guidelines for accounting for foreign currency transactions in line with International Financial Reporting Standards (IFRS).
Business Day reported that these guidelines provide clarity on the tax implications of foreign exchange differences to ensure accurate tax compliance.
According to FIRS, “Generally, only expenses that are wholly, exclusively, necessarily, and reasonably incurred in the production of taxable income may be deducted to ascertain the assessable profits for the relevant year of assessment.”
This is in accordance 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).
While these guidelines reference IFRS, FIRS acknowledged that certain treatments might not align perfectly with Nigeria’s tax regulations. The new statement aims to clarify the adjustments needed for determining tax implications arising from foreign exchange differences.
This new circular replaces Information Circular No. 2024/3 issued on June 14, 2024, by FIRS regarding the same subject.
In related developments, President Bola Tinubu has proposed amendments to the 2023 Finance Act, suggesting a one-time windfall tax on the foreign exchange revaluation profits of banks for the 2023 financial year.
The Senate, however, amended this proposal by raising the tax to 70 percent, stating that the windfall resulted from government policy rather than the banks’ efforts or value addition and should be redistributed.
The IFRS provides guidelines on handling foreign currency transactions within an entity’s financial statements. According to the FIRS, foreign exchange differences occur when the rate used for booking a foreign currency transaction differs from the rate on a later reporting or settlement date.
FIRS highlights the following example: “Assume that Needy Ltd borrowed $1m through a Nigerian bank on a date that the exchange rate was N500 to $1, and the loan must be repaid at the end of 24 months in the same currency.
“The loan would be recorded in the books of Needy Ltd on the date of the transaction as N500m ($1m x 500). At the accounting year-end, if the exchange rate has moved to N600:$1, the amount of loan due in naira would be N600m ($1m x 600). A difference of N100m has arisen due to an increase in exchange rate from N500:$1 to N600:$1,” the statement said.
FIRS explained that foreign exchange rates can either rise or fall. An increase in the exchange rate results in a loss for the paying party (e.g., Needy Ltd), while a decrease results in a gain.
Foreign exchange differences are classified as either realized or unrealized. Unrealized differences arise from accounting adjustments and do not involve actual payments or receipts, whereas realized differences occur when a foreign-currency transaction is settled at a different rate than initially booked.
The guidelines also specify that for monetary and non-monetary items, exchange differences will be treated differently. Exchange differences related to monetary items are considered realized when settled or recovered and are treated as taxable income or deductible expenses for tax purposes. Exchange differences on cash balances are realized upon conversion to another currency or monetary item.
These comprehensive guidelines from FIRS are designed to help businesses accurately account for foreign exchange transactions, ensuring compliance with Nigerian tax laws while referencing international standards.
