402 Foreign currency: tax treatment of capital allowances and trading losses of a company

Summary

This section is concerned with the calculation of capital allowances and loss relief for companies whose primary currency is a currency other than the euro.

The section recognises that companies choosing to do business from Ireland may not wish to have a euro currency focus to the business they transact from Ireland. In assessing the attractions of our 12½ per cent regime of corporation tax, foreign investors want to be assured that 12½ per cent means 12½ per cent of their profits as measured in say US dollars or whatever might be the primary currency of their business. Computing allowances for capital expenditure, and relief for any losses which may arise, in euro would create an uncertainty for non-euro businesses as to what the value of those allowances and reliefs were in the currency of the business. The net result could be effective rates of tax in terms of the currency of the business which could be less than or greater than the intended 12½ per cent rate.

This section eliminates any potential uncertainty by allowing companies which have a “functional currency” other than the euro to compute capital allowances and loss relief in that non-euro functional currency.

Section 402 originally only applied to companies carrying on a trade, the profits of which are taxable under Case I of Schedule D. With effect from 1 January 2010, the provisions of the section were extended to companies that are involved in the leasing of machinery or plant but that are not carrying on sufficient activities to be regarded as carrying on a trade.

Details

Definitions and construction

(1) “functional currency” is defined by reference to both resident and non-resident companies. The definition reflects the definition of “local currency” in SSAP No. 20 – “Foreign Currency Translation”. While guidance as to the criteria for determining the currency of the primary economic environment is provided by this section, the criteria suggested (see subsection (1)(b)) need not be conclusive in determining what is that currency. The “primary economic environment” in which a company operates is undefined (although guidance on this is provided in subsection (1)(b)) so as to allow any sufficiently compelling aspect or circumstance of the company which is not mentioned in subsection (1)(b) to take precedence over the criteria set out in that subsection.

The functional currency of a non-resident company need not determine the functional currency of its Irish trading activities.

For companies which make up their profit and loss account in euro terms that currency is their functional currency. The reference here is to a profit and loss account which has been “prepared” in terms of euro. This means that a set of euro accounts derived from accounts prepared in another currency would be ignored for this purpose. Whereas a change in functional currency would generally follow a significant change in circumstances, there is nevertheless the automatic entitlement to the euro as the functional currency where a company changes to preparing its accounts in that currency.

The notes on section 79 should be consulted for guidance on the meaning of “profit and loss account” and “rate of exchange”.

The determination of the currency of the primary economic environment should in all instances take account of, but not necessarily be decided by, the currency in which the net cash flows of the company (or, in the case of a non-resident company, its Irish trading activities) are generated. The currency of such cash flows is strongly indicative, rather than conclusive, evidence of the currency of the primary economic environment.

The provision for determining when expenditure is incurred mirrors the provision in section 316(2) which applies for the purposes of Part 9 generally.

Computation of capital allowances

(2) A company’s capital allowances are to be computed in terms of the company’s functional currency. The capital allowances are to be brought into the computation of the trading income or loss of the company before that income or loss is translated into a euro value.

The phrase “which may be nil” allows for the possibility that the result of the capital allowances computation in the functional currency is that none are due. The phrase conveys that the question of whether any allowances are due at all, which is implicit in computing the amount of such allowances, is also to be answered in terms of the company’s functional currency. Reference is made to a “charge” as well as an “allowance” to include balancing charges within the functional currency computation.

(2)(a)(i) The reference to allowances made “in taxing a trade” reflects the language of section 308. This reference read together with “by reference to capital expenditure” makes it clear that the section is dealing with capital allowances although, as in section 308, they are not referred to as such.

(2)(a)(ii) Although a capital allowance may be due in respect of an accounting period commencing after 1 January, 1994, if the capital expenditure in question was incurred before that date the capital allowance is to be computed by reference to the Irish pound, rather than functional currency, value of the expenditure at the time the expenditure was incurred.

Capital allowances are to be computed in functional currency terms so that they may be brought into the computation of trading income or loss in that functional currency before the net income or loss is translated into a euro value.

Two further aspects of the computation of capital allowances in functional currency terms are addressed.

(2)(b)(i) Firstly, the post 1 January, 1994 capital expenditure may not have been incurred in the functional currency of the company in question. For example, a “euro” company may have paid for plant manufactured in the UK in sterling or a “US dollar” company may have purchased computer equipment in euro. Section 79 requires companies to compute capital allowances in one currency only – the functional currency of the company for the accounting period in which the allowance is to be made. This single currency computation approach requires the sterling expenditure of the euro company to be translated into euro and the euro expenditure of the US dollar company to be translated into US dollars.

(2)(b)(ii) The second question which is addressed is what to do where the functional currency of a company changes, for example, when a euro company becomes a US dollar company. Where this happens there is to be no reopening of the computation of capital allowances which were made in accounting periods before that in which the functional currency changed. However, for the purposes of computing capital allowances to be made in accounting periods for which the company has the new functional currency, capital expenditures and allowances made should be translated into their values in terms of the new functional currency. The rate of exchange to be used, both in translating the expenditure and the allowances, is the “representative rate of exchange” for the day on which the capital expenditure was incurred.

(2)(c) With effect from 1 January 2010 the treatment set out above was extended to companies whose leasing activities are charged to tax under Case IV of Schedule D rather than Case I.

Computation of loss relief

(3)(a) The computation of loss relief under section 396, section 396A and terminal loss relief under section 397 are to be computed in terms of the company’s functional currency. (Although there is no reference to loss relief under section 455(3) this provision is to be taken as applying to such loss relief where a claim is made on that basis).

The relief or set-off of any loss so computed is then allowed in terms of euro values. The rate of exchange to be used is the average exchange rate for the period in which the loss relief is being allowed (that is, the rate of exchange for the period in which the set-off is being allowed). In practice, since the loss relief is being allowed against euro amounts it may be necessary to work back from the amount of euro loss relief required to the amount of functional currency loss relief available to be claimed – although this may appear to reverse the sequence set out in paragraphs (a) and (b).

(3)(b) The situation where the functional currency of a company changes is addressed. It should be noted that there is no question of the effect of any loss relief which was set off in an accounting period of the former functional currency of the company being revised. Any such set off is not to be disturbed. However, for the purposes of computing set-offs in accounting periods for which the new functional currency applies, losses computed and relief given in the terms of the former functional currency must be translated into the current functional currency. That translation is to be made at the average of the representative rates of exchange for the 2 currencies for the period in which the loss was incurred.

(4) Subsection (4) applies to companies whose leasing activities are charged to tax under Case IV of Schedule D.

(4)(a) Where a company makes a claim for loss relief under section 399(1), the losses are to be computed in terms of the company’s functional currency. The relief or set-off for any losses so computed is then allowed in terms of the corresponding euro value. The rate of exchange to be used in the conversion is the average exchange rate for the period in which the loss relief is allowed.

(4)(b) This deals with situations where the functional currency of a company changes. For the purpose of computing set-offs in accounting periods for which the new currency applies, any losses computed and, relief given, in the former functional currency should be translated into the current functional currency. The translation is to be made at the average of the representative rates of exchange of the two currencies for the period in which the loss was incurred.

Relevant Date: Finance Act 2019