Page 96 - SAIT Compendium 2016 Volume2

PN 4/1999 Income Tax acT: PracTIce noTes PN 4/1999
‘Market value’ in relation to a foreign currency option contract is de ned in section 24I(1). Where a taxpayer consistently includes any change in the value of all his foreign currency option contracts in his accounting pro t and the value is determined by applying a market-related valuation method (which apart from the intrinsic value of that option, also takes into account variables such as time), then the value so determined is the market value. In all other cases it is the ‘intrinsic value’ of that foreign currency option contract.
‘Intrinsic value’ is de ned in section 24I (1). It is the gain which the holder of a foreign currency option contract could realise by exercising that option contract at a given time, because the option strike rate at that time is more favourable than the spot rate. When the exercising of a foreign currency option contract will result in a loss for the holder of that contract, the intrinsic value is nil for both the holder and writer, because that option would not be exercised under such circumstances. This evaluation must be done on date of translation even where the holder of the foreign currency option contract does not have the right to exercise the option on that date, but only on maturity of the option.
The ‘market value’ of a foreign currency option contract is, for the writer of such contract a negative value (a liability) of which the absolute value is equal to the market value of such contract for the holder thereof. This means that where the market value of a foreign currency option contract increases for the holder of such contract and an exchange gain consequently accrues to such person in respect thereof, the writer of such contract incurs an exchange loss of the same magnitude.
In terms of the de nition of ‘realised’, a foreign currency option contract may be realised in three ways, namely— (a) by exercising the right in terms of that contract;
(b) by allowing such contract to expire without exercising the right in terms thereof; or
(c) by the disposal of that contract during the term thereof.
If a foreign currency option contract is realised by the exercising thereof, or by allowing the contract to expire without it being exercised, the ruling exchange rate is calculated by dividing the market value of that foreign currency option contract by the relevant foreign currency amount. The market value of a foreign currency option contract at the exercising thereof is equal to the intrinsic value at that time. The market value of a foreign currency option contract which has expired, is always nil.
It is important to note that the option holder’s loss is limited to the premium paid or acquisition cost, but his pro t potential is unlimited, while the writer’s pro t is limited to the premium received or consideration received on disposal, but his loss potential is unlimited.
See annexure C, example 3.
If a foreign currency option contract is realised by the disposal thereof, then the ruling exchange rate is calculated by dividing the amount received or accrued as a result of the disposal thereof, by the foreign currency amount.
4.4.5 AFFECTED CONTRACT
Where a taxpayer takes out cover by way of either a forward exchange contract or a foreign currency option contract to serve as a hedge for future loans, advances or debts in foreign currency the amounts of which (both capital and interest) can be determined with certainty, the forward exchange contract should be translated at the forward rate and the foreign currency option contract should be translated at the rate determined by dividing the consideration (e.g. premium or like consideration paid or received on acquisition of the foreign currency option contract by the foreign currency amount of that contract. This option is available only where the underlying exchange item has not yet arisen at year-end, but for which an agreement has already been entered into and—
(a) the loan, advance or debt will be utilised to acquire any asset or to nance any expense; or (b) the loan, advance or debt will arise from the sale of any asset or the supply of any services, in the ordinary course of the taxpayer’s trade.
The effect will be that no exchange differences will arise on the translation of a forward exchange contract or foreign currency option contract entered into to serve as a hedge in respect of such a loan, advance or debt until the underlying exchange item comes into existence.
See annexure C, example 16.
5 Section 24I (3) – transitional exchange differences
‘Transitional exchange difference’ is de ned in section 24I (1). It is the accumulated unrealised foreign exchange gain or loss which, in respect of certain exchange items, existed on the date of commencement of section 24I. Every transitional exchange difference is included in income, or deducted therefrom, in terms of section 24I (2) if it complies with the basic requirements of that section. Such inclusion or deduction must be effected taking into account the phasing- in provisions, as incorporated in section 24I (3).
Section 24I of the Act came into effect from the beginning of the rst year of assessment ending on or after 1 January 1994. Therefore, if the taxpayer’s year of assessment ends on 28 February 1994, the date of commencement would be 1 March 1993.
Transitional exchange differences are determined in respect of all exchange items which existed on the last day of the year of assessment which ended prior to the commencement of section 24I, except for loans, advances or debts contemplated in paragraph (b) of the de nition of ‘exchange item’, which are of a capital nature. The capital nature of these exchange items should be determined according to the ordinary rules relating to capital versus income.
An example of a loan in respect of which a transitional exchange difference need not be determined, is a long-term loan from a South African holding company (which loan is not oating or circulating capital in the hands of the lender) to its foreign subsidiary, where such loan forms part of the xed investment in such subsidiary by such holding company.
In order to determine a transitional exchange difference, the provisions of section 24I are deemed to apply on the transaction date of the relevant exchange item and on the last day of the year of assessment (date of translation) which ends immediately prior to the commencement of section 24I. The transitional exchange difference is calculated by multiplying the difference between the ruling exchange rate on those two dates, by the foreign currency amount of the exchange item. The transitional exchange difference so determined must, however, be adjusted to ensure that all the
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