Abstract

This article considers the tax rules in relation to the deferral of unrealised foreign exchange gains and losses (referred to in tax terms as ‘exchange differences’) in respect of foreign loans between related parties and whether the deferral rules can be extended to include parties to the loan agreement other than the debtor and creditor. The rules applicable to foreign exchange gains and losses are dealt with in section 24I of the Income Tax Act, 1962 (‘the Act’). This provision subjects realised gains or losses to income tax, but defers the tax treatment of exchange differences on certain loans and debts to subsequent years in which the underlying asset is brought into use.
Unrealised foreign exchange gains and losses (referred to as ‘exchange differences’) in respect of foreign currency loans (loans in foreign currency constitute ‘exchange items’) between related parties are deferred until the settlement or realised date of the loan, meaning that these gains and losses are not reflected in taxable income while the loan is not settled.
The deferral rules applicable to a ‘group of companies’ and ‘connected persons’ are found in section 24I(10A)(a) of the Act. The rules are comprehensive, but the particular issue for consideration in this article is the meaning of the words in the following extract:
‘… [N]o exchange difference arising during any year of assessment in respect of an exchange item … shall be included in or deducted from the income of a person in terms of this section—
(i) if, at the end of that year of assessment—
(aa) that person and the other party to the contractual provisions of that exchange item—
(A) form part of the same group of companies; or
(B) are connected persons in relation to each other …’ (my emphasis).
The key question considered in this article is whether a guarantor to a loan agreement or any other party for that matter, being a party to a loan agreement, brings the agreement within the ambit of section 24I(10A)(a)(i)(aa), where such party or parties are either a ‘connected person’ in relation to the borrower or part of the same ‘group of companies. The hypothesis here is that these entities are party to the contractual provisions of the exchange item, namely the loan. The crisp issue is whether ‘the other party’ referred to in section 24I(10A)(a)(i)(aa) is intended to apply narrowly to a typical lender-borrower relationship or whether it should apply broadly to any party to the contractual provisions of an exchange item.
The article considers principles of statutory interpretation applicable to the definitive article ‘the’ in respect of ‘the other party’. It is submitted that the legislature could have used phrases such as ‘a party’, ‘any party’ or ‘another party’ but instead deliberately chose the phrase ‘the other party’. The article concludes that the provisions must have been intended to apply to an arrangement between the borrower and lender in the context of a loan arrangement and not any other party to the contractual provisions of the loan arrangement.
Accordingly, it is submitted that the deferral of unrealised gains and losses in respect of a foreign loan or debt between parties within a ‘group of companies’, or who are ‘connected persons’, is restricted to the debtor and creditor in relation to the loan agreement and does not extend to other persons (such as a guarantor) that may be party to such an agreement.