Jak vyjmout nerealizované kurzové rozdíly ze základu daně

How to exclude unrealised exchange rate differences from the tax base

Exchange rate differences are generally part of the income tax base, both realised and unrealised.

In 2014, in response to the decisions of the Supreme Administrative Court, the wording of Section 23(1) of the Income Tax Act was amended, which now explicitly referred to accounting expenses and income for determining the tax base of accounting units. Following this modification and the relevant explanatory memorandum, the General Financial Directorate[1] issued an Information in which it confirmed that the tax base in relation to accounting also includes unrealised exchange rate differences.

Unrealised exchange rate differences result from the obligation of the accounting entity to revalue  assets and liabilities expressed in foreign currency into Czech currency at of the balance sheet date (at the Czech National Bank rate). As this is only an accounting operation, the entity is in effect making a hypothetical gain or loss, which - often significantly - affects its tax liability.

What tools does the entity have now to ensure that its tax base is not affected by unrealised exchange rate differences?

In addition to the existing tool of hedge accounting, two new tools have been added to the "consolidation package" since 2024: the option to use a "functional currency" in the accounting and the option to exclude unrealised exchange differences from the tax base in the period in which they are booked.

Functional currency

The transition to a functional currency is relatively complicated and can only be made by entities that meet the relevant criteria (in particular, they carry out the majority of their transactions in that foreign currency).

This topic has been covered in our previous alerts HERE and HERE. When booking in the functional currency, a substantial part of transactions (i.e. those in the functional currency) will not give rise to exchange rate differences. However, the willingness of accounting units to take advantage of the option of switching to the functional currency seems to be weakened in practice so far, in particular by the costs and practical problems associated with the adaptation of accounting software, the need to keep all records in CZK  for VAT purposes and also by the fact that a possible return to accounting in CZK is only possible if the functional currency ceases to be the functional currency.

Choice of the 'exchange rate exclusion regime’

Unlike the functional currency, the exclusion regime for unrealised exchange differences is a purely tax concept. In our view, it is particularly suitable for taxpayers who have long-term foreign currency assets or liabilities. 

Unlike the introduction of functional currency or hedge accounting, this scheme is relatively flexible. In this case, it is only necessary to submit a notice of entry into this regime to the tax authorities within 3 months of the beginning of the tax period for which the first tax return under this regime will be filed (e.g. for the tax return for calendar year 2024 this is by the end of March 2024).

Exiting the scheme is a bit more complicated - generally, the scheme will not end until the end of the tax year following the tax year in which the taxpayer notifies the tax authority of the withdrawal from the scheme.

This means that the shortest period of the scheme is two years - if a taxpayer notifies that they are entering the scheme by the end of March 2024, and immediately notifies that they are exiting the scheme in April 2024, then this regime will be effective applicable on the tax returns for 2024 and 2025.  

For the sake of completeness, we would like to add that the taxpayer will still file a tax return for the year 2026 in the exchange rate exclusion regime, however, in accordance with the provisions of Section 23i(5) of the Income Taxes Act  the taxpayer, will adjust the accounting  result in this tax return by the exchange rate differences not included in the tax base in the periods in which the taxpayer was a taxpayer in the exchange rate exclusion regime. Although the taxpayer will still be in the exchange difference exclusion regime in 2026, the unrealised exchange differences will again be part of the tax base in the 2026 tax return (both for 2026 and for previous years).

Maintenance of hedge accounting

If an entity maintains hedge accounting and the hedge is effective, then the revaluation of the relevant hedging item is charged to equity instead of affecting profit or loss through unrealised exchange rate differences. Profit or loss is then affected only by exchange differences relating to the realised hedged item.

If an entity elects this option, it shall have the hedging relationship properly documented and shall periodically review the hedging relationship over its term and be able to demonstrate that it is sufficiently effective.

Generally, hedge accounting can be discontinued only if the hedge is terminated or the hedge does not meet the conditions set out in the accounting rules (e.g. it is not sufficiently effective).

The above summary suggests that the relatively most flexible option for avoiding taxation of unrealised foreign exchange gains and losses is a pure tax treatment of the exclusion of unrealised foreign exchange differences. 

In conclusion, we would like to add that the above brief commentary cannot substitute for a detailed tax assessment of a particular situation. We would be happy to assist you in evaluating which option might be the most suitable one for your company.

If you have any questions, please contact the authors of this article or the EY tax team with whom you regularly work.

Authors:
Ladislava Zamazalová

Zuzana Mikulová

[1] https://www.financnisprava.cz/assets/cs/prilohy/d-seznam-dani/Kurzove_rozdily_2013.pdf