Forex gains and losses a no brainer?

Hi all – given that this is my first blog on transferpricing.co.za, a short introduction may be apt. More importantly, given that this is my first blog EVER, please bear with me as I make the transition from formal writing to being BLOGGY. As far as intro’s go, I am a Partner at Grant Thornton in South Africa, heading up the Transfer Pricing practice. I have been consulting on tax matters since 2001, having spent the last 11 years at Grant Thornton and the earlier years at KPMG and EY. Prior to embarking on my tax consulting career, I spent 7 years “on the other side” working in cost and financial accounting and reporting environments the manufacturing and the financial services sectors. More to the topic, I have been involved in TP for 10 years and for so many reasons, love every minute of it…even when people think that a one-pager will suffice as a TP report or policy.

So the first discussion I wanted to put out on this blog is the treatment of foreign exchange gains and losses for TP purposes. Given the volatility of the South African Rand against other major trading currencies, it is highly likely that any company that has significant cross border related party transactions and balances will also have material realised and unrealised foreign exchange gains and losses. While this has an effect on the reported profitability of a company, it poses further challenges for us mere mortal TP practitioners. One of these challenges is that when searching for comparable companies as part of a benchmarking study it is often obvious that comparable companies to our test party which are based in other countries do not always experience the same degree of currency volatility and therefore foreign exchange gains and losses. This is particularly evident in companies that are based in the Euro zone and whose trade is mainly in that currency zone.

So in order to stick to comparability principles, foreign exchange adjustments are considered and permitted in terms of the OECD Guidelines. This is however a double-edged sword as it is important to appreciate that if adjustments are made to the tested party’s results, you should arguably do this consistently going forward – you cannot do the adjustment only when it suits you. In practice, you may find that in year one, there are large foreign exchange losses and through making adjustments to ensure comparability, you are still able to place a tested party into an arm’s length and hey presto, everyone is happy. In year two, the test party company may have large foreign exchange gains which contribute to a reported overall profit. However, you may find that once the foreign exchange gains are adjusted for, that your tested party is not looking that pretty anymore. At this stage, you may be inclined to not want to make the foreign exchange adjustment. Generally speaking, you should be consistent with your previous treatment and this may leave you in a difficult position.

You may want to have your cake and eat it, but remember about that double edged sword that will slice the cake! Have a good weekend and chat soon.

What are your thoughts?

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