The Supreme Administrative Court (hereinafter referred as „SAC“) published a breaking decision in the matter of unrealized exchange rate gains on its website. In its judgment file no. 5 Afs 45/2011 – 94 as of 19^th April 2012 the SAC ruled that although the unrealized exchange rate gains are included into the economic result according to the accounting methods, from the income tax point of view, they do not constitute a taxable income according to the Income Tax Act No. 586/1992 Coll. (hereinafter referred to as „Income Tax Act“).

Background of the case solved

A tax subject received long-term foreign currency credits related to the build-up of a real estate project in the Czech Republic and therefore it bore an exchange rate risk which was not secured. When closing the books and compiling the final accounts, the tax subject performed the conversion of these EUR credits into Czech crowns (using valid exchange rate as of the balancing day). Then it posted the incurred difference from the conversion (exchange rate profit) in favour of the economic result.

Question

There was a question whether the exchange rate gains which incurred from the conversion of long-term liabilities in foreign currency into Czech crowns as per the balancing day on P/L report accounts, may represent a real income of the tax subject which shall be taxed under the income tax act.

Relevant conclusions

SAC stated in the above judgment that at the moment of the mere change of the foreign exchange rate and its recording in the bookkeeping, when an unrealized exchange rate profit is booked (the so-called revaluation of foreign currency liabilities), such a fact does not constitute a taxable income. According to SAC the unrealized exchange rate gains, apart from the realized ones, are only a fictive income incurred for accounting purposes and it does not generate a real increase of assets based on the management of assets (Sec.18 Para. 1 of the Czech Income Tax Act). SAC considers as a profit (real income): „ A gain can only be constituted by such an appreciation of the Czech crown in relation to a foreign currency that is accompanied by a physical cash flow, but that is only apparent as at the date of the  transaction (i.e. upon a repayment that requires fewer Czech crowns).”

Open issues

This judgment contradicted the current application procedures and left many questions open. First of all, there is a question how this judgment will be perceived from the standpoint of the interpretation of the income tax act in other cases. For example, if it does not concern only a decision in this specific case which, due to its uniqueness, does not have a character of an established judgment of the Supreme Administration Court. In the light of the argumentation of the judgment for instance a question, whether the logic of the judgment should not be applied also to other similar gains posted in the P/L accounts, exists, moreover if the exchange rate losses could be, under certain conditions, tax non-deductible expenditures, whether the accounting is a complete information resource for purpose of the stipulation of taxable income of the company before adjustments stated in Sec. 23 of the Czech Income Tax Act.

The General Financial Directorate (hereinafter referred to as „GFD“) has not issued an information in this matter for a public yet. According to the unofficial information, the GFD perceives the above stated judgment only as a decision on the specific case which, due to its uniqueness, does not have a character of an established judgment of the Supreme Administration Court. For this reason the GFD does not plan to apply this in the tax proceedings and they plan to apply the currently established application procedures concerning the taxation of exchange rate differences. This currently unofficial opinion of GFD can bring a certain support to the tax payers who do not want to change anything in the current practice.

On the other hand a judgment according to which the unrealized exchange rate profits are not a taxable income exists and there can be tax payers to whom such interpretation can suit, for example development companies.

Should you be interested in this issue, we are at your disposal for eventual consultations. We will be pleased to review your specific situation, whether it concerns the period for which the tax return has not been submitted yet, or past periods.

We will notify you of the further progress in this matter.