The question of whether unrealised foreign exchange gains arising from financial instruments are taxable under Ghana’s tax laws has engendered debate among consultants, practitioners, officers of the Ghana Revenue Authority (GRA), and the general public for some time now. This has become topical following the promulgation of the Income Tax (Amendment) Act, 2023, Act 1094.
In the Income Tax Act, 2015, Act 896 (as amended) (the ‘’ITA’’), the Parliament of Ghana defines key concepts including ‘financial instrument’, when financial cost is incurred, and when financial gain is derived.[i] A realised foreign exchange gain occurs when, among others, a financial instrument is sold or disposed of, resulting in a profit. The gain is considered ‘’realised’’ because it has been converted into cash or an equivalent asset. On the other hand, an unrealised foreign exchange gain occurs when, among others, there is an increase in the value of a financial instrument that has not yet been sold or disposed of. It represents a paper profit because it has not yet been officially realised as cash or its equivalent.[ii] Unrealised foreign exchange gains fluctuate in value based on market conditions.
To better illustrate when an unrealised foreign exchange gain occurs, let us consider the case of an interest rate swap. In simple terms, a swap is a derivative instrument in which two parties agree to exchange cashflows or assets based on predetermined terms. Swaps are primarily used to hedge risks and involve underlying assets such as interest rates, currencies, etc.
For example, at the start of a swap agreement, Party X agrees to pay a fixed interest rate of 35% annually to Party Y, while Party Y agrees to pay a variable interest rate tied to a benchmark rate such as the Bank of Ghana Monetary Policy Rate (MPR) (say, at an initial benchmark rate of 30%). If the benchmark rate drops to 27% after a period of time, Party Y, which pays the variable rate, will benefit from the lower interest rate environment due to the decline in the interest it will be paying to Party X.
This situation creates an unrealised gain for Party Y. The gain is unrealised because the swap agreement is in force, and Party Y has not yet exited the swap or realised the gain through termination or settlement of the contract.
This article focuses on the potential lacuna concerning the taxation of unrealised foreign exchange gains for taxpayers.
Key Tax Provisions with respect to Foreign Exchange Gains under the ITA
The question of whether an unrealised foreign exchange gain is taxable depends on whether it meets the relevant provisions provided under the ITA. Before I proceed to discuss the taxability or otherwise of an unrealised foreign exchange gain, it is crucial to point out that Section 25 of the ITA, which talks about foreign currency and financial instruments, does not stand alone. The section starts with the wording ‘’this section applies where under the rules in Division II or IV of Part II…’’.
Part II of the ITA presents what constitutes income of a person and what should be deductible for tax purposes. Division II focuses on ‘’Assessable Income’’ while Division IV touches on ‘’Deductions’’. The combined effect of Sections 5(2)(a)(iii) and 6(2)(a)(ii) of the ITA (both of which fall under Division II, as indicated above) is that a taxpayer who has not made a gain from the realisation of a capital or investment asset cannot be said to have earned income from business or investment. Section 38 of the ITA further lists circumstances that result in the realisation of a capital asset.
I refer to the case of Kassar v. Comptroller of Customs and Excise [1963] 1 GLR 109-122 which discusses the appropriate canon of interpretation expresio unius est exclusio alterius. This principle means that the express mention of one implies the intended exclusion of another in a pair or group not so mentioned. Section 25 of Act 1094 provides in unambiguous terms that unrealised foreign exchange losses are to be disallowed as deductions for the purposes of determining the assessable income of a taxpayer.[iii] The question that lingers on in the minds of tax consultants is why the same unambiguous language was not used in the case of unrealised gains?
Now, let us turn to some of the reasonings advanced by proponents who argue for the inclusion of unrealised gains as part of the assessable income of a taxpayer.
Firstly, it is argued that a close reading of section 5(2)(a)(vii) of the ITA seems to suggest that an amount derived by a taxpayer that would have otherwise been included in calculating investment income of that taxpayer is classified as business income.
However, it is worth noting that section 5(2)(a)(vii) should be read in the context of section 6(2)(a)(ii). A strict interpretation of this latter section implies that the income from investment referred to therein does not cover ‘’unrealised’’ matters within the context of realising an investment asset.
In the case of Perseus Mining (GH) Ltd v. The Commissioner-General, Suit No. H1/137/2022 (Unreported), the Court of Appeal at pp 27 stated that ‘’… forward sales contract price, therefore, is the price of selling gold by using forward sales contracts which is a derivative financial instrument recognized and accepted under S. 131(1)(a)(ii) of the Income Tax Act, 2015 (Act 896) …’’
The Court of Appeal further stated that ‘’… On the other hand, if at the time of delivery the spot price has shot up, the difference is treated as profit for purposes of tax assessment. In other words, the profit is added to his business income and assessed to be taxed.’’
From the foregoing, it appears that the decision of the Court of Appeal, although limited to whether or not a loss from a derivative instrument is deductible from business income, casts doubts on the position that gains from a derivative, unless realised, may not be deemed taxable.
Recommendation
It is my opinion that, to the extent that Parliament of Ghana in its wisdom stated clearly and in unambiguous terms that unrealised foreign exchange losses are not tax deductible, similar amendments ought to be passed for unrealised foreign exchange gains. This is important because:
(i) It has the potential to cause revenue loss for the government – especially, where taxpayers consider this as non-taxable income amid the uncertainty surrounding it.
(ii) It will relieve taxpayers of the burden of paying interest years later where the revenue authority (and the courts) hold that the gains were taxable after all.
The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.
Derick Kwasi Boamah is the author of this article. Derick is an Assistant Manager, Global Compliance & Reporting, with Ernst & Young, Ghana. He may be contacted at [email protected]. The article was reviewed by Kofi A. Akuoko (Senior Manager) and Isaac Nketiah Sarpong (Tax Partner) of Ernst & Young, Ghana. Kofi and Isaac may be contacted at [email protected] and [email protected] respectively.
[i] Section 131(3)(a) of the ITA provides that ‘’… a person derives a financial gain when the person derives interest from a financial instrument’’.
[ii] Section 38(1)(a) of the ITA provides that ‘’… a person who owns an asset realises the asset if that person parts with the ownership of that asset, including when that asset is sold, exchanged, transferred, distributed, redeemed, destroyed, lost, expired or surrendered’’.
[iii] Section 25(6) of the ITA provides that ‘’an unrealised foreign exchange loss shall not be allowed as a deduction’’.
