Clarifies the Treatment of Foreign Currency Transactions for Financial Reporting and Internal Revenue Tax Purposes

June 28, 2023 REVENUE MEMORANDUM CIRCULAR NO. 12-2024 SUBJECT : Clarifies the Treatment of Foreign Currency Transactions for Financial Reporting and Internal Revenue Tax Purposes TO : All Internal Revenue Officials, Employees, and Others Concerned This Circular is hereby issued to clarify the differences between the foreign exchange (forex) gains/losses recognized in the financial statements prepared under the Philippine Financial Reporting Standards (PFRS)/Philippine Accounting Standards (PAS) and the forex gains/losses as income or allowable deduction for income tax purposes pursuant to the provisions under Sections 32 and 34 (D) of the National Internal Revenue Code (NIRC) of 1997, as amended, Sec. 96 of Revenue Regulations (RR) No. 02-40, RR No. 06-2006, and other related revenue issuances. SDAaTC This is also issued to clarify and prescribe the guidelines on the use of appropriate forex rates in recording and reporting foreign currency transactions for tax purposes. For purposes of this Circular, the Philippine Peso (PhP) is considered as the functional currency and other currencies are considered as foreign currency. This Circular does not cover Banks and other Financial Institutions and those using functional currency other than Philippine Peso in the financial statements. I. DEFINITION OF TERMS The following terminologies as defined below shall only be applicable to the references made to such terms under this Circular. Foreign Currency is a currency other than the functional currency of the reporting entity ( e.g. , currency other than PhP). Functional Currency is the currency of the primary economic environment in which the reporting entity operates; that is the currency of the environment in which an entity primarily generates and expends cash. Foreign Currency Transactions are transactions denominated in any currency other than functional currency for a particular entity. Foreign Exchange Rate is the price of a unit of foreign currency in terms of the domestic currency. For example, the exchange rate is conventionally expressed as the value of one United States Dollar (USD) in PhP equivalent ( e.g. , US$1 = P50.00). Forex Spot Rate is the current exchange rate at which a currency can be bought or sold. Interbank Reference Rate is the exchange rate that banks pay when they engage in currency trades with other banks. AaCTcI Closing Rate is the final price at which a currency is traded at the end of the forex trading day. Foreign Currency Conversion is the conversion of one currency into another at a specific rate known as the foreign exchange rate. Foreign Currency Translation is an accounting method of restatement, in the currency in which a company presents its financial statements, of all assets, liabilities, revenues and expenses that are denominated in foreign currencies. Remeasurement is the process of re-establishing the value of an asset or foreign currency to provide a more accurate financial record of its value on a company's financial statements. Remeasurement is often used by companies that conduct business in multiple currencies. Other Comprehensive Income (OCI) this includes revenues, expenses, gains and losses that are yet to be realized for accounting purposes and are excluded from net income ( e.g. , foreign currency translation gains or loss, unrealized gain or loss on investment that are available for sale, etc.) Closed and Completed Transaction is a taxable event that has been consummated as fixed by identifiable events occurring in a particular year ( e.g. , actual sale or disposition of asset, etc.). II. TABULAR LIST OF DIFFERENCES PARTICULARS PFRS Current Tax Treatment 1. Initial measurement of foreign currency transactions All foreign currency transactions are recorded in the entity's functional currency using the spot rate of exchange at transaction date. Foreign currency transactions are translated into Philippine Peso using the prevailing interbank reference rate on the date of transaction. 1 This is the basis of the reportable transactions for taxes other than income tax ( e.g. , VAT, GRT, OPT, Excise, DST, etc.) 2. Unrealized gain or loss on remeasurement of monetary assets and liabilities denominated in foreign currency Recognized in profit or loss. Results to a temporary difference for which deferred tax accounting should be applied to reconcile accounting net income to taxable net income. 3. Unrealized gain or loss on remeasurement of non-monetary items carried at fair value currency transaction Recognized in profit or loss or OCI depending on the treatment of the changes in the fair value of the item itself. Not considered in the determination of the taxable income. 4. Realized gain or loss on settlement of a foreign currency transaction Recognized in profit or loss. Forex gains/losses arising from closed and completed transactions are considered as taxable income or deductible expense for income tax purposes. 2 III. PFRS TREATMENT PAS 21 requires an entity to determine its functional currency taking into account the primary economic environment in which an entity operates. Once the entity has determined its functional currency, all other currencies are treated as foreign currencies. acEHCD Initial Measurement A foreign currency transaction is recorded initially using the rate of exchange on the date of the transaction. The use of average rate is permitted as long as they are a reasonable approximation of the actual. (PAS 21.21-22) Subsequent Measurement At each reporting date (PAS 21.23): Foreign currency monetary amounts are reported using the closing rate. Any unrealized gain or loss arising from the translation of monetary assets and liabilities the end of the reporting period is generally recognized in profit or loss. Non-monetary items carried at historical costs are measured using the historical exchange rate at the date of the transaction. This means that they are not remeasured reporting date. Non-monetary items that are carried at fair value are translated using the exchange rates at the date the fair value is measured. Any unrealized gain or loss arising from the translation is recognized in the same way the change in fair value is recognized in the financial statements. For example, when the change in the fair value of a non-monetary item is recognized in OCI, then unrealized gain or loss arising from the translation shall also be recognized in OCI. Settlement When monetary items are settled, the difference between the carrying amount of the monetary asset or liability and the consideration received/paid is recognized immediately in profit or loss. IV. CLARIFICATION ON ISSUES INCLUDING GUIDELINES RELATIVE TO THE TAX TREATMENT OF FOREIGN CURRENCY TRANSACTIONS Q1: For tax reporting purposes, how are foreign currency denominated transactions measured? A1: Foreign currency transactions shall be converted into functional currency using the exchange rate at the time an asset, liability, income and expense are recognized and measured/remeasured ( i.e. , the date of transaction, reporting date, settlement date). EcTCAD Q2: In relation to Q&A No. 1, what is the exchange rate to be used at initial recognition of foreign currency denominated transactions? A2: The spot rate on the date of transaction shall be used. Since the forex spot rates change from time to time within a particular day depending on the market trading activities, different forex spot rates are being published every trading day ( e.g. , open, close, high, low, weighted average, etc.) as a reference rate to be adopted for proper valuation reflecting the true income of foreign currency denominated transactions. Then, for purposes of this Circular, the taxpayer has the preference to adopt which spot rate to be used ( e.g. , open, close, high, low, weighted average, etc.) in the beginning of the taxable year as long as the spot rates adopted must be used consistently both in recording for financial accounting purposes and reporting for tax purposes for at least one taxable year. Q3: What exchange rate shall be used in converting foreign currency denominated transactions incurred on dates where there are no published forex rates available ( e.g. , weekends, holidays, etc.)? A3: Use the latest closing spot rate available on the business date immediately preceding the date of transaction. For example, Company A sold goods at $100 on November 30, 2022. No available forex data available on the said date since it falls on a holiday. The most recent closing spot rate available is that of November 29, 2022. Company A should convert its foreign currency transaction of $100 using the closing spot rate on November 29, 2022. Q4: What should be the source of forex rates to be used in converting foreign currency denominated transactions for tax purposes? A4: To standardize the forex rates to be used for tax purposes, the following rules are hereby prescribed to govern the conversion of foreign currency denominated transactions to Philippine Peso: a. The spot rate of exchange on the day of the transaction based on the Banker's Association of the Philippines (BAP) 3 published rates; 4 or b. In the event that the forex rate as stated in item (a) is impractical or not feasible, the spot rate on the day of the transaction based on other available exchange rates ( e.g. , Bangko Sentral ng Pilipinas (BSP), Bloomberg, Reuters exchange rates, etc.) shall be used subject to the following conditions: SDHTEC 1. A taxpayer electing to use forex rates other than BAP published rates must submit to the Revenue District Office (RDO) or Large Taxpayer District Office (LTDO) or Large Taxpayers Service (LTS) whichever has jurisdiction over the taxpayer, a notarized sworn statement stating the source of the forex rates to be used, the reason for using such forex rates other than BAP published rates and a statement allowing the BIR to have an access on the day-to-day forex rates used during BIR audit ( e.g. , access to subscription with Bloomberg, etc.) for the taxable year, within 30 days prior to the start of the taxable year. 2. The source of forex rates used in converting foreign currency denominated transactions, such as the URL/source where the forex rates are published or listed or a summary of the day-to-day exchange rates used for the taxable year must be available for presentation and submission, together with other supporting documents during BIR audit. Election of forex rates are irrevocable and must be used consistently both in recording for financial accounting purposes and reporting for tax purposes for at least one taxable year. The notarized sworn statement informing the concerned BIR offices of electing the use of forex rates other than BAP published rates shall be submitted. In case of subsequent change in forex rates used, a new notice shall be submitted to the concerned BIR office, which shall be applied from the start of the succeeding taxable year. Q5: How many decimal places on forex rates should be used when converting foreign currency denominated transactions? A5: Use the actual forex rates as published or listed based on the reference exchange rates opted in Q&A No. 4. In case the taxpayer's accounting system is not capable of adopting the exact number of decimal places as of those in the forex published rates, the taxpayer may use the maximum number of decimal places as designed in their respective system subject to written notification to the BIR office whichever has jurisdiction over the taxpayer for the system limitation. HSAcaE Q6: In relation to Q&A No. 4, what should be the source of forex rates to be used if the foreign currency transaction involved is denominated in a currency other than USD? A6: Given that BAP publishes USD/PhP spot rates only, taxpayers with foreign currency transactions other than USD are allowed to directly convert the foreign currency other than USD to PHP using the forex rates other than BAP published rates as stated in Q&A (4) (b) above following the conditions enumerated. Q7: What if the taxpayer incurred a foreign currency denominated transaction other than USD in the middle of the taxable year but initially elected to use BAP published rates? A7: The taxpayer is allowed to use the BSP spot rates for foreign currency transaction other than USD subject to the following conditions: a. The taxpayer shall summarize its foreign currency transactions other than USD with the following information: 1. Date of transaction 2. Amount of foreign currency transactions other than USD 3. Nature of transaction 4. Forex rate used in converting to PhP; and 5. PhP converted amount of the foreign currency transaction b. The requirement on item (a) must be available for presentation and submission, together with the supporting documents on the said foreign currency transactions during BIR audit. Q8: What if the taxpayer used forex rates other than BAP published rates but failed to notify the BIR as required under Q&A No. 4 (b) (1)? A8: The taxpayer will still be required to prove the reliability of exchange rate used during a tax audit. Moreover, corresponding administrative penalties under Section 255 of the Tax Code, as amended, would be imposed for first and second offenses. Subsequent offenses shall be considered as willful failure, and thus not subject to compromise. In the absence of any proof, the forex rates other than BAP published rates used by the taxpayer shall be disregarded during BIR audit. In case of foreign currency transactions denominated in USD, the same shall be converted using the BAP published rates, whereas for foreign currency transactions denominated in a currency other than USD, the BSP rates shall be used. Q9: Is the conversion prescribed under RMC 26-1985 for currencies other than the USD mandating to convert first the foreign currencies to USD using the prevailing exchange rate between the two currencies, now superseded? A9: Yes. With the availability of wide range of forex between foreign currencies other than USD to PhP, the practice of converting first to USD the foreign currency other than the USD is now superseded by Q&A No. 4 (b) and Q&A No. 6 of this Circular. AScHCD Q10: Is the use of monthly average exchange rates permitted in converting foreign currency transactions to Philippine peso for tax purposes? A10: No. Foreign currency transactions are converted into Philippine peso for tax purposes using the spot rate of exchange on the date of transaction. Q11: What is a foreign exchange difference? A11: A forex difference ( i.e. , gains/losses) results when there is a change in the exchange rate between the transaction date, balance sheet date and the date of settlement of any monetary items arising from a foreign currency transaction. Unrealized forex gains/losses results from fluctuations in exchange rates upon remeasurement between the transaction date and the balance sheet date. It is only a potential gain/loss where there is no real flow of wealth yet generated from the remeasurement for accounting purposes. Realized forex gains/losses results from changes in the exchange rates between the transaction date and the date of settlement. This represents the actual gains/losses incurred from a closed and completed foreign currency transactions. Q12: Are gains/losses arising from forex fluctuations on remeasurements of monetary and non-monetary assets and liabilities denominated in foreign currency included in the determination of the taxable income for income tax purposes? A12: The "Realization" principle adopted under RR No. 02-40 5 provides that for purposes of taxation, only the realized gain or loss from foreign exchange transaction will be subject to income tax. Under this principle, income is recognized when: (i) the earning process is complete or virtually complete, and (ii) an exchange has taken place. Unrealized gains or losses on forex fluctuations recognized in connection with the periodic remeasurement of assets and liabilities denominated in foreign currency to functional current are not considered as income/loss for purposes of computing taxable income. Such differences are temporary and should be monitored for which deferred tax accounting should be applied. These temporary differences will reverse when the respective assets and liabilities are disposed of or settled. These temporary differences which give rise to deferred tax assets/liabilities are required to be disclosed in the Notes of Audited Financial Statements (AFS). Q13: Are taxpayers required to separately record and report unrealized and realized forex gains/losses for income tax purposes? A13: The taxpayers should separately record and report unrealized forex gains/losses from the realized forex gains/losses arising from foreign currency transactions. HESIcT Only realized forex gains/losses, or those arising from closed and completed transactions, are considered as taxable income or deductible expense for income tax purposes. Realized forex gains/losses shall be substantiated with sufficient evidence that the same arose from a closed and completed transaction ( e.g. , schedule of foreign currency transactions resulting to forex gains/losses with reference to the bank statements on actual collection of receivables and payment of payables, etc.). Moreover, automatic reversal of unrealized forex differences to realized forex gains/losses in the succeeding year not arising from closed and completed transactions are strictly prohibited for income tax purposes. Q14: What are examples of events that will give rise to an actual gain or loss reportable for tax purposes? A14: Difference in foreign exchange rates will give rise to actual gain/loss when certain events occur, 6 such as, but not limited to the following: Exchange rate at the time of receipt of advance payments on contracts is different from the rate at the time income is earned and debited against advance payments; Exchange rate at the time of recording/recognizing accounts receivables is different from the rate at the time of actual collection of the account receivables; Exchange rate at the time advance payments are made to subcontractors is different from the rate at the time expenses on the sub-contract are incurred/recorded; Exchange rate at the time of recording/recognizing accounts payables is different from the rate at the time accounts payables are paid; Exchange rate at the time down payments for construction materials are made is different from the rate at the time of full-payment/settlement of the balance on the purchase price of the materials. Q15: Is netting or offsetting of forex gains and losses allowed for income tax purposes? A15: The practice of offsetting transactions of taxpayers and consequently the accounting and recording of the same and its related transactions in the books of the parties is strictly prohibited for taxation purposes. 7 AcICHD The gross amounts of gain and loss must be presented in the income tax return. However, for tax calculation purposes, forex loss is still allowed as a deduction following the rules on income tax deductibility. Q16: Where will forex gains and losses be presented in the income tax returns? A16: Forex gains shall be presented as part of "Other Taxable Income" and be included in the computation of "Total Taxable Income" or "Gross Taxable Income" in the income tax return. On the other hand, forex losses shall be presented as part of the "Ordinary Allowable Itemized Deductions" in the income tax return. Q17: What will be the basis for the reportable amount of transactions denominated in foreign currency for taxes other than the income tax ( e.g. , Value-Added Tax (VAT), Gross Receipt Tax (GRT), Other Percentage Taxes (OPT), Excise Tax, Documentary Stamp Tax (DST), etc.)? A17: Foreign currency transactions are converted into Philippine Peso using the prevailing spot rate on the date of transaction. This is the basis of the reportable transactions for taxes other than income tax ( e.g. , VAT, GRT, OPT, Excise, DST, etc.). For VAT purposes, the reportable amount for sale of goods or properties shall be the gross selling price or the gross value in money as supported by a corresponding sales invoice; while for sale or exchange of services, including the use or lease of property, it shall be the gross receipts as supported by a corresponding official receipt. For GRT and OPT, the reportable amount shall be the gross quarterly sales or receipts depending on the type of transaction subject to the said taxes. For Excise, the reportable amount shall be the excise taxes imposed and based on weight or volume capacity or any other physical unit of measurement (specific tax) and imposed and based on selling price or other specified value of the goods (ad valorem tax) generally before the removal/release of the excisable products. For DST, the reportable amount shall be based on the value of the documents subject to stamp tax. For withholding taxes, in general, the reportable amount shall be the value of the taxable income payment at the time it is paid or payable or when it is accrued or recorded as an expense or asset whichever comes first. Illustrations and Accounting Entries are reflected in the Annex "A" hereof, as guide for recording and reporting foreign currency transactions. caITAC All revenue issuances and BIR rulings inconsistent herewith are hereby considered amended, modified or revoked accordingly. Interpretations in BIR rulings and court rulings cited in this Circular can be subject to change under prevailing circumstances of latest court decisions and new laws enacted affecting the subject matter. All internal revenue officers, employees and others concerned are hereby enjoined to strictly implement the provision of this Circular. This Circular takes effect immediately. (SGD.) ROMEO D. LUMAGUI, JR. Commissioner of Internal Revenue ANNEX A Illustration and Accounting Entries For clarification and to guide the concerned taxpayers in recording and reporting foreign currency transactions, hereunder are illustrations involving foreign currency denominated transactions together with the corresponding accounting entries. ILLUSTRATION NO. 1 Company A is a VAT-registered domestic entity engaged in the export sale of goods. Company B is a non-resident foreign corporation (NRFC) which is a regular customer of Company A. On December 1, 2022, Company A sold goods to B worth $1,000,000.00 and issued the corresponding zero-rated sales invoice for the same amount. On January 10, 2023, Company B remitted $1,000,000.00 to Company A for which the latter issued the corresponding collection receipt. On the same day, Company A's bank credited the corresponding collection of $1,000,000.00 into its Peso account using the prevailing spot rate of exchange. Below are the forex rates on the following dates: Measurement Date Date Forex Rate Initial Measurement December 1, 2022 US$1.00 : PhP50.00 Subsequent Measurement December 31, 2022 US$1.00 : Php51.00 Settlement Date January 10, 2023 US$1.00 : Php50.50 Based on the foregoing, A should have the following entries in its books: A. To record the sale of goods of Company A to Company B on December 1, 2022 Particulars Debit Credit Accounts Receivable ($1,000,000 x P50) P50,000,000.00 Sales P50,000,000.00 B. To record the subsequent measurement on balance sheet date on December 31, 2022 TAIaHE Particulars Debit Credit Accounts Receivable ($1,000,000 x P1) P1,000,000.00 Unrealized Forex Gain P1,000,000.00 C. To record the deferred tax entry on the temporary difference on forex (assuming corporate income tax rate of 25%) for year 2022 Particulars Debit Credit Income Tax Expense Deferred P250,000.00 Deferred Tax Liability (P1,000,000 x 25%) P250,000.00 D. To record income tax payable for Year 2022. Assuming, Company A has a corresponding Cost of Sales amounting to P30,000,000.00 and operating expenses of P5,000,000.00, gross of unrealized forex loss. Net Taxable Income for the year is P15,000,000.00. Particulars Debit Credit Income Tax Expense (P15,000,000 x 25%) P3,750,000.00 Income Tax Expense Deferred P250,000.00 Income Tax Payable P3,750,000.00 Deferred Tax Liability (P1,000,000 x 25%) P250,000.00 For income tax purposes, income tax payable is P3,750,000.00. E. To record the collection of payment on the sale of goods (year 2023) Particulars Debit Credit Cash ($1,000,000 x P50.50) P50,500,000.00 Realized Forex Loss (1,000,000 x P0.50) P500,000.00 Accounts Receivable P51,000,000.00 F. To record the realization of unrealized forex gain upon collection (year 2023) Particulars Debit Credit Deferred Tax Liability (P1,000,000 x 25%) P250,000.00 Income Tax Expense Deferred P250,000.00 G. To record income tax payable for Year 2023 Particulars Debit Credit Deferred Tax Liability (P1,000,000 x 25%) P250,000.00 Income Tax Expense Current (P500,000 x 25%) P125,000.00 Income Tax Expense Deferred P250,000.00 Income Tax Payable P125,000.00 For income tax purposes, income tax payable is P125,000.00. ICHDca ILLUSTRATION NO. 2 Company C is a VAT-registered domestic entity engaged in manufacturing of electronic parts. Company D is a NRFC engaged in supplying machine and equipment used in manufacturing electronic parts. On November 15, 2022, Company C purchased a capital equipment worth $2,000,000.00, of which $500,000.00 was paid as downpayment, from D which the latter issued the corresponding invoice and receipt. On February 6, 2023, the imported equipment arrived in the Philippines for which C paid the corresponding taxes in the customs. On the same day, Company C paid D the outstanding balance of $1,500,000.00 on the purchase of the said equipment. Below are the forex rates on the following dates: Measurement Date Date Forex Rate Initial Measurement November 15, 2022 US$1.00 : PhP49.50 Subsequent Measurement December 31, 2022 US$1.00 : Php51.00 Settlement Date February 06, 2023 US$1.00 : Php51.25 Based on the foregoing, C should have the following entries in its books: A. To record the purchase of imported equipment by Company C to Company D on November 15, 2022. Assuming, it is the practice of Company C to record its equipment based on the date of the invoice. Particulars Debit Credit Equipment ($2,000,000 x P49.50) P99,000,000.00 Cash ($500,000 x P49.50) P24,750,000.00 Accounts Payable ($1,500,000.00 x P49.50) P74,250,000.00 B. To record the subsequent measurement on balance sheet date on December 31, 2022 Particulars Debit Credit Unrealized Forex Loss P2,250,000.00 Accounts Payable ($1,500,000.00 x P1.50) P2,250,000.00 C. To record the deferred tax entry on the temporary difference on forex (assuming corporate income tax rate of 25%) for year 2022 cDHAES Particulars Debit Credit Deferred Tax Asset (P2,250,000 x 25%) P562,500.00 Income Tax Benefit Deferred P562,500.00 D. To record income tax payable for Year 2022. Assuming, Company C has a net income from operations amounting to P60,000,000.00, gross of unrealized forex loss. Particulars Debit Credit Income Tax Expense (P60,000,000 x 25%) P15,000,000.00 Deferred Tax Asset (P2,250,000 x 25%) P562,500.00 Income Tax Benefit Deferred P562,500.00 Income Tax Payable P15,000,000.00 For income tax purposes, income tax payable is P15,000,000.00. E. To record the payment of taxes on customs and the payment of outstanding balance on the purchase of equipment. Assuming the other taxes is P200,000.00 (year 2023) Particulars Debit Credit Accounts Payable P76,500,000.00 Realized Forex Loss ($1,500,000 x P0.25) P375,000.00 Input VAT (99,000,000 x 12%) P11,880,000.00 Other Taxes (Customs Duties, etc.) P200,000.00 Cash P88,955,000.00 F. To record the realization of unrealized forex loss upon payment (year 2023) Particulars Debit Credit Income Tax Benefit Deferred P562,500.00 Deferred Tax Asset (P2,250,000 x 25%) P562,500.00 G. To record income tax payable for Year 2023. Assuming, Company C has gross income of P5,000,000.00 during the year. TCAScE Particulars Debit Credit Income Tax Expense Current P543,750.00 Income Tax Benefit Deferred P562,500.00 Deferred Tax Asset (P2,250,000 x 25%) P562,500.00 Income Tax Payable P543,750.00 Income Tax Expense Current = [P5,000,000 (GI) P375,000 (2023 Realized Forex Loss) P200,000 (Other Taxes P2,250,000 (2022 Forex Loss Realized in 2023)] x 25% For income tax purposes, income tax payable is P543,750.00. Footnotes 1. Revenue Memorandum Circular (RMC) No. 26-85, dated duly 15, 1985. 2. RR No. 2 Income Tax Regulations. 3. The Philippine Dealing System (PDS) rates used as interbank reference rate per RR No. 06-2006 already ceased publishing the FX spot summary rates pursuant to BAP advisory dated March 16, 2018. 4. www.bap.org.ph/markets/ 5. RR No. 2 Income Tax Regulations. 6. BIR Ruling [DA-359-03], dated October 10, 2003. 7. Revenue Memorandum Circular No. 61-2016 Prescribing Policies and Guidelines for Accounting and Recording Transactions Involving "Netting" or "Offsetting."