Strong US dollar? Time to rethink your tax plan

Naturally, human beings are creatures of habits and routines. Over the past few months, I have steadily been tracking the exchange rate trend of the United States of America dollar (USD or dollar) against the Tanzania Shilling and one thing has stood out. The dollar has been appreciating rapidly against our local currency.

Such a scenario is also observed in several African countries. Though several factors are prompting such a scenario, a major cause has been attributed to the US government’s adoption of contractionary monetary policies i.e., an upward revision of interest rate by the Federal Reserve with the sole aim of addressing the rising inflationary pressures.

Although in November 2023 the US Federal Reserve announced holding the interest rate steady as inflationary pressure eases, the dollar has continued to appreciate against our local currency. For instance, in January 2024 the dollar was traded at Sh2,517 as opposed to a year ago when the same currency was being traded at Sh2,320.

As tax is never a single-dimensional creature, events either politically or economically related transpiring across the globe will likely prompt a certain parity with taxation prospects. Thus, a certain wave of events may necessitate a revision of the construed tax plan. This begs a question in the context of what aspects of the tax plan need to be revisited amidst the persisting dollar saga.

The most pertinent group in the context of revising the previously construed tax plan amidst the persisting dollar saga might be local entities whose business dealings are heavily denominated in dollars i.e., mining entities.

The said entities may need to revisit their tax plans specifically on balance sheet items i.e., account payables and receivables, and transfer of assets/liabilities whose sale contract is denominated in dollars.

As the dollar appreciates, the equivalent local currency value of balance sheet items rises meaning a potential rise in the tax burden on such entities.

For instance, a rise in equivalent local currency value of dollar-denominated loans might mean an increase in interest expense outlay thus a potential rise in the tax burden in terms of withholding tax (WHT) obligations while on the other end interest receipts denominated in dollars will mean a potential rise in the tax burden in terms of corporate income tax (CIT).

Thus, such entities may contemplate revising their tax plan to the tune that a persisting dollar saga may not potentially increase their tax burden through the adoption of a string of measures including but not limited to agreeing on a fixed rate to be used to account for balance sheet items.

Resident persons having an ownership stake in foreign entities may consider revisiting their tax plan specifically on currency to be used in presenting financial gain i.e., deemed distribution arising from membership interest in such foreign entities.

The wisdom behind such contemplated revision stems from the fact that resident persons are taxed on their worldwide income according to the provisions of the income tax law.

This gives rise to the concept of Controlled Foreign Corporation (CFC) in the context of foreign entities in which resident persons hold an ownership stake. Taxation of such CFCs’ is through deemed distribution based on the CFCs' unallocated income.

Such deemed distribution needs to be included in the computation of taxable income of resident persons for a specific tax period. Usually, CFCs present their financials in dollars meaning the respective deemed distribution for purposes of taxing the resident persons holding an ownership stake in such CFCs’ need to be converted to local currency.

With the dollar gaining a strong momentum against our local currency, it might be pertinent for resident persons having an ownership stake in foreign entities to revisit their tax plan specifically on currency to be used for presenting the CFCs’ financials for the respective tax period.

For resident persons with a huge chunk of engagement with foreign suppliers, it might be pertinent to revisit their tax plan specifically on tax expense for the respective year of income and documentary evidence relating to the foreign exchange losses.

Considering the existing scenario, such persons are likely to have significant unrealized foreign exchange losses which might potentially mean an increase in the tax expense for the year of income, and in case of such losses being realized a plethora of documentary evidence might be required by the taxman to ascertain such realization.

Thus, such persons may revisit their tax plan to the extent of ensuring the tax expense accurately captures the potential impact of unrealized foreign losses and prepare the documentary evidence that might be required to ascertain the realization of such losses.

On the other side, resident persons with a slew of foreign receipts should revisit their tax plan to the extent that the persisting dollar saga doesn’t give rise to a surge in income tax payable as there is a potential possibility of a rise in the value of equivalent local currency receipts hence a potential rise in the taxable income

In a nutshell, it is time for taxpayers to do a deep dive into their business undertakings and discern all potential taxation aspects that may be impacted by the persisting dollar saga in terms of a potential surge in interest expense for taxpayers with foreign loans denominated in dollars, paying tax on foreign exchange gain rather than capital gain in terms of transfer of assets whose sale contract is denominated in dollars and a potential cash loss concerning withholding tax expense on services procured from foreign suppliers.

Thereafter, a critical review of the construed tax plan should be instituted with the sole aim of maximizing tax savings for the specific tax period. It might be pertinent to involve tax specialists in the review of such tax plan to ensure all technical aspects are being considered.

Benedict Kombaha is a Tax Manager with KPMG in Tanzania ([email protected]). The views and opinions are those of the author and do not necessarily represent the views and opinions of KPMG