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Petra Vaněčková | Alice Šrámková | March 8, 2023

Taxation or non-taxation of fair value or the application of hedge accounting in the current situation of rising interest rates and a strengthening Czech koruna rate

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Exchange difference and hedge accounting

In the course of the year 2022, there was a significant increase in interest rates and a simultaneous appreciation of the koruna against the euro.  This situation has its not insignificant impact on the profit and loss and subsequently on the corporate income tax base.  If the accounting entity has significant foreign currency liabilities, the appreciation of the koruna gives rise to exchange rate gains as of the date of the financial statements, which increase the tax base through higher pre-tax profit.  It was already ruled years ago that exchange rate differences from the conversion of receivables and payables in foreign currencies as of the date of the financial statements also enter the tax base.  However, for some entities this situation may be resolvable through hedge accounting.  Its use requires hedging documentation that demonstrates that the hedge is effective and that subsequently enables the entity to recognise those exchange differences not in profit or loss but in equity through valuation differences.

Rate swaps and currency forwards

A similar situation arises in the case of interest rate swaps.  A number of entities have entered into interest rate swaps to hedge interest rate risk, which change a variable interest rate to a fixed one.  According to the accounting regulations, such a derivative must be measured at fair value at the date of the financial statements and recognised either in the income statement or in equity through valuation differences.  In previous years, due to the administrative complexity of hedge accounting, entities often reported these derivatives as non-hedging through the income statement.  At the end of 2022, however, these interest rate swaps generally have a significant positive fair value, which, similarly to the appreciation of the koruna exchange rate, leads to an increase in both profit or loss and the tax base.  The application of hedge accounting may also be a solution in this case. Similarly, this can be applied to currency forwards.

If you think the above situation applies to you, please contact us.

Author: Alice Šrámková, Petra Vaněčková