CFM64430 | Accounts drawn up in a foreign currency: rates used for translation: change in tax calculation currency: example of carried back losses

Example of carried back losses

A company has a US Dollar functional currency in the year ended 31 December 2018 and made a taxable trading profit of $50m.

In the year ended 31 December 2019 the company changes its functional currency to Euros and makes a loss of Euros75m. The company elects to carry back the 2019 loss against the 2018 profit.

During both accounting periods, the company’s results relate to numerous transactions and it is considered that the ‘appropriate exchange rate’ should be the average exchange rate for the accounting period. Relevant exchange rates are:

£/$: average rate: y/e 31 December 2018 - 1:1.5

$/€: spot rate on 31 December 2018 - 1:1.25

The first step is to translate the Euro losses that are to be carried back into Dollar losses. This will be at the spot rate on the last day of the last accounting period during which the Dollar was the functional currency; i.e. 31 December 2018 - 1:1.25.

The next step is to translate the Euro losses into sterling losses at the same rate of exchange as the profits that are being offset are translated into sterling. As the exchange rate of the profits and losses will be the same, this will mean that up to $50m of losses could be offset (for the purposes of this example, assume that the company wants to offset the full amount of the $50m profit).

The maximum amount of loss that can be carried back is the Euro equivalent of $50m. Using the 1:1.25 $/€ spot rate on 31 December 2018, this equates to €62.5m. Consequently, €62.5m are carried back thus offsetting the $50m profit in that year.

This leaves €12.5m of losses to be carried forward, effectively in Euros, for offset against future trading profits in accounting periods after 31 December 2019. These will not be translated into sterling until they are offset against future profits.