Ghana’s Unrealized Exchange Loss Deduction Law: A Tax on Reality or a Hindrance to International Business?

Introduction: A Law That Penalizes Businesses for Currency Volatility

In an economy where currency depreciation and rising business costs are already major challenges, government’s decision to disallow unrealized exchange losses for tax purposes, following the 2023 amendment to Section 25 of the Income Tax Act, introduces additional burden for businesses. With the Ghana cedi continually losing value against major currencies, companies engaged in cross-border trade are already facing significant difficulties. Now, this tax law further complicates their financial outlook by disregarding certain exchange rate losses—losses that represent real economic challenges.

We’re all familiar with the broader economic struggles, but the real issue here is how this tax law deepens those challenges. This article delves into why the disallowance of unrealized exchange losses is not just a misguided tax policy, but also one that ignores essential accounting principles and the core tenets of the Income Tax Act (ITA), particularly the accrual concept and residual deduction rule. More importantly, we’ll explore how this policy further burdens businesses and why it’s time for a serious rethink.

Unpacking the Law: What Was Permitted Before and What Changed?

It’s been over a year since the April 2023 ITA amendment kicked in, and let’s just say—it hasn’t been a smooth ride for businesses. Before the change, companies could deduct both realized and unrealized exchange losses, even before settling a transaction, as long as they adhered to the finance cost limitation in Section 16 of the ITA. It made sense—fluctuations in exchange rates are a real economic hit, and businesses could recognize those losses when they occurred.

But now? Everything’s changed. The new amendment forces businesses to ignore exchange losses until they’re “realized”—that is, until the underlying transaction is settled. While this might seem like a minor technical tweak, in practice, it’s a whole different story. Companies are sitting on substantial exchange losses that are being disallowed for deduction, effectively inflating their tax bills.

And here’s the kicker: while the law disallows the deduction of unrealized exchange losses, you would expect a similar provision for equal treatment of unrealized exchange gains—yet the amendment remains conspicuously silent on this point. Was this omission a mere oversight, or was it deliberately left out? The lack of clarity has left consultants confused and divided in their interpretations, while businesses grapple with the fallout of yet another layer of uncertainty. While this is yet another unresolved issue with the amendment, it’s not the focus of this article. For now, we’ll zero in on the tax implications of unrealized exchange losses—the real burden businesses are carrying under the current law.

The Crux of the Problem: When Transactions Straddle Multiple Reporting Years

The real problem with this tax law emerges when foreign currency transactions straddle multiple financial periods. Consider this: If a business makes an international purchase in year 1 but settles the payment in year 2, the exchange losses incurred during the first year become “unrecognized” for tax deduction per the current law. Yet, by the time the transaction is finally settled in the second year, only a portion of the total loss becomes deductible. Why should a legitimate business expense be partly ignored simply because it hasn’t yet materialized in cash?

Let’s break this down with a simple example.

A Numerical Example to Illustrate the Issue

Suppose a business purchases goods from a foreign supplier for $100,000. At the time of purchase, the exchange rate is GHS 10 to $1, meaning the payable is GHS 1 million. By year-end, the Ghanaian cedi has depreciated further to GHS 12 to $1. This creates an unrealized exchange loss of GHS 200,000, as the liability on the company’s books now stands at GHS 1.2 million.

Under the current law, the business cannot deduct this GHS 200,000 loss for tax purposes because the transaction has not yet been settled. The following year, when the exchange rate hits GHS 15 to $1 and the company finally settles the debt, they incur another loss, bringing the total payable to GHS 1,500,000.

In Year 2, the business can deduct a realized exchange loss of GHS 300,000. However, this fails to account for the fact that the business had already incurred GHS 200,000 of the total GHS 500,000 exchange loss in Year 1. The first year’s loss is effectively disregarded, even though it was a real, measurable cost of doing business.

So, why should the law penalize businesses by failing to recognize part of their total exchange loss? Are businesses expected to simply eat the costs of currency depreciation until they settle their accounts?

Adding to this, IAS 21 - The Effects of Changes in Foreign Exchange Rates reinforces the accounting treatment. According to the standard, "When the transaction is settled in a subsequent accounting period, the exchange difference recognized in each period up to the date of settlement is determined by the change in exchange rates during each period." Thus, exchange gains and losses should be progressively recognized, reflecting the real economic changes over time.

The Government’s Perspective: A Flawed Justification?

From the government’s point of view, this law may have been introduced as part of broader efforts to generate higher tax revenues. With the Ghana Cedi depreciating steeply between 2022 and 2023, businesses were recording substantial exchange losses, which significantly reduced their taxable income. In response, the government, facing slower growth in tax revenues, likely saw the disallowance of unrealized exchange losses as a way to boost immediate tax collection.

This speculation about revenue generation is not far-fetched when viewed in the context of other recent tax measures. We have seen the introduction of minimum chargeable income for loss-making businesses, withholding taxes on lottery winnings, tax on gross gaming revenue for lottery operations, and even higher personal income tax bands—all policies seemingly designed to squeeze more from those already in the tax net. The disallowance of unrealized exchange losses seems to be another revenue-generating tool rather than a nuanced response to business behavior. By focusing solely on immediate revenue gains, the government may have overlooked the long-term fairness of this approach.

The government’s rationale seems to be that if the currency stabilizes or even strengthens in future years, those unrealized losses that have been allowed as deductions might never materialize, creating an unfair tax advantage for businesses. The reasoning might go something like this:

"Okay, so you made a loss on paper this year because the cedi depreciated against the dollar, driving up the cost of goods you purchased on credit. But what happens if the exchange rate returns to normal next year? That loss you got a deduction for never really materializes, giving you an unfair tax advantage."

At first glance, this might seem plausible. It is true that in some cases, the unrealized loss may never fully materialize if the exchange rate stabilizes. However, what this reasoning misses is the broader picture.

Why This Reasoning Only Tells Half the Story

The fear that unrealized losses might simply "disappear" in future years, giving businesses an unfair tax advantage is not entirely accurate. Let’s say that in the above example, the Ghanaian cedi returns to GHS 10 to $1 again in Year 3, and the company’s unsettled liability returns to GHS 1,000,000. In that case, the business would indeed record an unrealized gain of GHS 500,000 (same as the total exchange loss from past 2 years), which would be taxable.

In other words, any appreciation in the currency would automatically correct the earlier loss, resulting in a gain that the government could tax. Effectively, there are no tax advantages from the currency movements. There is no scenario where a business can deduct an unrealized exchange loss without recognizing the corresponding gain later, should the currency recover. This is simply how accounting works.

By disallowing unrealized losses, the government is simply forcing businesses to ignore the very real costs they incur in volatile currency environments. This approach contradicts the basic residual deduction rule from Section 9 and also the accrual concept from Sections 19 and 21 of the ITA, which requires businesses to recognize expenses and income as they are incurred, not just when cash changes hands.

A Flawed Law That Hurts Business Confidence

Ultimately, the disallowance of unrealized exchange losses is an unfair tax burden on businesses that operate internationally, particularly those with Ghanaian functional currencies. This law penalizes them for currency depreciation—a factor entirely outside their control. Worse still, it undermines sound accounting principles, forcing businesses to pretend that their actual costs don’t exist until they settle their accounts.

In a country where the currency is weakening year after year, businesses are already struggling to stay competitive in the international market. This law does nothing to help; instead, it heaps yet another burden on them, with no reasonable justification.

Conclusion: It is Time to Reconsider the Law

Tax policy should reflect the economic realities businesses face, not distort them. The disallowance of unrealized exchange losses does just that, forcing companies to navigate a tax landscape that ignores real costs.

As someone working in tax consultancy, I’ve seen firsthand how this law burdens businesses with hefty tax bills that seem more punitive than fair. While I may have indulged in a lengthy analysis, the severity of the issue demands it. If Ghana wants to foster international trade and business growth, it must revisit this law and align it with principles of fairness and consistency in taxation.

Ignoring the problem won't make it go away, and we can only hope the government recognizes this and acts before businesses are pushed further to the brink—both financially and operationally.