Foreign currency advances during the financial year

13 June 2022

Michal Daňsa, Partner, Head of Business Services Outsourcing |
Lukáš Toman, Manager |

We have been following the topic of foreign currency advances for you for a long time. Most recently, in April, we highlighted a recent position of the Supreme Administrative Court that has a major impact. The court ruled that of the two approaches being applied, the one used by a minimum of companies is the correct one. In the following lines, we therefore give you an overview of what to look out for in your company during the year. My colleague Jiří Pospíšil follows this article with an analysis of the reporting of advances as of the balance sheet date.

The essence of the two different interpretations of the treatment of foreign currency advances lies in determining when and how exchange rate risk arises and how that risk is accounted for. The usual practice is to book the advance made (and, of course, similarly for advances received) at the current exchange rate and then, on receipt of the invoice, to deduct the advance paid again at the current invoice rate. This often results in an exchange rate expense or income from the difference between the exchange rate used when the advance was made and the exchange rate used when the invoice was settled. However, the Court has currently confirmed the interpretation that there is (with some exceptions) no exchange rate risk associated with the advance paid. Thus, the advance is to be dealt with at the original exchange rate, meaning there is no longer any exchange rate expense or income on account of the settlement of the foreign currency advance.

This interpretation is particularly relevant to the acquisition of assets and inventories but is also generally valid in other areas, such as the acquisition of services or the purchase of energy. The interpretation is also mirrored for advances received. For example, an advance on fixed assets is to be understood as part of the purchase price. Thus, the cost of the asset consists of the advances (valued at the exchange rate at the date of the advances) and the additional payment (valued at the exchange rate at the date of receipt of the invoice).

From the above, it is therefore evident that the issue is far from being limited to that discussed in detail in the article „Foreign currency advances as of the balance sheet date“, but the issue has significant implications for day-to-day operational activities. We therefore recommend that you analyse the extent to which your company is affected by foreign currency advances and the risks associated with them. In particular, we draw attention to the increased risks for recipients of investment incentives. We will be happy to assist you with an analysis of the current situation and subsequent solutions.

It is recommended that an analysis of relevance and potential impacts be carried out as soon as possible. In terms of timing, there is no "transitional provision", no "cooling-off period" or the like. The court has merely interpreted the law, the wording of which has long been the same in this area. Among other things, this means that the tax administration can "go back in time" in its audit procedures and use this issue for tax audits of previous years. Fortunately, in view of the statements of the tax administration and our current experience, there are no indications of this so far. From a practical point of view, we recommend using 2022 for a possible change in accounting methods so that the final balances of foreign currency advances are already reported in full accordance with current case law. We would be happy to discuss any changes in methodology with you.

Early action is also recommended in terms of technical solutions within the accounting software. It is very likely that your company is using software that cannot effectively handle this new interpretation of valuation and settlement of foreign currency advances automatically. We would be happy to help you contact your software provider to request a software modification that will allow the application of appropriate automated accounting procedures.

In the following articles we will also deal with the issue of foreign currency advances from the perspective of value added tax.