Functional Currency: A New Approach in Czech Accounting
The possibility of keeping accounts and paying taxes in a foreign currency has been discussed for some time. According to the original plans, it was to be introduced in the new Accounting Act, which won’t, however, come into effect until 1 January 2025 at the earliest. Rather surprisingly, however, the concept of a “functional currency” has already appeared in a draft amendment to the current Accounting Act, which is due to come into force on 1 January 2024 as part of the final draft of the consolidation package.
The basic idea of the functional currency concept is based on International Financial Reporting Standards (IFRS) defining a functional currency as the currency of the primary economic environment in which an accounting entity operates and conducts most of its business and financial transactions. While the definition of the accounting currency is based on IFRS, the proposal does not define the “primary economic environment”, e.g. what percentage of the volume of transactions should be in foreign currency. As companies will have to demonstrate the use of a functional currency, the criteria must be clearly defined.
Voluntarily, but only under certain conditions
The Ministry of Finance plans to limit the possibility of using a functional currency for Czech companies to the three main global currencies: EUR, USD and GBP. The use of other currencies is not yet planned. Companies that conduct the majority of their transactions in one of these currencies will have the option to keep their accounts in that currency from 1 January 2024. This will be a voluntary decision (unlike IFRS, where the use of a functional currency is mandatory), but companies will have to demonstrate that the currency primarily affects their business, making it a “functional currency”. The Czech crown will then become a foreign currency for these companies. This change may have a significant impact on the amount and structure of profit or loss as a result of the effect of foreign currency exchange rates.
The government proposal implies that for accounting purposes the exchange rate announced by the central bank competent for the accounting currency, e.g. the European Central Bank for euros or the FED (not the CNB) for dollars, will be used and may differ from the exchange rate used for value added tax purposes.
Measure twice, cut once
It will only be possible to change the accounting currency on the first day of the fiscal year. However, a change from the functional currency to CZK will only be possible if the chosen accounting currency ceases to be a functional currency as defined above. So if you are thinking about using a functional currency, think carefully, because a future reversion will not be so easy (it cannot happen merely by company decision).
Paying taxes in a foreign currency? Perhaps some …
While the government also intends to allow the payment of taxes in foreign currency, this will probably only apply to income taxes, not VAT and other taxes or social and health insurance payments. Therefore, in these cases, or when converting all receivables and payables into Czech currency, exchange rate differences will arise.
Uncertainties remain
Many accounting programs are currently unprepared for the fact that the accounting currency may not be CZK. As the legislative process is far from complete, accounting software developers will be forced to respond very quickly. It also remains unclear how data comparability will be maintained during the transition. Transitional provisions have not yet been discussed in detail. Similarly, the currency companies using a functional currency will report in, for example, to the Czech Statistical Office, has not been decided.
Please take all the above information as a guide. We will continue to monitor the situation closely for you and inform you of the final form of this major change in Czech accounting as soon as possible.
