Policy paper

Corporation Tax: the disregard and bringing into account of profit and losses on derivative contracts hedging acquisitions and disposals of shares (Regulations 2022)

Published 9 March 2022

Who is likely to be affected

Companies who use derivative contracts to hedge foreign exchange risks relating to acquisitions or disposals of substantial shareholdings.

General description of the measure

Currently, companies that have an investment in shares can use a derivative contract (hedging instrument) to hedge the foreign exchange risk of that investment. Any exchange gains or losses on the hedging instrument are initially disregarded for tax purposes.

This matches the tax treatment of the gains and losses from the instrument, which are otherwise usually treated as income items, to the capital treatment of shares. Further rules may then bring the exchange gains or losses on the hedging instrument back into account for tax when the company later disposes of the shares.

Derivative contracts, such as deal contingent forwards, which are used to hedge foreign currency risks on the acquisition and disposal (as opposed to the holding) of large shareholdings do not fall within the existing disregard and bringing into account rules. To address this, new regulations will be laid to bring derivative contracts used in these scenarios within the existing rules.

Policy objective

The measure was identified as part of the consultation on the UK funds regime to consider reforms which hold the potential to enhance the UK’s competitiveness as a location for asset management and for investment funds.

Profit and losses on derivatives used to hedge foreign currency risks on acquisition and disposals of shareholdings are taken into account as income items during the lifetime of the instrument. This gives rise to a mismatch with the tax treatment of the shares, which may not be taxed or relieved until the shares are ultimately disposed of, or may be covered by an exemption. This means the hedges are not effective in removing foreign exchange volatilities, because tax liabilities are still exposed to exchange rate fluctuations. This is a source of uncertainty for business.

This measure seeks to remove this mismatch for all companies and not just asset management companies or investment funds.

Background to the measure

At Budget 2020, the government announced that it would carry out a review of the UK funds regime, covering tax and relevant areas of regulation. The review started with a consultation on the tax treatment of asset holding companies (AHCs) in alternative fund structures, also published at Budget 2020.

The government responded to that consultation in December 2020, launching a second stage consultation on detailed design features of a new regime for AHCs. The government’s response to that consultation was published on 20 July 2021.

In that response, the government committed to exploring the possibility of introducing legislation on hedging instruments used to hedge foreign currency risk on acquisition and disposals of substantial shareholdings. This measure introduces the required changes.

Detailed proposal

Operative date

This measure will have effect for companies entering into derivative contracts from 1 April 2022.

Current law

Current law is contained within secondary legislation. The Loan Relationship and Derivative Contracts (Disregard and Bringing into Account of Profits and Losses) Regulations S.I. 2004/3256 (the ‘Disregard Regulations’) were introduced in 2004 and allow companies to match the tax treatment of the fair value movements in the derivative contract to the hedged item. If the rules apply, exchange gains or losses are disregarded.

The Exchange Gains and Losses (Bringing into Account Gains or Losses) Regulations 2002 S.I. 2002/1970 (‘EGLBAGL Regulations’) may bring back into account exchange gain or losses arising on derivatives used to hedge foreign currency risks when there is a disposal of the asset. However, capital gains and losses of share disposals are often exempt due to the substantial shareholdings exemption at Schedule 7AC to the Taxation of Chargeable Gains Act (TCGA) 1992.

The new regime for qualifying asset holding companies also contains an exemption from capital gains and losses for most share disposals at paragraph 53 of schedule 2 of Finance Act 2022.

Proposed revisions

Secondary legislation will introduce a new regulation 5ZA to extend the Disregard Regulations so that they cover scenarios where companies use a derivative contract to hedge foreign exchange risk on the:

  • acquisition cost of shares, together with any incidental costs of acquisition
  • proceeds from the disposal of shares, or any relevant dividend paid as part of the disposal, or
  • subscription of shares or entering into a creditor loan relationship with another company for the purpose of funding, directly or indirectly, an acquisition of shares

The new regulation will:

  • include all derivative contracts within scope and allow for exchange gains and losses to be disregarded; for deal contingent forwards and options all profits and losses from the hedging instrument will be disregarded
  • only apply where the item being hedged is in connection with the acquisition or disposal of a shareholding that constitutes a substantial shareholding following paragraph 8 of Schedule 7AC to TCGA 1992; or is a holding of qualifying shares where the company is a qualifying asset holding company under Schedule 2 Finance Act 2022

The statutory instrument will also include amendments to the EGLBAGL Regulations to bring previously disregarded amounts back into account in cases where there is a chargeable gain or loss brought into account on the disposal of shares. In most cases, no amounts will be brought back into account where the derivative hedges a relevant dividend or a creditor loan relationship in respect of an anticipated transaction.

Summary of impacts

Exchequer impact (£million)

2021 to 2022 2022 to 2023 2023 to 2024 2024 to 2025 2025 to 2026 2026 to 2027

The Office for Budget Responsibility will include the impact of this measure in its forecast at Spring Forecast 2022.

Economic impact

This measure is not expected to have any significant economic impacts.

Impact on individuals, households and families

There is no impact on individuals as this measure only affects companies. The measure is not expected to impact on family formation, stability or breakdown.

Equalities impacts

It is not anticipated that there will be impacts for those in groups sharing protected characteristics.

Impact on business including civil society organisations

The measure benefits business by removing tax volatilities from exchange gains and losses associated with these transactions.

This measure is expected to have a negligible impact on the costs for the estimated 100 large companies a year which enter these transactions. One off costs will include familiarisation with the changes and updating software to account for the change in tax treatment. There are expected to be no continuing costs.

Customer experience is expected to remain broadly the same because the administration to comply with these changes is not expected to be burdensome.

This measure is not expected to impact civil society organisations.

Operational impact (£million) (HMRC or other)

This change will result in no operational impacts for HMRC.

Other impacts

Other impacts have been considered and none have been identified.

Monitoring and evaluation

The measure will be kept under review through communications with affected stakeholders.

Further advice

If you have any questions about this change, please contact Financial Products Team email: financialproductsbai@hmrc.gov.uk.

Declaration

The Right Honourable Lucy Frazer QC MP, Financial Secretary to the Treasury has read this tax information and impact note and is satisfied that, given the available evidence, it represents a reasonable view of the likely costs, benefits and impacts of the measure.