Corporation Tax: Disregard Regulations for derivative contracts
Find out if companies need to elect in to the Disregard Regulations for hedging of derivative contracts.
As a result of changes to accounting standards, most companies will in the future be required to apply fair value accounting for derivative contracts. They will therefore need to consider whether to elect in to regulations 7, 8 or 9 of the Disregard Regulations.
This is particularly relevant for companies which previously applied Old Generally Accepted Accounting Principles (GAAP) excluding Financial Reporting Standard (FRS) 26.
In many cases the deadline for making an election is 6 months from the start of the first relevant accounting period.
The Disregard Regulations only apply for the purposes of Corporation Tax. They do not apply to individuals (and other entities) within the charge to Income Tax.
The accounting standards used to prepare financial statements changed on 1 January 2015 and many companies will need to apply one of the following:
- EU-endorsed International Financial Reporting Standards (IFRS)
- FRS 101
- FRS 102
In addition, from 1 January 2016 the Financial Reporting Standard for Small Entities (FRSSE) is being withdrawn. As a result many small companies will also be applying the requirements of section 1A of FRS 102 from 2016.
See the guidance on accounting standards: the UK tax implications of new UK GAAP for details of the key accounting changes and tax considerations.
Hedging: Corporation Tax treatment
There are essentially 2 options governing how hedging relationships are treated for Corporation Tax.
Following amounts in profit or loss
The default option is an approach which simply follows the amounts recognised through profit or loss in most cases.
Computational provisions to restore Old UK GAAP
The alternative option is to apply the detailed computational provisions laid out in regulations 7, 8 and 9 of the Disregard Regulations (SI 2004/3256). These largely operate to restore the treatment that would have arisen under Old UK GAAP (where FRS 26 does not apply).
For periods of account starting on or after 1 January 2015, companies must elect in to regulations 7, 8 and 9 rather than the previous elect out approach. Companies which applied fair value accounting in earlier periods will continue with the same treatment without having to make new elections.
There are strict time limits for the election, which must be made by the later of:
- 6 months from the start of the accounting period where fair value accounting first applies
- 6 months from the first relevant contract being entered into
- 12 months from the end of the accounting period for non-large companies - a company is large if it is a qualifying company for the Senior Accounting Officer rules, see schedule 45 FA 2009
When a company might elect in to regulations 7, 8 and 9
Companies affected by the changes to accounting standards need to consider whether to make an election under the Disregard Regulations. They should take advice on this as appropriate, as they would normally when preparing their Corporation Tax computations.
An election can specify which of regulations 7, 8 and 9 apply to the company’s derivative contracts. Where this is not specified, the election will apply all 3 regulations.
Below is some general guidance for companies that have not previously had to consider the impact of the Disregard Regulations. This does not constitute advice on the approach a company should take - which will depend on its own particular circumstances. The Disregard Regulations contain anti-avoidance rules to prevent manipulation of the rules in this area.
Designated hedging relationship
A company may adopt an approach where it designates hedging relationships for accounting purposes and not to elect in to regulations 7, 8 and 9 of the Disregard Regulations. Generally in this case, the tax treatment will simply follow the amounts recognised in profit or loss. Amounts taken to a cash flow hedging reserve are disregarded under regulation 9A. This approach may be appropriate for companies which use hedge accounting and have effective hedges.
Under this approach the company will typically be taxed on any fair value movements recognised in profit or loss, for example relating to any undesignated hedges or any hedge ineffectiveness recognised in the profit or loss account. This approach therefore may not be appropriate where the company is not able to, or chooses not to, designate hedging relationships for accounting purposes, or where its hedging relationships have a significant amount of hedge ineffectiveness.
Elect in to regulations 7, 8 and 9 of the Disregard Regulations
Alternatively a company may decide to elect in to regulations 7, 8 and 9. These regulations override the accounts and broadly operate to restore the Old UK GAAP treatment (where FRS 26 does not apply). Adjustments will be needed in the company’s Corporation Tax computation. The effect in most cases will be to remove fair value volatility where the derivative is part of a hedging relationship. This approach may be appropriate for companies which cannot use, or do not wish to use, hedge accounting or for companies where there is significant hedge ineffectiveness.
No designated hedges and no election made
More unusually, some companies may adopt an approach of neither designating hedging relationships nor making an election in to regulations 7, 8 and 9. In this case, the tax treatment will follow the amounts recognised in profit or loss, which is likely to mean the company will be subject to tax on fair value volatility in the accounts.
For an overview of how hedging works see the Corporation Tax: derivative contracts, hedging and Disregard Regulations guidance.
There are also Corporation Tax: hedging arrangement examples which explain Corporation Tax treatment for common hedging arrangements.
You can find more detailed information on derivative contracts, hedge accounting and the application of the Disregard Regulations in the Corporate Finance Manual. This manual has been updated to reflect the changes to accounting practice.
There are also overview papers on FRS 101 and FRS 102 which highlight the key tax considerations that arise for companies that transition from Old UK GAAP to the new standards.