CFM33210 - Loan relationships: the matters and computational rules: credits and debits: amounts not brought into account: revaluation

CTA09/S324

Restrictions on debits resulting from revaluation S324 sets certain restrictions on when a debit may be brought into account in respect of the revaluation of an asset that represents a creditor relationship. But, there are significant exclusions.

Exclusions

The section does not apply:

  • Where {fair value accounting CFM33130} is used. In this context, this means for tax purposes, so if a company draws up its financial statements under GAAP applying fair value accounting, but is required to apply an amortised cost basis for tax, S324 is in point.
  • To debits arising from exchange differences.

Effect

Where S324 is in point, it provides that a debit is only taken into account in relation to revaluation of the asset representing the creditor relationship where this arises from:

  • an impairment loss (CFM33220), or
  • a release by the company of all or part of the debt.

This means that, for instance, under accounting standards previously in force, companies would not get relief for a general bad debt provision, or for writing down a debt to the lower of cost or market value, even if such a debit features in the company’s accounts. This applies both to loan relationships and to relevant non-lending relationships that are treated as loan relationships by CTA09/PT6/CH2.

Note, however that under more recent accounting standards, for instance under IAS or FRS102, an impairment loss may be computed in respect of a class of assets and S324 does not prevent a deduction, because it is made in respect of an impairment loss and in accordance with GAAP. See {CFM33220}.

If an amount is disallowed for tax purposes, because it is

  • a revaluation of a debt that is not an impairment loss, or
  • a general bad debt provision that was, in a period of account beginning before 1 January 2005, not permitted under ICTA88/S74 (1)(j), or
  • a revaluation of a debt that was, in a period of account beginning before 1 January 2005, disallowed by the rule in FA96/S85(2)(c) denying debits where an accruals basis allowed for revaluation (other than for exchange gains and losses or authorised bad debt arrangements);

a credit arising from reversal of the amount will not be taxable - CTA09/S325.

Fair value hedge adjustment: example

A company holds a debt security (a creditor loan relationship) that pays interest at a fixed rate. In order to hedge the risk that the securities might fall in value, as a result of an increase in prevailing interest rates, it enters into an interest rate swap (pay fixed rate, receive floating rate), effectively converting the interest receivable from a fixed to floating rate. It designates a fair value hedge of interest rate risk, with the bonds as the hedged item and the swap as the hedging instrument.

The effect of using hedge accounting is that the carrying value is adjusted by an amount that is equal and opposite to changes in the fair value of the bonds, in so far as that arises from interest rate changes. Amounts arising from the fair value of the swap and the change in carrying value of the debt securities are taken to the income statement. (They should be equal and opposite, except to the extent of any hedge ineffectiveness.) No adjustment is made to the fair value of the bonds for any other reason, for example if the credit status of the issuer changes.

F(No.2)A15 changed the definition of fair value accounting, to the effect that an adjustment made to the carrying value of a loan relationship which was hedged by a designated fair value hedge was an accepted part of amortised cost accounting, see CFM33130. Any amount arising in profit or loss from such an adjustment does not result from revaluation and is not denied by S324 - see CTA09/S324(3A).

The same view was taken before the amendments made by F(No.2)A15.

Accordingly, if interest rates rise and amounts are debited to the income statement as the fair value hedge adjustment decreases, CTA09/S324 does not preclude the company from obtaining relief.