Beta This part of GOV.UK is being rebuilt – find out what this means

HMRC internal manual

Corporate Finance Manual

From
HM Revenue & Customs
Updated
, see all updates

Loan relationships: tax avoidance: index-linked gilt-edged securities: relevant hedging schemes

Relevant Hedging Schemes

In order to meet condition 1 at CTA09/S400A(2) it is necessary that a company is party to a ‘relevant hedging scheme’.

This is defined at subsection (6) as being ‘a scheme the purpose, or one of the main purposes, of any party to which, on entering into the scheme, is to secure that the index-linked capital return on the security, or a proportion of it, is hedged’.

Consequently, it is not enough to be able to identify a return from an index-linked gilt-edged security that is hedged (i.e. paid away), but it must also be the case that the arrangements that resulted in the hedge must be part of a scheme that was entered into with that result in mind.

For example, it is perfectly normal for different companies within large groups in the financial sector to hold different positions with respect to index-linked returns and, in most cases, those positions would have been entered into independently of each other. These rules are intended to deal with cases where the ultimately equal and opposite transactions have been entered into with that result as a main purpose (or one of the main purposes). That will be a question of fact with reference to the individual circumstances of the relevant transactions.

Example 1

A company has a long-term commitment to a significant future liability. In order to remove the exposure to inflation implicit within the future commitment, the company purchases index-linked gilts.

This would not be a relevant hedging scheme. The company has not entered into a scheme or arrangement with a purpose of securing that the inflationary aspect of holding index-linked gilts is hedged. Rather, the existing exposure to inflation is being hedged through holding the index-linked gilts.

Example 2

A company invests in index-linked gilts and then enters into a total return swap, receiving a LIBOR-based interest rate and paying away an amount based on movements in the RPI.

As the main purpose, or one of the main purposes, of entering into the total return swap was to secure that the future inflation exposure on holding the index-linked gilts was hedged, then this would be a relevant hedging scheme.

Example 3

A company enters into a total return swap, receiving a LIBOR-based interest rate and paying away an amount based on movements in the RPI. A week later, the company purchases index-linked gilts with no purpose other than to provide the income that would be paid away under the total return swap.

As the main purpose of entering into the total return swap was to secure that the future inflation exposure on holding the index-linked gilts was hedged, then this would be a relevant hedging scheme. It does not matter that the total return swap was entered into before the index-linked gilts were purchased.