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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Derivative contracts: introduction: basic computational rule

The basic computational rule

The basic rule is that the credits and debits to be brought into account are those which, when taken together, ‘fairly represent’ for the accounting period in question all profits and losses of the company which arise to it from its derivative contracts and related transactions, and all expenses incurred by the company under or for the purposes of those contracts or transactions (CTA09/S595).

‘Related transaction’ means any disposal or acquisition, in whole or in part, of rights or liabilities under a derivative contract (CTA09/S596). There is more about this at CFM51060.

Computing credits and debits: follow the accounts …

The credits and debits in question are those that are recognised in determining the company’s profit or loss for the period in accordance with generally accepted accounting practice (GAAP). ‘GAAP’ is defined at FA04/S50: it includes International GAAP as well as UK GAAP. These credits or debits will include any foreign exchange gains or losses.

Credits or debits in reserves (for example, the Statement of Total Recognised Gains and Losses, or the Statement of Changes in Equity) are brought into account as well as those in the profit or loss account or income statement. Amounts shown in the accounts are brought into account for tax purposes even if the company is no longer party to the derivative contract.

If the company does not draw up accounts in accordance with GAAP, the rules operate as if it did.

There are special provisions to ensure that amounts do not drop out of account when a company changes its accounting policy, even if profits or losses from a revaluation of the company’s derivative contracts are not explicitly shown in the accounts.

These general principles are described in more detail at CFM52030.

In this manual, for convenience, accounting standards post 2005 may be referred to as ‘IAS’ even though externally, the term more commonly used is ‘IFRS’ which is usually taken to include both IFRS and the older IAS-prefixed accounting standards.

The CFM also uses the term ‘old UK GAAP’. This term is not strictly accurate and again is used for convenience. It means UK GAAP excluding FRS 26 and associated standards.

… except where you don’t

The basic ‘follow the accounts’ rule is, however, subject to a number of statutory exceptions. The main areas which constitute exceptions are given below, but the list is not exhaustive. You should look at the detailed guidance where special rules apply.

  • Where a derivative contract is transferred between two companies in the same group, the transfer is treated as giving rise to neither a gain nor loss (CFM53000).
  • The Disregard Regulations modify the normal computational rules in certain situations where a derivative contract acts as a hedge (CFM57000).
  • Foreign exchange gains and losses on derivative contracts that are used to hedge a company’s investment in a foreign operation may be disregarded (and may later be brought back into account) under the ‘forex matching’ provisions (CFM62000).
  • Anti-avoidance rules may apply in certain cases (CFM56000). Targeted anti-avoidance provisions in CTA09/S606A prevent exchange gains from being matched where a ‘one way exchange effect’ is present (CFM63100).
  • Securities that are convertible into, or exchangeable for, shares, or securities where the redemption value is linked to the value of shares, may contain embedded derivatives from a tax perspective. Where these are recognised separately for tax purposes, special rules apply. There are also special provisions for derivatives embedded into other types of contract and for certain sorts of property derivatives (CFM55000).