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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Derivative contracts: introduction: priority rules

Boundaries with other tax provisions

In general, amounts that are brought into account for the purposes of the derivative contracts rules in respect of any matter are the only amounts that can be brought into account for CT purposes. This means that the derivative contracts regime takes priority over any other rules under which profits or losses on derivatives might be brought into account. CFM50070 outlines the tax rules you need to consider if the derivative contracts rules do not apply.

The main exception is where an amount could be charged under either the loan relationships or the derivative contracts rules. Here the loan relationships rules take priority. This situation is most likely to occur where an amount due under a derivative contract is paid late, creating an interest-bearing debt - see example 2 below.

Example 1

A trading company enters into a swap as part of a tax avoidance scheme. It is agreed that the unallowable purposes rule (CTA09/S690) applies, with the result that debits arising on the swap are not allowed under the derivative contracts rules. As a result of the priority rule in CTA09/S699, the company cannot then claim the debits as trading deductions, or in any other way.

Example 2

A company is party to an interest rate swap, under which it must make payments to the counterparty each quarter based on a floating rate of interest. It fails to make a payment on the due date and, under the terms of the contract, pays interest on the late payment.

The interest arises as part of the contractual arrangements between the parties, and so could be seen as falling within the derivative contracts rules. Equally, when the payment is not made on time, it creates a money debt - interest on which is brought within the loan relationships rules by CTA09/S481. CTA09/S700 provides the tie-breaker: the company will get relief for the interest it pays under loan relationships, not derivative contracts.

In practice, the point will normally be academic, since both regimes are likely to produce the same debits (or credits), that are brought into account in the same way.