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HMRC internal manual

Corporate Finance Manual

Derivative contracts: accounting conditions: introduction

Why have an accounting condition?

The definitions of ‘option’, ‘future’ and ‘contract for differences’ (CFD) in Part 7 of CTA09 are based on those in the Financial Services and Markets Act 2000 (FSMA 2000). These definitions are very wide, and without some further qualification they would bring in all sorts of contracts that would not normally be regarded as derivatives.

For regulatory purposes, the definitions in FSMA 2000 are limited by the FSMA 2000 (Regulated Activities Order) 2001 (RAO). Very broadly, the limitations in the RAO look at purpose, that is, whether someone entered into a futures contract for a commercial or an investment purpose, or whether a non-financial trading company entered into a contract as a hedge. But it is not practical to have to consider the purpose of each of a company’s relevant contracts before you can decide how it should be taxed.

So the legislation takes a different route. CTA09/S576 provides a definition of ‘derivative contract’. A company’s contract is only a derivative contract for corporation tax purposes if it is a ‘relevant contract’. However for a relevant contract to be a derivative contract, it must be treated for accounting purposes as a derivative (with some exceptions) (CTA09/S579). This means that most commercial contracts - for example, an agreement to purchase a property, with completion at a later date - do not come within the derivative contract rules because they are not accounted for as derivatives.

CFM50220 tells you more about the accounting requirement. The other ways in which a contract can satisfy the CTA09/S579 conditions are described at CFM50240 onwards.

Section 579 is the main filter that is applied to determine whether a relevant contract qualifies as a derivative contract. When the derivative contracts regime was first introduced in 2002, a number of derivatives - principally property and equity derivatives - were excluded because of their ‘underlying subject matter’. There are still some underlying subject matter exclusions (see CFM50700 onwards), but these have become considerably less important.

Finally, two types of contract by-pass all of the filters and are explicitly treated as derivative contracts. They are:

  • Contracts that have certain holdings in unit trusts, OEICs or offshore funds as their underlying subject matter (CTA09/S587 - see CFM54040); and
  • ‘Associated transactions’ under the ‘shares as debt’ loan relationships rules (CTA09/S588 - see CFM45260).