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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Derivative contracts: relevant contracts: meaning of contract

‘Contract’ and ‘party to a contract’

Although ‘derivative contract’ is a defined term in Part 7 CTA09, the word ‘contract’ is not further defined and retains its everyday meaning - an exchange of promises or agreement between parties that is legally enforceable.

In law, all derivatives transactions between two parties which are executed under the umbrella of an ISDA Master Agreement (or similar master agreement) are regarded as part of the same contract (CFM13100). However, two or more transactions ought not to be regarded as being a single relevant contract for the purposes of Part 7 solely because they are executed under the same master agreement.

In certain cases, particularly where tax avoidance is suspected, HMRC staff may feel that two or more financial instruments are so closely linked that they should be treated as a single composite transaction. They should consult CTIAA (Anti-Avoidance Group) before advancing an argument of this sort.

Internal derivatives

Some companies, particularly banks, may enter into internal derivative transactions - for example, one division of a bank may hedge interest rate risk arising from its loan book by entering into an interest rate swap with the bank’s trading desk (which in turn hedges the overall risk externally).

Strictly speaking, such transactions cannot be contracts, since a person (including a company) cannot enter into a contract with himself. They therefore cannot be ‘derivative contracts’. However, where a company has treated such internal transactions as derivative contracts for tax purposes and this has previously been accepted, HMRC staff should not challenge the arrangement unless there are significant amounts of tax at stake (for example, if one end of an internal derivative is treated as giving rise to trading credits and debits, and the other end to non-trading debits and credits, and this affects the company’s CT liability). Advice should be sought from CTIAA (Financial Products Team) before any challenge is made.

Party to a contract

A company (or other person) is party to a relevant contract if they have entered into or acquired the contract (CTA09/S578). A person acquires a contract if they become entitled to the rights under the contract, and subject to the liabilities.

The legislation extends the meaning of ‘party to a contract’ to cover the case of embedded derivatives. A derivative embedded in a loan relationship, a non-financial contract or another derivative is not a separate contract, so a company cannot - in normal parlance - be party to it. For tax purposes, however, the company is treated as being party to a relevant contract - see CFM50410 onwards.