Derivative contracts: bringing amounts into account: basic computational rule
The general premise - follow the accounts
The basic premise, in CTA09/S595(1)-(2) is that the derivative contracts rules operate by reference to company accounts, and the amounts to be brought into account are those amounts recognised under Generally Accepted Accounting Practice (GAAP) in determining the company’s profit or loss. GAAP means UK GAAP and IFRS - see the Business Income Manual, BIM31000. For periods beginning on or after 1 January 2005, there is no longer a concept of authorised accounting methods.
But this is subject to the further requirement in CTA09/S595(3) that credits and debits must be the amounts which, taken together, fairly represent the profits or losses arising to the company for the period from its derivative contracts and related transactions. This includes expenses incurred by the company for the purposes of the derivative contracts (CFM51090). There is more about ‘fairly represents’ at CFM51050.
‘Related transaction’ is defined at CTA09/S596 - see CFM51060.
CTA09/S597 elaborates on what is meant by ‘recognised in determining a company’s profit or loss for the period’. It means any amount that is recognised for accounting purposes in
- the company’s profit and loss account, income statement or statement of comprehensive income; or
- the statement of total recognised gains and losses (STRGL), statement of recognised income and expense (SORIE), statement of changes in equity (SOCIE) or statement of income and retained earnings for that period; or
- any other statement of items brought into account in computing the company’s profit or loss for that period, whatever name is given to it.
The inclusion of amounts taken to reserves - the STRGL or statement of changes in equity -means that, in tax computations that take the profit and loss figure as a starting point, the company may have to make adjustments to bring in such amounts.
S597(3) gives one exception to the general rule. That is where the accounts contain a prior period adjustment resulting from correction of a fundamental error in the accounts of an earlier year or years. In such a case, the company’s tax liability will be computed (or recomputed) on the basis that it had correctly accounted for its derivative contracts in the earlier year or years. ‘Fundamental error’ includes a material prior period error as defined in IAS 8.
By contrast, a prior period adjustment resulting from a change of accounting policy in relation to a company’s derivative contracts will give rise to a taxable credit or allowable debit (and see also CFM52030 in relation to changes in accounting policy). HMRC staff should consult a compliance accountant in any case where there is doubt over whether a prior period adjustment results from a fundamental error.