Derivative contracts: bringing amounts into account: 'fairly represents'
Amounts fairly representing profits or losses
Important as the company’s accounts are, they do not provide the last word on the tax treatment of a company’s derivative contracts. CTA09/S595(3) imposes an additional requirement - the credits and debits to be brought into account must, when taken together, ‘fairly represent’ the company’s profits or losses on its derivative contracts.
This does not mean it is possible arbitrarily to set aside the accounts in any case where the treatment accorded to a derivative contract appears - either to HMRC or to the taxpayer - to give an unfair tax result. However, the legislation imposes certain limitations to the ‘follow the accounts’ approach.
The credits or debits must be those that, taken together, represent a profit or loss of the company, as the terms ‘profit’ or ‘loss’ are generally understood. For example, a company may transfer an in-the-money derivative contract to its parent company as a dividend-in-specie. This is reflected as a debit in the accounts. But even if the debit appears in one of the statements listed at CTA09/S597(1), it does not fairly represent any ‘loss’ of the company - rather, it is a distribution of profits already made. The debit cannot be deducted under CTA09/Part 7.
Moreover, the profit or loss must relate to the company’s derivative contracts, and not to some other matter. For example, a company using a derivative contract as a hedge of interest rates may show, as one line of its published accounts, a composite of the interest payable (or receivable) and amounts payable or receivable under the hedging derivative. In many cases it will not be necessary to identify separately ‘loan relationships’ and ‘derivative contracts’ credits and debits. But where it is necessary, the legislation sanctions looking below the surface of the accounts to pick out those credits or debits that together make up the derivative contract profit or loss.