CFM51100 - Derivative contracts: the matters and computational rules: exchange gains and losses

CTA09/S606

Exchange differences

CTA09/S606 puts it beyond doubt that the profits and losses arising to a company on its derivative contracts include exchange gains and losses.

Position for periods of account beginning on or after 1 January 2016

For company periods of account beginning on or after 1 January 2016, the effect of amendments to CTA09/S595 and 597 made by F(2)A15 is that amounts, including exchange differences, initially recognised as items of other comprehensive income, rather than as items of profit or loss, are not brought into account for tax. However, amounts are taxed if transferred from OCI to become items of profit or loss.

Position for periods of account beginning before 1 January 2016

However, before the F(2)15 changes, in periods of account beginning before 1 January 2016, the position was more complicated because as a general rule amounts recognised in reserves would normally be taxable.

Where exchange differences were taken to reserves, however, there were two situations in which they are not taxed.

The first was where the gain or loss arose on a currency derivative, such as a forward currency contract or cross-currency swap. This exemption caters for the commonplace situation where the currency derivative hedges the company’s investment in a foreign operation, such as an overseas subsidiary, and in accordance with former UK GAAP accounting standard SSAP 20 all or part of the exchange difference was ‘matched’ in reserves with the exchange gain or loss arising on the investment.

The second situation is where part of a company’s business (such as a branch) prepares its financial statements in a currency that is not the company’s functional currency, and the company uses the closing rate/ net investment method to translate the branch results into its functional currency. This will give rise to an exchange gain or loss, which is taken to reserves; such amounts are not taxed or relieved.

The tax treatment of exchange differences on loan relationships and derivatives is explored in more detail at CFM60000+. In particular, there is guidance on the statutory definition of exchange gains and losses at CFM61030, and on ‘forex matching’ - the disregard (and bringing back into account) of exchange gains and losses on derivatives that hedge a company’s investment in a foreign operation - at CFM62000+.