Derivative contracts: bringing amounts into account: exchange gains and losses
CTA09/S606 puts it beyond doubt that the profits and losses arising to a company on its derivative contracts include exchange gains and losses.
Where exchange differences are taken to reserves, however, there are two situations in which they are not taxed.
The first is where the gain or loss arises 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 SSAP 20 all or part of the exchange difference is ‘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 onwards. 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 onwards.