Derivative contracts: departures from accounts: mandatory fair value accounting
Circumstances in which fair value accounting must be used
There are two main scenarios in which credits or debits must be determined for tax purposes on the basis of fair value accounting, regardless of the actual accounting method adopted by the company. (Fair value accounting is defined at CTA09/S710 as a basis of accounting under which assets and liabilities are shown in the company’s balance sheet at fair value).
The circumstances, which are set out at CTA09/S600 - 602, are:
- Where the contract comes within Part 7 because it passes the test in CTA09/S579(1)(b) - it is not treated as a derivative for accounting purposes, but is or forms part of a financial asset or liability, and would be a derivative were it not for there being a large upfront payment (see CFM50280). Contracts of this kind may be encountered as part of avoidance schemes, and the requirement to use fair value accounting is designed to ensure that economic profits or losses are brought into account in each accounting period.
- Where the contract is treated as a derivative contract by CTA09/S587, because its underlying subject matter is a holding of shares in an open-ended investment company (OEIC), units in a unit trust or an interest in an offshore fund (CFM54040).
A transitional rule applies where a contract first comes within CTA09/S587, having been a chargeable asset in the previous accounting period. The company is treated for capital gains purposes as having disposed of the contract at market value at the end of the first accounting period; the resultant chargeable gain or allowable loss is brought into account when it ceases to be party to the contract (CTA09/S660). The contract is then brought into the derivative contracts rules at market value at the start of the second accounting period (CTA09/S602).
CTA09/S603 contains a further provision which is ancillary to the ‘shares as debt’ rules in Chapter 7 Part 6 CTA09 (see CFM45000 onwards). If an ‘associated transaction’ (CFM45260) is not a derivative contract, it is nevertheless treated as such (CTA09/S588) and fair value accounting must be used in respect of it.