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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Derivative contracts: group continuity: transfers on or after 16 March 2005: examples

Intra-group examples on or after 16 March 2005: examples

Example 1

L Ltd prepares accounts to 31 December, and does not use fair value accounting for its derivative financial instruments. It holds a commodity option, amortising the premium it paid over the life of the option. At 31 March 2006, it assigns the option to M Ltd, another company in the same group, for its fair value of £600,000.

At 31 December 2005, the unamortised amount of the premium in the accounts of L Ltd is £550,000. If the company drew up a balance sheet at 31 March 2006, it would be £500,000. Thus the ‘notional carrying value’ of the option for the purposes of CTA09/S625 is £500,000, and the transfer is treated as taking place for that consideration. For tax purposes, L Ltd is entitled to a debit of £50,000 (rather than any profit on disposal of the option shown in its accounts). No profit (or loss) therefore arises on the actual transfer.

M Ltd is treated as acquiring the option for the same amount, £500,000. Assuming that M Ltd also uses an accruals basis of accounting, it is likely to amortise the £600,000 it paid over the remaining life of the option. For tax purposes, however, it must base the amortisation on the notional transfer value of £500,000. Thus there will be a mismatch between tax and accounts, persisting over the remaining life of the contract.

Example 2

The facts are as for example 1 of CFM53060 - G novates an interest rate swap on 31 March 2004 to fellow group company, H Ltd - except that, rather than terminating the swap, H Ltd novates the swap to Z Ltd on 1 December 2005. Z Ltd is a member of the same group as G Ltd and H Ltd. The swap is out of the money, and H Ltd pays Z Ltd £50,000 in consideration of the novation.

Because there has been a previous transfer to which CTA09/S625 applied, the tax-adjusted carrying value of the contract is not the same as its carrying value in H Ltd’s accounts. Under CTA09/S702(3), CTA09/S625 will apply for the purposes of determining the carrying value. So the carrying value for tax purposes at 1 December 2005 will be the value at which the swap was originally acquired by G Ltd - in other words, nil.

H Ltd is therefore treated as disposing of the swap for nil, giving rise to neither profit nor loss. Similarly, Z Ltd is treated as acquiring it for nil. Thus if, for example, Z Ltd accounts for the swap at fair value, showing it as a liability of (say) £40,000 at 31 December 2005, the company will be entitled to a debit of £40,000, rather than being taxed on the credit of £10,000 shown by its accounts