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HMRC internal manual

Corporate Finance Manual

Derivative contracts: tax avoidance: exchange gains and losses where Sch 28AA applies

Exchange gains and losses on non arm’s length derivative contracts

CTA09/S694 applies to exchange gains and losses on derivative contracts where an adjustment is made under TIOPA10/Part 4 (transfer pricing). It aligns the adjusted transfer pricing figures with the amounts on which exchange gains and losses can be given. This rule is necessary because the transfer pricing rules do not apply to exchange gains and losses.

S694(2) applies to derivative contracts where, in an accounting period, the effect of Part 4 is to tax a company as if it were not party to the derivative contract at all - in other words, it applies to situations where parties dealing at arm’s length would simply not have become party to the derivative. S694(3) provides that any exchange gains and losses on that contract are also left out of account.

S694(4) deals with the situation where there is adjustment under Part 4 because on arm’s length, the terms (including the amounts of any payments) would have been different. S694(5) and (6) require exchange adjustments to be made that would give the same result as if the contract had been agreed on arm’s length terms.


Rabyard UK plc enters into an interest rate swap with a Japanese subsidiary under which it pays 2% in sterling on a notional principal amount of £100m in return for receiving fixed 1% rate yen payments on the same notional sum.

In Year 1 net debits of £1 million arise on the interest rate swap, while a £50,000 exchange gain also arises on the accrued amounts. It is agreed that Part 4 applies and that no part of the debit is allowable. Under S694(3) the exchange gain will also be disregarded.