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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Derivative contracts: tax avoidance: consideration not fully recognised by accounting practice

Disposals for consideration not fully recognised by accounting practice

Some companies seek to shelter profits artificially on their derivative contracts (and loan relationships - see CFM39080) by transferring them to other companies in exchange for the issue of shares. It is claimed under GAAP that the transferor is not required to recognise any accounting profit. This is despite the fact that the shares obtained are fully marketable and are capable of being realised for the same cash value at which the derivative contract could have been sold.

CTA09/S698 was introduced to address this form of avoidance and has effect for disposals on or after 16 May 2008.

The rule applies where a company:

  • disposes in an accounting period (in whole or in part) rights or liabilities under a derivative contract, and
  • the consideration for the disposal is not wholly in the form of money (or a debt that falls to be settled by way of money), and
  • the consideration, in accordance with GAAP, is not fully recognised in the accounts for that accounting period or any other accounting period, and
  • the company has a ‘relevant avoidance intention’.

‘Relevant avoidance intention’ means the intention of eliminating or reducing the credits to be brought into account for the purposes of the derivative contract rules.

S698 operates by bringing into account the full amount of the consideration received for the accounting period in which the disposal took place and takes priority over CTA09/PT7/CHP5 (Continuity of treatment on transfers within groups).

However, S698 will not apply if the consideration brought into account in respect of the disposal is increased under the transfer pricing rules at TIOPA10/Part 4.