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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Derivative contracts: hedging: hedging relationship

What is a hedging relationship?

Regulations 7, 8 and 9 all require a ‘hedging relationship’ between a derivative contract and a particular hedged item. Regulation 2(5) defines what is meant by a ‘hedging relationship’.

If the derivative and the hedged item are accounted for by the company as a hedge in accordance with IFRS, New UK GAAP or FRS 26 of Old UK GAAP, there is automatically a ‘hedging relationship’ for the purposes of the Disregard Regulations. Where a hedging relationship has been accounted for as a hedge under the relevant accounting standard, the company will have documented its hedging strategy, and the nature and purpose of the particular hedge under consideration, (CFM27070).

There may, however, be a ‘hedging relationship’ for tax purposes even where the criteria in IFRS, New UK GAAP, or FRS 26 of Old UK GAAP for hedge accounting are not satisfied. The test is whether the hedging instrument is intended to act as a hedge of:

  • the exposure to changes in fair value of an asset or liability, or an unrecognised firm commitment, which is attributable to a particular risk and could affect the company’s profit or loss;
  • the exposure to variability in cash flows associated with an asset, liability or forecast transaction, which is attributable to a particular risk and could affect profit or loss; or
  • a net investment in a foreign operation of the company.

CFM57060 gives guidance on the interpretation of ‘intended to act as a hedge’.

A ‘hedging instrument’ may comprise all or only part of a derivative contract. Similarly, the ‘hedged item’ may be all or only part of the overall asset, liability or transaction.