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HMRC internal manual

Corporate Finance Manual

Derivative contracts: hedging: hedging relationship: HMRC enquiries

Hedging relationship: enquiries

It is the company’s responsibility when preparing its CTSA returns and tax computations to apply the Disregard Regulations where appropriate. HMRC staff should not normally need to make detailed enquiries about whether a hedging relationship exists in transactions where the regulations have been applied, or try to argue that the derivative is in fact hedging some other asset, liability or forecast transaction.

Enquiries may be appropriate where:

  • It appears that the company’s policies have not been adhered to. For example, it is claimed that interest rate risk in relation to a particular borrowing is unhedged, when the company’s risk management policy is to hedge all such transactions.
  • It is claimed that no hedging relationship exists between a particular derivative and an asset or liability, despite clear objective correlations (for example, in principal amount, date on which the transactions were entered into, maturity date, and so on).
  • The Disregard Regulations are applied inconsistently - it is claimed that no hedging relationship exists in year 2 when it existed in year 1 (or vice versa), although there have been no changes in the instruments concerned.
  • The company’s return discloses use of a financial avoidance scheme, or there is reason to believe that the derivative transactions may be part of tax avoidance arrangements.
  • The accounts reflect significant losses on derivative contracts, but the nature of the company’s activities is not such that it is considered likely to enter into such contracts speculatively.

A company’s intention in becoming party to a derivative contract is a question of fact. In any case where it is unclear whether or not a hedging relationship exists, HMRC staff should have regard to all the available evidence. This may include:

  • any contemporaneous documentation of the company’s intentions in undertaking the transaction, including (but not limited to) board minutes, internal memos and communications with external parties;
  • accounting entries, and supporting documentation (for example, hedge effectiveness computations); and
  • oral evidence from the people involved in the transactions.