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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Derivative contracts: hedging: regulation 7

This guidance applies to periods of account starting on or after 1 January 2015 where the company has elected for regulation 7 to apply.

Currency contracts hedging forecast transactions

In cases where a company has elected for regulation 7 to apply, this regulation will have effect when the following conditions are satisfied:

  • The company must be party to a derivative contract whose underlying subject matter consists wholly of currency. This means that the regulation does not apply to cross-currency interest rate swaps, since both an exchange rate and an interest rate are designated in such swap contracts (CA09/S583(4)). These swaps fall within regulation 9 as an interest rate swap.
  • There must be a hedging relationship (CFM57050) between all or part of the contract and a forecast transaction or firm commitment (‘the hedged item’) of the company.
  • Fair value profits or losses on the hedged item are not brought into account for the purposes of corporation tax. This includes the case where the hedged item is a forecast transaction that is not recognised in the balance sheet at all. Here ‘fair value profits or losses’ takes its normal meaning rather than the definition in regulation 2(1) which applies only to derivatives and loan relationships.

The effect of regulation 7 is that the fair value changes on the contract, wherever they appear in the accounts, are disregarded for tax purposes. The disregarded amounts are brought back into account at a later time - see CFM57210. If only part of the contract hedges the forecast transaction or firm commitment, a proportionate part of the fair value changes is disregarded.

Typically, regulation 7 can apply where the company uses a forward currency contract (or, more rarely, a traded currency future or a currency option) to hedge foreign exchange risk arising from some future inflow or outflow of funds.

The regulation can apply where the company accounts for a cash flow hedge in accordance with IFRS, New UK GAAP, or FRS 26 under Old UK GAAP, or where it does not account for a hedge at all in accordance with those standards. If the currency contract is the hedging instrument in a designated fair value hedge, however, regulation 7 does not typically have effect. CFM57090 looks at this in more detail.

A company may elect under regulation 6A that regulation 7 applies to any of its currency contracts that meet the regulation 7(1) conditions. If no election is made then regulation 9A will apply to such contracts that are designated cash flow hedges. This is explained at CFM57370.

CFM57100 and CFM57120 contain examples of how amounts are disregarded under regulation 7, and brought back into account under regulation 10, where cash flow hedges have been accounted for. CFM57110 looks at what happens where no hedge has been accounted for, or the hedge is not 100% effective.

CFM57130 covers the treatment of regulation 7 contracts where a company adopts IFRS, New UK GAAP, or FRS 26 under Old UK GAAP for the first time.