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HMRC internal manual

Corporate Finance Manual

Derivative contracts: hedging: when regulation 7 applies

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

Application of regulation 7 to different types of hedge

Companies can only elect into regulation 7 where the currency contract is hedging something that is yet to happen (an ‘anticipatory hedge’). This may be a firm commitment of the company (such as a contract that will result in the company having to pay for trading stock at a future date), or a highly probable forecast transaction. The regulation does not apply if the currency contract hedges foreign exchange risk on an existing asset or liability - for example, it will not apply to a forward currency contract hedging an existing loan.

The company may account for the currency contract as the hedging instrument in either a cash flow hedge or a fair value hedge. Alternatively, it may not account for a hedge at all, even though a ‘hedging relationship’ (CFM57050) exists.

Cash flow hedges

Regulation 7 can apply if the company accounts for the currency contract as the hedging instrument in a cash flow hedge of foreign exchange risk. Nothing is brought into account in respect of the forecast transaction - the hedged item - until it actually happens. So the third bullet point at CFM57080 will be satisfied - no fair value profits or losses on the hedged item are brought into account for CT purposes.

Fair value changes to the contract that relate to the hedged risk will be taken to reserves (such as the statement of other comprehensive income (OCI)). Regulation 7(4) makes it clear that, where such fair value changes are disregarded under regulation 7, this takes priority over any disregard under CTA09/S606(3).

Fair value hedges

A company may account for a currency contract as a fair value hedge of a firm commitment. IFRS, New UK GAAP, or FRS 26 under Old UK GAAP does not allow a forecast transaction (where there is no firm commitment) to be the hedged item in a fair value hedge. Where a fair value hedge has been accounted for, the company must bring the firm commitment ‘on balance sheet’, so that changes in the fair value of the firm commitment are reflected in the income statement (where they offset fair value changes in the hedging derivative - see CFM27130 for a general description of fair value hedges).

Regulation 7 can have effect if the fair value changes on the firm commitment are not taken into account for tax purposes. If, however, fair value movements are taken into account, for example as trading income and expenditure, there will be a natural offset - both before and after tax - between fair value changes on the hedged item and the hedging instrument. Regulation 7 has no effect in such a case.