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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Derivative contracts: hedging: regulation 9: scope

This guidance applies to periods of account starting on or after 1 January 2015 where the company has elected for regulation 9 to apply. 

Scope of regulation 9

Where a company has elected for regulation 9 to apply, this regulation will have effect when the following conditions are satisfied:

  • there is a hedging relationship between all or part of an interest rate contract, and any of the risks arising in respect of an asset, liability, receipt or expense (‘the hedged item’), and
  • fair value profits or losses on the hedged item are not brought into account for CT purposes.

‘The hedged item’ is not the overall asset, liability, receipt or expense, but the particular risk that the contract is intended to hedge. It follows that the reference in regulation 9(1)(b) is to fair value profit or loss corresponding to the fair value loss or profit on the hedging instrument.

Examples

  • A company hedges the risk of fair value changes in its fixed rate debt by entering into a fixed to floating interest rate swap that it designates as a fair value hedge. Regulation 9(1) will not have effect because fair value profits or losses on the hedged item matching those on the hedging instrument are brought into account for CT.
  • A company has a floating rate foreign currency borrowing. It decides to hedge exposure to the floating interest rate, but not to foreign exchange risk (effectively converting the debt into fixed foreign currency debt). Regulation 9(1) will have effect because the company does not bring into account for CT purposes fair value changes on the hedged item in respect of the risk being hedged. It is immaterial that exchange gains and losses on the borrowing go through profit and loss account and are charged to CT. Not only will these not be fair value profits or losses, because a financial liability will normally be accounted for on an amortised cost basis, but they do not relate to the risk being hedged.

Regulation 9 cannot have effect where

  • The hedged item is a loan relationship with an unconnected party that is being accounted for at fair value through profit and loss. In such a case, fair value changes in the loan relationship are being brought into account for CT purposes. Fair value changes in any derivative used to hedge interest rate risk will also go through profit and loss, providing a natural hedge. The offset will apply for tax purposes, as well as for accounting purposes, so there is no need for regulation 9.
  • The interest rate contract has been designated as a fair value hedge of a loan relationship with an unconnected party. The effect of designating a fair value hedge is that the carrying value of the loan relationship is adjusted for fair value changes relating to the risk being hedged (CFM27140). So, where interest rate risk is being hedged, fair value profits and losses relating to interest rate changes will go through profit and loss account, and will be taken into account for CT purposes. Here again, there is no need for regulation 9 to have effect since the company has an effective hedge both pre-tax and post-tax.

The Regulation can have effect where

  • The interest rate contract has been designated as a cash flow hedge of a loan relationship asset or liability that is accounted for at amortised cost. No fair value changes on the loan relationship are brought into account for tax purposes. See the example at CFM57330.
  • The interest rate contract provides a fair value hedge of a loan relationship with a connected person; or a connected party loan relationship is accounted for at fair value through profit and loss. While fair value changes in the hedged item will go through profit and loss in the accounts, for tax purposes CTA09/S349(2) requires an amortised cost basis to be used. Thus the condition in regulation 9(1)(b), that fair value changes are not brought into account for CT, is met.
  • There is a hedging relationship (CFM57050) between an interest rate contract and a loan relationship asset or liability, but the contract has not been accounted for as a cash flow hedge or a fair value hedge. Where the loan relationship is accounted for on an amortised cost basis, there will be no fair value changes brought into account for CT purposes.
  • The hedged item is a regulatory capital security (within the scope of the Regulatory Capital Securities Regulations) in relation to which the company uses fair value accounting.