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HMRC internal manual

Corporate Finance Manual

Foreign exchange: tax rules on exchange gains and losses: examples of exchange gains and losses

Examples of computing exchange gains and losses

Example 1a

Breadknoll Ltd, a UK company, prepares its accounts in sterling.

The company buys some stock from an American supplier on 1 July 2005 for US$40,000, which is the sterling equivalent of £20,000. Payment is due on 1 October 2005.

On 1 October 2005 the company buys $40,000 so it can pay the supplier. The dollars they bought only cost £18,500.

The company has to value the same debt at two different dates, and in the interim the exchange rate has moved to its advantage. Therefore, the company is able to buy $40,000 for only £18,500, which is less than the £20,000 it would have to have paid if it had done so on 1 July 2005. Therefore, Breadknoll Ltd has made an exchange gain of £1,500.

Example 1b

If the exchange rate on 1 October 2005 had moved the other way so that it cost the company £22,500 to buy the $40,000, the company would have had to pay more than it expected when it placed the order.

The result is an exchange loss of £2,500.

Example 1c

The exchange rates may have gone up and down in the period between 1 July and 1 October. However, if the exchange rate on 1 October was, once again, $40,000 = £20,000 then there is no profit or loss.

It does not matter that the rates have gone up or down in the meantime. No exchange gain or loss arises.

Example 1d

Assume, however, that Breadknoll Ltd has an accounting date of 31 August. On 31 August $40,000 = £15,000. On settlement on 1 October $40,000 = £20,000 as above. The accounts to 31 August 2005 will show an exchange gain of £5,000 on balance sheet translation of this money debt. The accounts to 31 August 2006 will show an exchange loss of £5,000. The net exchange gain or loss on the transaction is still nil but this result is only achieved over two accounting periods.

Example 2

HTM plc prepares its accounts in sterling. The company has the following assets throughout the accounting period:

cash of €120,000

US $ bank account with a credit balance of $45,000.

It also has a liability in the form of a loan of US $72,000. This liability is hedged by a currency contract. The loan is accounted for using the rate implied in the currency contract.

These amounts are translated into sterling on the balance sheet. Any difference between the sterling value of the foreign currency balances at the two accounting dates is taken to the profit and loss account as follows:

  $ loan $ bank account € cash
31 Dec 2010 72,000 / 1.58 =    
£45,570 45,000 / 1.54 =
£29,221 120,000 / 1.98 =
  31 Dec 2011 72,000 / 1.58 =
£45,570 45,000 / 1.58 =
£28,481 120,000 / 2.10 =
  Exchange gain or (loss) Nil (£740) (£3,463)

Because the loan is translated at the contracted rate no exchange differences will arise. This still complies with the S475 definition. There is a valuation at each date but it will always produce an exchange gain of nil (CTA09/S 475(1)(2)).

The exchange loss on translation in the profit and loss account is £4,203 (740 + 3,463).