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HMRC internal manual

Corporate Finance Manual

Foreign exchange: tax rules on exchange gains and losses: loan relationships and derivative contracts: exchange differences in reserves

Exchange differences in reserves

Where exchange differences arising from a loan relationship or derivative contract are recognised in reserves, these amounts are not brought into account for tax. This follows the general rule at CTA09/S308.

CTA09/S328(3) provides for amounts arising on the retranslation of a business from its functional currency to another currency which are taken to other comprehensive income (OCI). Under the general rule such amounts will not be brought into account when initially recognised in OCI but they are also not to be brought into account where they are subsequently recycled to profit or loss.

Previous treatment of exchange differences in reserves

For periods of account beginning before 1 January 2016, the general rule was that amounts recognised in reserves would generally be brought into account. CTA09/S328(3), however, provided that exchange differences were not to be brought into account in two circumstances. 

The first is where exchange gains or losses on a loan relationship are taken to the statement of total recognised gains and losses (STRGL), other comprehensive income (OCI) or to equity.  The loan relationship in question may be an asset or a liability.

For example, exchange differences arising on a loan by a company to a foreign subsidiary, where that loan forms part of the company’s long-term investment in the subsidiary, are sometimes taken to reserves.  Where that is the case, such exchange differences are disregarded for tax purposes, and are brought into account only on disposal of investment, in accordance with regulation 13(2A) of the Exchange Gains and Losses (Bringing into Account Gains or Losses) Regulations 2002, SI 2002/1970.

Equally, SSAP 20 allowed exchange differences arising on borrowings that hedge a company’s investment in a foreign operation to be offset in reserves against exchange differences on the investment itself.  Here again, the relevant credits or debits are initially disregarded, but the exchange differences may be brought back into account (as capital gains or losses) on disposal of the hedged asset.

The second circumstance is where exchange profits or losses arising on translation of part of a company’s business from one currency to another are taken to reserves. This will happen where the results of an overseas branch, or other part of a company’s business that is conducted in a different currency, is incorporated into the company’s accounts using the closing rate/net investment method – CFM26200. This applies to the whole of the exchange difference thrown up by use of the closing rate/net investment method, not just the portion derived from translating loan relationships.

In addition, exchange gains and losses may appear in reserves if a company prepares its accounts in a presentation currency that is different to its functional currency.  In this case the tax rules override what is the accounts and the company must prepare its CT profits or losses by reference to its functional currency - CFM64210.

For both loan relationships and derivative contracts, the Treasury has power to prescribe through regulations that exchange gains or losses are disregarded, and where necessary are brought back into account.  These regulations are the Disregard Regulations (SI 2004/3256), which – among other matters covered – allow companies no longer using SSAP 20 to continue ‘forex matching’ for tax purposes.  Detailed guidance is at CFM62000 onwards.