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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

The major difference between exchange gains and losses and all other credits or debits from loan relationships or derivative contracts lies in the treatment of amounts taken to reserves.

CTA09/S328(3) provides that exchange gains and losses are not taxable or relievable 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) 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 allows 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.

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.