CFM61170 - Foreign exchange: tax rules on exchange gains and losses: loan relationships and derivative contracts: special rules on fair value accounting: Exchange Gains and Losses Regulations

Applying the EGL Regulations

The Exchange Gains and Losses Regulations (SI 2005/3422) apply where

  • a loan relationship asset is accounted for as an available for sale asset, or
  • a loan relationship asset or liability is accounted for at fair value through profit or loss, or
  • where the asset or liability, or part of it, is the hedged item in a designated fair value hedge, and the risk being hedged is, or includes, exchange risk.

In each case, the regulations define the exchange gain or loss arising between two times. The times in question may be the beginning and end of an accounting period, but they do not have to be. For example, if in year ended 31 December 2006, a liability (accounted for at fair value through profit or loss) was matched with shares from 1 October 2006 onwards, we would be interested in the exchange gain or loss arising between 1 October and 31 December 2006.

Where a bond, loan note or similar asset is denominated in a currency that is not the company’s base currency, and is accounted for as an available for sale asset (see CFM21590), changes in the fair value of the asset attributable to currency movements will go through the profit and loss account. Fair value changes attributable to interest rate movements and other factors will be initially credited or debited to reserves, to be ‘recycled’ to profit and loss on sale, realisation or impairment of the asset.

In this case, the accounting treatment itself effects the necessary separation. The exchange gain or loss is the amount taken to profit and loss account (or income statement) that fairly represents the profit or loss attributable to exchange movements. There is an example at CFM61180.

Where the asset or liability is accounted for at fair value through profit and loss, it is the change in fair value between the two times in question that is attributable only to fluctuations in the spot rate of exchange between the currency of the asset or liability, and the company’s base currency.

In practice, it is acceptable for this amount to be determined on the same basis as for an available for sale asset, in other words by assuming - for the purpose of working out exchange gains or losses - that the loan relationship is accounted for on an amortised cost basis. See, again, the example at CFM61180.

If a loan relationship (or part of a loan relationship) is designated as the hedged item in a fair value hedge, the carrying value of the loan relationship will be adjusted through profit and loss for fair value changes attributable to the risk being hedged. Where the risk being hedged is exchange risk (and nothing else), the fair value changes taken to profit and loss will represent exchange gains or losses. Where more than one risk is being hedged - normally, where both exchange risk and interest rate risk are hedged - the exchange gain or loss will be that part of the fair value change which is attributable to fluctuations in the spot rate of exchange.