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HMRC internal manual

Corporate Finance Manual

Foreign exchange: matching under SSAP 20: how the legislation developed

History of matching

Before FA 1993, exchange gains and losses on both shares and long-term loans were ignored for tax purposes until disposal. On disposal any exchange gains and losses on the shares would be taken into account in the CG computation. The loan would have been a ‘nothing’ and any exchange gains and losses arising on it would never have been recognised for tax purposes.

The case of Pattison v Marine Midland Ltd (57TC219) led to a major change in the tax treatment of matched foreign exchange gains and losses. In this case, a bank operating internationally aimed to stay matched in each foreign currency it used in order to minimise its exposure to exchange gains and losses. In the accounts at each balance sheet date the foreign currency assets and liabilities were retranslated into sterling. To the extent that the foreign currency assets and liabilities were matched, exchange gains and losses were netted off in reserves. Only exchange gains and losses on unmatched foreign currency liabilities were taken through the profit and loss account.

The Revenue wanted to override the accounting treatment for tax purposes and bring into charge the exchange profits on the asset side of the transaction (lending to customers). The loss on the liability side (subordinated loan stock) was not allowable, the Revenue argued, because the loan stock was on capital account. The Revenue lost the case. The thrust of the decision was that the company had carefully matched its assets and liabilities to avoid fluctuations caused by exchange rate changes. The Revenue was seeking to tax the company as though it had not taken these precautions. The Courts decided this was not justified.

SP1/87 was issued, after extended consultation, to clarify acceptable practice on matching. This statement no longer applies to companies and was revised in 2002 to reflect this, although it still applies for non-corporates (BIM39521). For companies there followed a full review of the taxation of foreign exchange that led to the enactment of the forex rules in FA 1993.

FA 1993 changes

The rules brought in by FA 1993 removed the capital/revenue divide for foreign exchange gains and losses. Exchange movements on a loan were taxed within the new forex regime but a potential tax mismatch arose because the matched gain or loss on shares would not be taken into account until there was a disposal of the shares, whereupon exchange differences would be reflected in the capital gain.

The solution adopted was elective matching. The Exchange Gains and Losses (Alternative Method of Calculation of Gain or Loss) Regulations 1994 applied to accounting periods beginning on or after 23 March 1995. In certain circumstances companies could elect to follow the accounts for tax purposes where assets and liabilities were matched. Exchange gains and losses on the liability were deferred, and only brought into account when there was a disposal of the matched asset.

From 1 October 2002

The primary legislation makes matching mandatory for taxation purposes if used in the accounts in accordance with GAAP. So the rules apply without election, unlike the previous regime. Transitional rules apply in relation to assets disposed of on or after 1 October 2002 which had been the subject of elective matching before that date (see CFM86230).

The mandatory matching rules are included in ‘The Exchange Gains and Losses (Bringing into Account Gains or Losses) Regulations 2002’ (SI 2002/1970), which apply for accounting periods beginning on or after 1 October 2002. These Regulations deal with bringing exchange gains or losses on matched liabilities into account. In order to do this, they have to set out rules for determining which assets and liabilities are regarded as matched. CFM62370 gives further guidance on exchange differences that are disregarded, and CFM62270 onwards deals with bringing amounts into account.

From 1 January 2005

In periods of account beginning on or after 1 January 2005, companies may account for foreign currency transactions under IAS 21 or FRS 23, rather than SSAP 20. If they do so, exchange gains or losses on liabilities or derivatives continues to be disregarded where, in economic terms, the liability or derivative hedges exchange risk arising from shares, ships or aircraft. But the disregard comes about as a result of the Disregard Regulations (SI 2004/3256), rather than through the operation of CTA09/S328(3) or CTA09/S606(3) - see CFM62600 onwards.