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HMRC internal manual

Corporate Finance Manual

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Foreign exchange: matching: bringing amounts back into account: examples of 'just and reasonable' approach

Cases where ‘net gain’ or ‘net loss’ must be ascertained in a just and reasonable manner

Three further examples (drawing on the same facts as at CFM62380) illustrate more complex circumstances where it is necessary to adopt a just and reasonable approach.

Example 4

The facts are as in Example 3 of CFM62380, but the associated borrowing is a constant $5 million.

As before, the first $3 million of the borrowing is regarded as matching the loan relationship asset. The remaining $2 million partially matches the chargeable gains assets. The company can compute the exchange loss to be brought into account upon disposal of the Fynvane A Inc shares in any manner that is just and reasonable.

It might be reasonable, having regard to the company’s hedging policy and the reasons for which the $5 million borrowing was taken out, to regard the Fynvane B Inc investment as being unhedged, so that the available $2 million is matched wholly with the Fynvane A Inc investment. This means that exchange losses arising on $2 million would be brought into account as an allowable loss in the period to 31 December 2005. The company would need to take a consistent view if there was a subsequent disposal of the Fynvane B Inc shares. This investment has been regarded as unhedged up to 1 July 2005, so no gains or losses relating to this period would be brought into account.

Alternatively, the company might regard the borrowing as partially hedging both the Fynvane A Inc and Fynvane B Inc investments, to an equal extent. Thus it would apportion the available $2 million equitably between the two shareholdings, bringing in exchange losses on $1,666,666 ($2,000,000 x 2.5 / 3) of the liability on disposal of the Fynvane A Inc shares. Again, it would need to take a consistent view on any future disposal of the Fynvane B Inc shares.

Example 5

The company disposes of the shareholding in Fynvane A Inc on 1 July 2005. It has hedged its total US dollar investments in foreign entities by a revolving credit facility, on which there have been advances and repayments as follows:

Date Advance (repayment) Balance
     
1 January 2003 $5,000,000 $5,000,000
1 July 2003 ($500,000) $4,500,000
1 December 2003 ($2,500,000) $2,000,000
1 January 2004 $8,000,000 $10,000,000

 

Fynvane Ltd decides it would be just and reasonable to match the liability to the shareholding in Fynvane A Inc in priority to that in Fynvane B Inc.

In the year to 31 December 2003, the first $3 million of the borrowing is matched to the loan relationship asset, and the balance to the Fynvane A Inc shares. Total exchange losses of (say) £150,000 were taken to reserves in the year. It is possible to determine how much of that figure relates to borrowings matched to the shares disposed of, by calculating the losses matched to the loan relationship asset, and subtracting them.

Suppose that the exchange rate at 1 December 2003 is $1.55/£, and at 31 December 2003 it is $1.58/£. The exchange loss on that portion of the borrowing matched to the loan relationships asset is found by computing the exchange difference on a loan of variable amount that starts at $3 million and reduces to $2 million on 1 December 2003:

Sterling equivalent of $3 million at 1 January 2003 ($1.6/£) £1,875,000
   
Less sterling equivalent of $1 million at 1 December 2003($1.55/£) ( 645,161)
Less sterling equivalent of $2 m balance at 31 December 2003($1.58/£) (1,265,823)
Exchange loss (£ 35,984)

 

Thus the exchange loss applicable to that portion of the borrowing matched to the Fynvane A Inc shares is £150,000 - £35,984 = £114,016.

In the period 1 January 2004 to 1 July 2005 the Fynvane A Inc shares are fully matched, so the exchange loss on the matching liability arising in this period is:

$2 million at 1 January 2004 ($1.58/£) £1,265,823
   
$2 million at 1 July 2005 ($1.45/£) £1,379,310
Exchange loss £ 113,487

 

The total exchange loss, to be brought into account as an allowable loss, is therefore

£114,016 + £113,487 = £227,503.

Example 6

The facts are as in Example 5 above. On 31 December 2006, Fynvane Ltd disposes of both the loan relationship asset and the shares in Fynvane B Inc. The borrowing under the revolving credit facility remains at $10 million until 31 December 2006. The exchange rate at 31 December 2006 is $1.65.

The loan relationship asset has been fully matched from 1 January 2004 to 31 December 2006. For this period, the exchange gain to be brought in on disposal under Reg13, and the loss on the matching borrowing, will be self-cancelling (as in Example 1 above). For the year ended 31 December 2003, an exchange gain arose on the permanent as equity loan:

$3 million at 31 December 2003 ($1.58/£) £1,898,734
   
$3 million at 1 January 2003 ($1.60/£) £1,875,000
Exchange gain £ 23,734

 

The loss on the borrowing matched to the loan relationship asset, in the same period, was £35,984 (see Example 5 above). Thus a net £12,250 loan relationships debit is allowable in the year to 31 December 2006.

On the just and reasonable view taken on the 2005 disposal, the Fynvane B Inc shares were unmatched in the year to 31 December 2003, but have been fully matched thereafter. Thus an exchange gain arises on the hedging liability:

£500,000 at 1 January 2004 ($1.58/£) £316,456
   
£500,000 at 31 December 2006 ($1.65/£) £303,030
Exchange gain £ 13,426

 

This will be brought in as a chargeable gain in the year to 31 December 2006.