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HMRC internal manual

Corporate Finance Manual

Foreign exchange: matching under the Disregard Regulations: why special rules are needed

Special rules needed

Special tax rules are needed to make this work because shares and loan relationships are normally taxed in a different way. An exchange gain or loss on a loan relationship is taxed each year whilst the exchange gain or loss on the shares is taxed, if at all, on disposal. In practice, many share disposals will not constitute chargeable gains because of the substantial shareholding exemption.

For a company that continues to account in accordance with “old UK GAAP”, SSAP 20 permits the exchange gain or loss on the liability to be taken to reserves to the extent that it can be set off there against the exchange gain or loss on the matched asset. So in the above example, the exchange gain on the loan, £13,584 would be set off against the exchange loss on the asset, £13,584 in reserves in line with SSAP 20. Nothing would be brought into account for tax purposes in respect of these exchange movements until disposal, if at all.

These rules do not work under International Accounting Standards and their UK equivalents.

A foreign operation may take the form of a branch of a company, in which case IAS 39 hedging is permissible in the individual accounts of the company.

But with this exception, hedging of a net investment in a foreign operation is permissible only in consolidated accounts. In the case of a foreign operation that takes the form of a subsidiary, IAS 39 does not allow hedging of the net investment at single entity level (unlike under SSAP 20). Therefore there is no special accounting treatment adopted and no way of seeing from the accounts

  • whether matching of assets with liabilities is intended, or
  • how much of an exchange difference arising on a liability should be offset against exchange differences on one or more assets.

A company may designate a fair value hedge under IAS 39 of the shares at single entity level. But because the rules for hedge designation are strict this may not always be possible. For more on fair value hedges see CFM27110.

During consultation, companies indicated that, despite the change in accounting treatment, they wanted to continue matching for tax purposes at single entity level in line with their economic intentions. Most companies will wish to hedge in order to avoid an unpredictable impact on their business through foreign exchange movements, and where hedging achieves a ‘balanced’ commercial position, it is reasonable for this to be reflected in the company’s tax position.

The rules to allow this are contained in The Loan Relationships and Derivative Contracts (Disregard and Bringing into Account of Profits and Losses) Regulations 2004 - SI 2004/3256 as amended by SI2005/2012, SI2005/3374, SI2006/3236, SI 2007/948 and SI 2007/3431. These are generally collectively referred to as the ‘Disregard Regulations’.

Regulation 3 (CFM62630) deals with loan relationship matching and regulation 4 (CFM62680) deals with derivative contract matching.

The broad aim is to preserve matching treatment for tax purposes in circumstances where it was permitted under SSAP 20.

For companies still using SSAP 20, CTA09/S328(3) and CTA09/S606(3) continue to operate to provide tax matching. See CFM62200 onwards for those rules. For such companies therefore there is generally no need to apply the Disregard Regulations to match foreign exchange movements - the primary legislation takes priority.

For background on the history of matching for tax purposes see CFM62220.