Foreign exchange: matching under the Disregard Regulations: currency of foreign operation
‘Denominated in the relevant currency’
A taxpayer company’s commercial objective will be to hedge its exchange exposure arising from its investment in foreign operations. A ‘foreign operation’ may be a branch or a direct or indirect subsidiary (or a branch of such a subsidiary) that has a different functional currency from the taxpayer company.
The regulations refer to assets and liabilities denominated in the relevant currency. ‘Denominated in’ is not defined, and in HMRC’s view the currency denomination of an asset or liability will normally be defined by the functional currency of the environment of the business operation within which the asset or liability is located. Thus, in the appropriate context, the currency in which a monetary item is regarded as ‘denominated’ may differ from its nominal currency.
Where the taxpayer company holds shares in ‘company A’, there may be more than one foreign operation underlying those shares. For example, ‘company A’ may itself have a functional currency of US dollars (i.e. its business operations are conducted in a US dollar currency environment), but have two subsidiaries, one also having a dollar functional currency (company X) but the other operating in Euros (company Y). If the taxpayer company is hedging its US dollar exposure, regulation 4A seeks to identify and value the underlying US dollar assets and liabilities - in other words, the assets and liabilities of X will be included as well as those of A itself, but not those of Y. The underlying assets and liabilities held by company Y will be regarded as denominated in Euros.
The assets and liabilities, whether monetary or non-monetary, of a company with (for example) a US dollar functional currency should generally be regarded as ‘denominated’ in US dollars. Particular scenarios are discussed in more detail below.
- Where a company has a branch with a functional currency that differs from that of the main or ‘head office’ business operations of the company, the assets and liabilities of that branch are not ‘denominated in the relevant currency’ - thus, in the example above, if company X had a branch conducting business in Canadian dollars, its assets and liabilities would be excluded from the tally of underlying US dollar denominated items and would be regarded as denominated in Canadian dollars.
- Where a company (say company X above) carries on business in a US dollar environment, it may still have sales or expenses priced in other currencies and related payables or receivables, which may or may not be hedged into US dollars. So long as the business is regarded as a foreign operation conducted in a US dollar environment, the payables and receivables will still be regarded as denominated in dollars and there will be no need to undertake a detailed dissection of the accounts of company X to determine some other nominal currency in which the assets and liabilities are denominated. This is consistent with the economic risk being hedged. If the group prepares consolidated accounts in sterling, exchange differences relative to the US dollar, arising from the operations of company X, will be reflected in the income statement or profit and loss account. However, exchange differences between the US dollar and sterling will be reflected in equity (in the cumulative translation reserve), and it is the economic exposure to that currency (the US dollar) that is intended to be hedged by a net investment hedge.
- Equally, the US dollar functional currency foreign operations of company X might be funded by borrowing in some other currency and swapped into US dollars by a cross-currency swap. In these circumstances the borrowing and swap would be regarded as denominated in US dollars.
- Exceptionally, a significant financial asset or liability denominated in some other currency might need to be excluded. Thus in the example, if X had advanced debt of SFr 500 million to another member of the group in a different ownership chain (and this was a large amount in the context of X’s balance sheet, and was not swapped into US dollars), it would be necessary to consider whether such an activity was, in reality, part of the X’s US dollar operations, or whether it was in effect a separate foreign operation with a Swiss franc functional currency. In the latter case, the debt asset would not fall to be taken into account under regulation 4A where the ‘relevant currency’ is US dollars. However, such a situation would be exceptional, and nothing in the legislation should be taken as compelling companies to exclude financial assets or liabilities in some different currency where these have an immaterial effect on the taxpayer company’s exposure to the ‘relevant currency’ or where they are clearly part of the company’s normal trading or business operations. HMRC staff should consult CT&VAT (Financial Products) in any case where they believe that particular assets or liabilities should be excluded under this paragraph.
Having identified the assets and liabilities concerned, it is necessary to place a value on them. This is explained at CFM62760.