Foreign exchange: matching under the Disregard Regulations: ascertaining net asset value
What value is accorded to underlying assets and liabilities?
The net asset value underlying matched shares (shares in ‘company A’) is the value of the underlying assets, less the value of underlying liabilities, denominated in the relevant currency (CFM62750). In determining these values, two cases need to be considered: where the taxpayer company holds 100% of the shares in company A, and where it does not.
Company A is a wholly owned subsidiary
Suppose that the taxpayer company is seeking to match shares in company A, and A has direct or indirect subsidiaries X, Y and Z. If company A were to prepare consolidated accounts, such accounts would show the assets and liabilities of X, Y and Z (as well as the assets and liabilities of A itself), but would eliminate balances and substantially eliminate any transactions between A, X, Y and Z. (The effect of intra-group transactions is not wholly eliminated on consolidation if they are between companies with different functional currencies). Regulation 4A(3) provides that underlying net asset value at any time is determined by reference to these assets and liabilities which would appear in a notional consolidated balance sheet of company A, drawn up at that time.
If company A has no direct or indirect subsidiaries, and so would not prepare consolidated accounts, the net asset value is determined with respect to the single entity accounts that A prepares. In some cases where this applies, the taxpayer company may be able to demonstrate that the carrying value of these net assets is significantly higher in the consolidated accounts of a parent company, for instance as a result of acquisition accounting (see example 3 at CFM62770). It will, in such cases, be the carrying value in the consolidated accounts of the parent that determines the net asset value, not the value A’s single entity accounts - in line with regulation 4A(4).
‘Consolidated accounts’ has the meaning that it has for accounting purposes - regulation 2. Accounting principles will determine what is included in the consolidation. Some examples are given at CFM62770.
From a commercial viewpoint, what is important to a group of companies in determining its hedging strategy is its net investment in the foreign operation or foreign operations underlying the shares, as shown in the actual consolidated accounts of the group. So regulation 4A(4) directs the company, in determining whether an asset or liability would appear in company A’s notional consolidated balance sheet and, if so, what value would be accorded to it, to have regard to the accounting treatment of the asset or liability in consolidated accounts prepared by the taxpayer company or by any company controlling the taxpayer company.
This means that the taxpayer company, in ascertaining the value of net assets underlying matched shares, can take its cue from the actual group accounts. If, for example, the matched shares are in a US company (company A), the company doing the matching does not have to hypothesise that company A has prepared notional consolidated accounts under US GAAP. If the group prepares its consolidated accounts using IFRS, the taxpayer company must use IFRS when identifying and placing a value on the underlying net assets and liabilities.
The legislation does not, however, restrict the taxpayer company to using the group’s published accounts. Where for example the ultimate parent company is not UK resident, and the top UK company prepares unaudited consolidated financial statements for internal purposes, there is no bar to the taxpayer using such statements to arrive at a value for net assets underlying a shareholding.
For the avoidance of doubt, regulation 4A(5) makes it clear that this does not prevent intra-group transactions, which would be represented in consolidated accounts prepared by company A but would be eliminated on preparation of the overall group accounts, from being taken into account.
Company A is not a wholly owned subsidiary
Where the taxpayer company is not the sole shareholder in company A, the procedure described above applies with some modification. If for example the net assets underlying the shares in company A are valued at 100, but the taxpayer company holds only 60% of the ordinary shares in company A (and there are no other classes of shares), it is clear that the taxpayer company should only be able to match liabilities or derivatives up to a value of 60.
Thus regulation 4A(6) provides that if the company does not directly hold all of the issued shares in company A, the underlying net asset value is reduced by such amount as is just and reasonable, having regard to the proportion of the shares in A held by the taxpayer company, and the rights attached to such shares.
For example, suppose that the taxpayer company held all of the ordinary shares in company A, but another group company held redeemable preference shares issued by A, giving it no right to assets in a winding-up apart from the nominal value of the shares. It would be reasonable in such a case to attribute 100% of the value of the underlying net assets to the company that holds the ordinary shares, excluding only the nominal value of the preference shares. If a class of shares had some voting rights, but very limited rights to distributions and proceeds on liquidation, it would be appropriate to attribute almost all of the net asset value to other shares.