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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Foreign exchange: matching: anti-avoidance: ‘one-way bet’ schemes: options

Regulation 5 ceases to have effect from 22 April 2009

Regulation 5: option schemes

Regulation 5 counters a disclosed ‘one-way forex bet’ scheme that relies on a disparity of tax treatment between currency options and options over foreign currency denominated treasury bills.

In the scheme, a company (‘Company A’), which accounts in sterling and wishes to hedge its forex exposure in respect of an investment in a subsidiary:

  • Grants a call option to another group member (‘Company B’) over US dollar treasury bills - so that if the dollar strengthens, the price of US dollar denominated bills will rise, and Company B will exercise the option (so that Company A makes a loss, effectively overpaying for the bills).
  • Acquires a put option over US dollars - so if the dollar weakens below the strike price of the option, Company A will exercise its option (and so make an economic profit selling the dollars for more than their market value).

Thus Company A makes a commercial profit if the dollar weakens, and a loss if it strengthens. Company A can use the combination of instruments to hedge shares in a company with a US dollar functional currency. This means that, under SSAP 20, gains or losses on the options are taken to reserves.

For tax purposes, however, only the gain on the put option - if the dollar weakens - falls within FA02/SCH26/PARA16(3)(a), and is disregarded. If the dollar strengthens, and Company A has a loss because the call option is exercised against it, the loss is claimed as allowable because it does not arise on an option ’whose underlying subject matter consists wholly or currency’ - it is therefore outside of Para 16(3)(a).

Regulation 5 will apply where an arrangement satisfies four statutory conditions.

  • A company must be party to two or more derivative contracts under an arrangement to hedge a currency risk.
  • The contracts, when taken together, must be intended to act as a hedge of that currency risk.
  • The arrangements must be such that, if a profit arises on at least one of the derivative contracts, the profit would fall within FA02/SCH26/PARA16(3); but if a loss arose on at least one of the contracts, it would not fall within that sub-paragraph.

The loss mentioned in the bullet point above must arise on a derivative contract that is an option.

Where all these conditions are satisfied, any loss on the option is disregarded in determining the company’s taxable profit or loss.