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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: FA 2009: ‘one way exchange effect’: example of application of the TAAR

Example: application of legislation to dual currency loan scheme

A company (HoldCo) hedges a US denominated shareholding with a dual currency loan, in the structure shown at CFM63010. HoldCo accounts in sterling, and prepares accounts to 31 December. HoldCo’s parent company (Plc) has borrowed externally in dollars. For simplicity, it is assumed that the whole of the amount borrowed is on-lent to HoldCo.

Diagram of structure

In year ended 31 December 2010, Plc and HoldCo roll over the dual currency loan (DLC) three times, with the following results:

Period Currency movement Tax result
     
1 January - 31 March Dollar weakens HoldCo does not exercise option to repay DLC in sterling. HoldCo has matched exchange gain on loan, Plc’s tax position is flat.
1 April - 30 June Dollar strengthens HoldCo exercises option and loan repaid in sterling. Plc has exchange loss on external borrowing, HoldCo has neither gain nor loss.
1 July - 30 September Dollar strengthens HoldCo exercises option and loan repaid in sterling. Plc has exchange loss on external borrowing, HoldCo has neither gain nor loss.
1 October - 31 December Dollar weakens HoldCo does not exercise option to repay DLC in sterling. HoldCo has matched exchange gain on loan, Plc’s tax position is flat.

The parties to the arrangement are Plc and HoldCo, and the elements of the arrangement in year ended 31 December 2010 are the external loan; each instance of the dual currency loan; and the shares in the subsidiary (on which, however, no taxable exchange gains or losses will apply). These arrangements include an option within the dual currency loan (see CFM63180, second bullet point), or alternatively, if the repayment currency is determined automatically by reference to exchange rates, the loan will be a relevant contingent contract.

Suppose that, for each dual currency loan, the option is exercisable (only) on the maturity date. 31 March, 30 June, 30 September and 31 December are all possible test days.

Consider the situation at 31 March. Between 1 January and 31 March, the dollar weakens by (say) 10%. For tax purposes, neither HoldCo nor Plc bring any exchange gains or exchange losses into account, so amount A is nil. What would happen if the dollar had depreciated by 10%? The loan would have been repaid in sterling, so that HoldCo would have neither exchange gain nor exchange loss, but Plc would have a loss on its external borrowing. So amount B would not be nil - it would be a negative quantity (an overall loss).

The matching rules are integral to this effect. If there were no matching, HoldCo would - in the actual scenario - have a taxable exchange gain on the dual currency loan. Looking at HoldCo and Plc together, there would be an overall ‘relevant exchange gain’ equal to the ‘relevant exchange loss’ in the counterfactual scenario. Both legs of the condition at CTA09/S328A(3) are therefore satisfied.

The arrangements also cause Plc to gain a tax advantage in the accounting period. If it had on-lent the funds to HoldCo through a ‘plain vanilla’ US dollar loan, it would have neither exchange gains nor losses in the period; as matters stand, it has losses in the periods to 30 June and 30 September that are unmatched by any exchange gains. All of the conditions in CTA09/S328(4A) are therefore satisfied. As a result, the exchange gains arising to HoldCo in the accounting period, which would otherwise be matched, are brought into account.