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HMRC internal manual

Corporate Finance Manual

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Foreign exchange: accounts drawn up in a foreign currency: part of a business

CTA10/S9 -Translation of accounts for part of a business into the presentation currency

Under IAS 21 (or FRS 23), where a non-UK resident company carries on a trade in the UK through a permanent establishment and the non-UK company prepares its accounts in a currency other than sterling, the profits and losses of the permanent establishment after capital allowances and any other adjustments required by the Corporation Tax Acts are calculated in the foreign currency and the resulting profit or loss is translated into sterling. This applies to profits or losses calculated in accordance with GAAP so includes profits or losses from a trading or rental business, loan relationships, derivative contracts and intangible fixed assets. It excludes capital gains, foreign dividends etc, which are calculated in sterling.

The balance sheet of the foreign currency branch is also re-translated each year. Any exchange differences arising on the re-translation will be taken to the statement of changes in equity and disregarded for tax purposes by CTA09/S328(3).

This is different to the positions before 2005, when there was an explicit rule at FA93/S93A that applied where

  • a company accounted in one currency but its results incorporated the results of part of its business carried on in a different currency, or
  • the UK permanent establishment of a non-resident company prepared its return of accounts in one currency using financial statements prepared in a different currency.

Usually in such cases, the company kept part of its books in one currency and consolidated the results into its accounts (prepared in another currency) using the closing rate/net investment method. The tax rules at FA93/S93A essentially incorporated these accounting rules in legislation for the avoidance of doubt (CFM86150).

Example

Kanweb Ltd is a company operating in the UK through a permanent establishment that keeps books in different currencies for various discrete parts of its business. Its functional currency is the Euro but it also keeps a US dollar book and a Swiss Franc book. Accounts for the entity as a whole are prepared in Euros. The accounting date is 31 December. The company has adopted IAS 21. In accounting period ended 31 December 2010 there are the following results

The Euro accounts show a profit before adjustments of €1.98m made up as follows:

   
     
Main business 1,200,000  
US dollar results translated into Euros 495,360 (translated from $600k at $1:€ 0.8256)
Swiss Franc results translated into Euros 290,835 (translated from SFr 450k at SFr 1:€0.6463)
Total result 1,986,195  

There is disallowable expenditure of $75,000 in the US dollar book and capital allowances of SFr 25,000 on the Swiss Franc book. There are also capital allowances on the main business of €80,000.

As the entity as a whole has a functional currency of Euros and accounts in that currency, CTA10/S9 applies. The profit is therefore calculated for tax purposes in Euros and then translated into sterling.

The company should therefore take the US dollar result and the Swiss Franc result, adjust for any unallowable expenditure, deduct capital allowances and then translate it into Euros for tax purposes, as follows:

Main business
€1.2m less €80,000 €1,120,000
   
  Dollar book
$600,000 plus $75,000 = $675,000 $675,000 @ 0.8256 = €557,280
  Swiss Franc Book
SFr 450,000 less SFr 25,000 = SFr 425,000 SFr 425,000 @ 0.6463 = €274,678  
  Total Euro Case I € 1,951,958
  Translate into sterling at average rate for year 0.68 £1,327,331

If, the return is in sterling, those figures are used for tax purposes in accordance with CTA10/S5 provided they are prepared in line with generally accepted accounting practice.