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HMRC internal manual

Corporate Finance Manual

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Other tax rules on corporate finance: Change of accounting policy: amounts excluded

Change of Accounting Practice: Regulation 3C

Certain debits and credits arising on a change of accounting policy are not brought into account under the Change of Accounting Practice Regulations, for any period. These are set out in Regulation 3C. These are in general amounts relating to derivative contracts that are embedded, or are hedging instruments and there is an interaction with the Disregard Regulations (see CFM57000). Regulation 3C(2) lists certain cases where the transitional adjustments are excluded. These are detailed below.

The Disregard Regulations also operate to initially exclude certain debits and credits on a change of accounting policy in respect of certain currency, debt and commodity contracts - see CFM57130 and CFM57200.

Derivative contracts in convertible securities (embedded derivatives)

Where a company

  • has a debtor relationship on a convertible or asset linked security;
  • was previously within FA96/S92A or FA96/S93 immediately before the company’s first period of account beginning on or after 1 January 2005; and
  • adopts a new accounting framework/policy whereby the company ‘bifurcates’ (separates) the loan and the option to convert for accounting purposes, FA02/SCH26/PARA16(3) (see CFM85030)

    Regulations 4 to 11 SI1994/3227 (see CFM86310)

    Regulation 4 SI2004/3256 (see CFM62680).

The company is required for tax purposes to apply the derivative contracts rules to the option. CFM81000 and CFM37500 has more on convertible and hybrid securities.

Debits and credits on the loan will not be brought into account, by virtue of Regulation 12 of the Disregard Regulations. Regulation 3C(2)(a) ensures that transitional adjustments on the embedded derivative are also not brought into account.

Derivative contracts that are embedded in a contract that is not a loan relationship

Derivative contracts that are embedded in a contract that is not a loan relationship are treated as closely related to the host contract for tax purposes. Such contracts (excluding interest rate contracts within Regulation 9 of the Disregard Regulations) are taxable in accordance with CTA09/S616 (CFM50430). Regulation 3C(2)(b) specifies that debits and credits that arise on the transition to a new accounting framework/policy on such contracts are never brought into account.

Interest rate hedges under Regulation 9 of the Disregard Regulations

Regulation 9 of the Disregard Regulations deals with interest rate derivative contracts used for hedging. Generally, these are cases where the loan relationship being hedged is accounted for at amortised cost and fair value amounts are not recognised in the accounts or brought into account for CT purposes (for example, in the case of connected party debt). Debits and credits on such contracts are brought in on an accruals basis. In effect, the tax treatment of such contracts under ‘old UK GAAP’ continues where Regulation 9 of the Disregard Regulations applies and there are no transitional debits or credits to spread. Regulation 3C(2)(c) therefore specifies that no transitional adjustments arising on such contracts are brought into account.

Regulation 3C(2)(ca) applies for accounting periods beginning on or after 1 January 2009 for derivative contracts where the underlying subject matter is wholly or partly currency. Debits and credits arising from such contracts could represent the reversal of exchange gains or losses which had not been brought into account for periods prior to the change in accounting policy by specific provisions. Such debits and credits are excluded by Regulation 3C, so preventing a company suffering from a double charge or gaining relief twice. The provisions involved are:

Loan relationships hedged by interest rate contracts

Regulation 3C(2)(d) applies where a foreign currency loan relationship is hedged by a derivative contract.

Where there is a change to a new accounting framework/policy:

  • From the loan relationship being accounted for at the rate implied in the contract - as a ‘synthetic sterling’ asset or liability; to
  • The derivative being brought onto the balance sheet at fair value and the loan relationship being translated at spot rate,

There will be two adjustments - the first to the derivative contract and the second to the loan relationship.

Where Regulation 9 of the Disregard Regulations applies, the adjustment to the derivative contract is effectively ignored, and Regulation 3C(2)(d) disregards the loan relationship adjustment as well.

Regulation 3C(2)(da) applies for accounting periods beginning on or after 1 January 2009 for loan relationships denominated in a currency other than the company’s functional currency. Debits and credits arising from such contracts could represent the reversal of exchange gains or losses which had not been brought into account for periods prior to the change in accounting policy by specific provisions. Such debits and credits are excluded by Regulation 3C, so preventing a company suffering from a double charge or gaining relief twice. The provisions involved are:

Interest rate hedges under Regulation 9A of the Disregard Regulations

Under Regulation 6(5) of the Disregard Regulations a company may elect out of Regulation 9 of the Disregard Regulations, so that the normal tax treatment of derivative contracts will apply to bring in fair value movements on designated interest rate hedges. Where a company elects out of Regulation 9, then Regulation 9A will apply to disregard for tax purposes the amounts recognised in the statement of equity (that is, the amount recognised as an effective hedge), until they are recycled to the income statement.

Regulation 3C(2)(e) exempts the spreading on transition amounts that have gone to reserves rather than income. It is aimed at the opening adjustments to the cashflow hedge element of shareholders’ equity reserves. This is because these amounts will subsequently be recycled through the income statement, potentially leading to double counting. Amounts that adjust the opening balance of the income statement or profit and loss can never be recycled and are therefore included in the 10 year spread (CFM76090).

Reversal of previous exchange gains and losses

Very occasionally an issue can arise where transitional adjustments represent the reversal of previous exchange gains and losses, typically where the company treats the loan as an equity instrument. The COAP Regulations (reg 3C(2)(ca) and reg 3C(2)(da)) provide that such transitional adjustments are not to be brought into account to the extent that those previous exchange gains or losses had been disregarded for tax.