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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Old rules: derivative contracts: transitional provisions: Para 4A examples

Example of how Para 4A operated

Example 1

A company prepares annual accounts to 31 January. On 28 January 2005, it bought exchange- traded futures contracts over the FTSE 100 index for £600,000. The contracts were held speculatively (but not as trading stock), and the company marked them to market in its accounts. At 31 January 2005, the mark to market value was £550,000.

On 2 April 2005, the company closed out the futures by entering into equal and opposite contracts. The value of the contracts on 2 April was £630,000.

The contracts were ‘financial futures’ to which TCGA92/S143 applied, and were therefore chargeable assets for the purposes of FA02/SCH26/PARA4A. Since SI 2005/646, which removed shares from the list of excluded subject matters, applies to accounting periods beginning on or after 1 January 2005, the equity futures are treated as derivative contracts throughout the whole of the accounting period 1 February 2006 to 31 January 2007.

SI 2005/646 also introduced Para 4A and, since the Order came into force on 16 March 2005 and cannot have retrospective effect, it could not provide for a deemed disposal before that date. So the futures were treated as having been disposed of for CG purposes on 16 March 2005, but for a consideration of £550,000 - their accounting value at 31 January 2005.

The £550,000 was treated as a payment received by the company and hence as disposal consideration under TCGA92/S143(6). The costs of £600,000 were treated as incidental costs of disposal. A capital loss of £50,000 therefore arose. (Note that, had there been a gain, there would be no indexation allowance - see CG56084). This was treated as arising on 2 April 2005: the company effectively ceased to be party to the contracts when it closed them out, although this may not be the legal position.

Under Sch 26, a credit of £80,000 arose - the value of the contract when it was closed out, less its accounting value at 1 February 2006. The company cannot set off its capital loss against this credit.

Example 2

The facts are as in example 1, except that the company closed out the contracts on 2 March 2005.

Since the contracts were not held on 16 March 2005, the amendments to Sch 26 made by SI 2005/646 have no application. The futures remained chargeable gains assets throughout, and any profit or loss when they are closed out was dealt with under TCGA92/S143.

Example 3

The facts are as in example 1, except that in its accounting period to 31 January 2005, the company accounted for the contracts at historic cost. On 1 February 2005, the company adopted FRS 26 for the first time, and began to account for the derivatives at fair value. In its accounts to 31 January 2006, it brings in a debit of £50,000 as a prior year adjustment, representing the difference between cost (£600,000) and fair value on 1 February 2005 (£550,000).

As in example 1, the company was deemed to have disposed of the contract on 16 March 2005. The deemed disposal value was £600,000, its accounting value on 31 January 2005. Thus neither a capital gain nor a capital loss arose.

The fair value increase of £80,000 between 1 February and 2 April was, again, brought in as a derivative contracts credit. The prior period adjustment gave rise to a debit of £30,000 (FA02/SCH26/PARA17B (1)). This is, however, subject to the spreading provisions of the Change of Accounting Practice regulations (CFM76060).