CFM96070 - Interest restriction: group-interest: derivative contracts: overview

Relevant derivative contracts

TIOPA10/S412(2)

Relevant income and relevant expense amounts include profits and losses from relevant derivative contracts. These relevant derivative contracts are derivative contracts whose underlying subject matter consists of the following:

  • interest rates
  • an index determined by reference to income or retail prices
  • currency
  • loan relationship asset or liability
  • any other subject matter that is subordinate in relation to the others specified or of small value in comparison with the whole.

Examples of relevant derivative contracts would typically include interest rate swaps, cross currency swaps, currency forwards, retail prices index (RPI) swaps and credit default swaps.

Amounts of exchange gains and losses, impairment losses and amounts in respect of non-finance related derivatives are excluded from being relevant income and relevant expense mattes.

TIOPA10/S411(1)(e),(2)(d)

It is possible that groups use relevant derivative contracts in a way that is totally unrelated to the financing structure. As a result, relevant income and relevant expense amounts will not include amounts from relevant derivative contracts where:

  • the derivative hedges risks arising in the ordinary course of a trade (other than risks arising in the ordinary course of a financial trade), and
  • the derivative was entered into wholly for reasons unrelated to the capital structure of the worldwide group, or any member of the worldwide group.

Example

TradeCo Ltd enters into a currency forward to hedge its costs of buying stock which are priced in US dollars (USD). The contracted amounts under the forward do not relate to the company or the group’s borrowings. Although the currency forward is a relevant contract (being a contract over currency), amounts arising from the contract are excluded from net group-interest expense. Instead, all amounts on the contract recognised as items of profit or loss in the group’s financial statements are included in group-EBITDA.

Application of the Disregard Regulations

In calculating the amounts of net group-interest expense and group-EBITDA any amounts of fair value movements arising on derivative contracts that have a hedging function are removed. Instead, the amounts from those derivative contracts should be recognised in line with the hedged item. This is achieved through the application of the Disregard Regulations (SI2004/3256) to adjust the amounts recognised in the group’s financial statements.

This provision is intended to limit the potential mismatch between amounts taken into account in computing a UK group company’s tax-interest amounts or tax-EBITDA and the corresponding amounts taken into account in computing the worldwide group’s net group-interest expense or group-EBITDA. It is also intended to reduce the potentially distortive effects of fair value movements from the calculation of the group ratio arising from derivatives that fulfil a hedging function.