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HMRC internal manual

Guidance on Real Estate Investment Trusts

Property rental business income: loan relationships and derivative contracts: interpretation

Hedging - IAS designation and hedging relationships

If the company has, in its accounts, designated all or part of a derivative contract as a hedge, that designation is conclusive in determining whether, and to what extent, the contract is hedging (section 599(4)(b) CTA 2010).

Where the contract does not meet IAS requirements for designation as a hedge, it may nevertheless be accepted as ‘hedging’ for the purposes of section 599(3)(b) CTA 2010. HMRC will accept that a derivative contract is hedging if it operates as a cash flow or fair value hedge in accordance with the criteria for a ‘hedging relationship’ to exist, as defined in regulation 2(5) of the 2004 Loan Relationships Disregard Regulations. Derivatives are explained in the Corporate Finance manual at CFM13000 onwards.

Property derivatives

Company C (a UK-REIT) may, as part of its business strategy, decide it wants exposure to shopping centres. To put that strategy in place, C may decide to acquire a property derivative that gives exposure to that sector for the length of time between deciding the strategy and buying some shopping centres.

Where the derivative is in relation to funds awaiting first investment in property, it will not be hedging in relation to C’s property rental business, because until the shopping centre is acquired, no asset of the property rental business exists.

The derivative may be taken out as part of a strategy to switch an existing property portfolio from say commercial to shopping centres. Provided the commercial property was part of C’s property rental business, and the derivative comes within the meaning of ‘hedging’ then the property derivative will be hedging in relation to C’s property rental business.

Hedging derivatives normally get capital gains treatment under sections 640 and 641 CTA 2009. But the section 599(3) CTA 2010 set-aside overrides sections 640 and 641 CTA 2009, and the gains or losses are within the property rental business in the same way as ‘income’ property derivatives.