CFM16550 - Transition to IAS: the Change of Accounting Practice Regulations: amounts not brought into account

Change of Accounting Practice: Regulation 3C

This guidance describes the treatment of loan relationships and derivative contracts in accounting periods beginning on or after 1 January 2005.

Certain debits and credits arising on a change from UK GAAP to IAS 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 CFM13250+). Regulation 3C(2) lists five cases where the transitional adjustments are excluded.

Derivative contracts in convertible securities

Where a company had a debtor relationship on a convertible security (i.e. had issued convertible debt) and was previously within FA96/S92A, then if on adoption of IAS or FRS 25 and 26 for accounting purposes the company separates the loan and the option to convert, FA96/S94A(2)(b) requires that the company applies the derivative contracts rules to the option to convert.

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 not embedded in loan relationships

Derivative contracts that are embedded in a contract that is not a loan relationships contract 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 FA02/SCH26 paragraph 45(L) (see CFM13552). Regulation 3C(2)(b) specifies that debits and credits that arise on the transition to IAS 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 IAS accounts or brought into account for CT purposes (for example, in the case of connected party debt) – CFM13288+. 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.

Loan relationships hedged by interest rate contracts

Regulation 3C(2)(d) applies where a foreign currency loan relationship is hedged by a derivative contract. Before transition, the loan relationship is likely to have been accounted for at the rate implied in the contract – as a ‘synthetic sterling’ asset or liability. On transition there will not only be an adjustment to the derivative contract, to bring it on to the balance sheet, but also to the loan relationship to retranslate it from the contracted rate to the spot rate. 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.

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 ( CFM13302), so that the normal tax treatment of derivative contracts under FA02/SCH26 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 ( CFM16545).