CFM2200 - Taxing FOREX: what's new

In this section you will find details of the major changes introduced to the FOREX legislation by FA2002.

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Scope and basic rules

Matching

Deferred gains

Convertible securities

Anti-avoidance

Transitional rules

Currency accounting

Click on here to returnScope and basic rules

The old rules for dealing with exchange differences on monetary assets and liabilities and currency contracts were set out in FA 1993. This has largely been repealed, and FA 1996 has been amended by FA02/SCH23 to assimilate FOREX into loan relationships. The new rules will apply to accounting periods beginning on or after 1 October 2002.

Although its aim was to align tax treatment with the accounts, the FA 1993 legislation laid down prescriptive rules - which operated independently of the accounts - for computing taxable credits or allowable debits that arose in respect of exchange differences.

These rules are now all gone, together with the associated terminology of qualifying assets and liabilities and so on. With them has gone FA96/SCH9/PARA4, which prevented exchange gains and losses from being treated as part of the profits, gains or losses arising on loan relationships.

Exchange gains and losses arising on loan relationships, and computed in accordance with an authorised accounting method, are now (with certain exceptions) treated as an integral part of whatever profits, gains or losses arise on the loan relationship. This has been achieved by inserting a new section FA96/S84A into the loan relationship legislation, and amending FA96/S85 which deals with the authorised accounting methods.

At the same time, FA96/S100 has been amended to introduce the concept of a S100 relationship. This is a money debt that does not arise from the lending of money. Exchange gains and losses, as well as interest, on S100 relationships are brought into account as if the debt were a loan relationship, thus ensuring that exchange differences on such things as trade debts continue to be taxable or relievable. Foreign currency held by a company is also brought in as a S100 relationship.

The loan relationship legislation goes on to treat

  • trading exchange gains or losses as Case I receipts or deductions, while
  • non-trading exchange gains and losses are aggregated with other non-trading amounts to arrive at the Case III profit or non-trading deficit.

Gains and losses arising on currency contracts now come within the derivative contract rules in FA02/SCH26.

The effect of these changes is to simplify the company’s tax computations - in most cases, the tax treatment of exchange gains and losses will match the accounts treatment - and to reduce the scope for artificial avoidance.

Guidance on the basic tax treatment can be found at CFM9200+.

Click on here to returnMatching

There are two major changes from the FA 1993 rules, both aimed at aligning tax with accounts.

The first concerns exchange differences arising on long-term loans made to a foreign subsidiary. Where such loans perform an equity function, exchange differences may be taken to reserves under SSAP20. The FA 1993 regime nevertheless required such exchange differences to be taxed or relieved. Now, FA96/S84A (3)(a) ensures that they are not recognised immediately. The exchange gain or loss is brought into account on disposal of the long-term loan.

The second concerns exchange differences on liabilities which hedge a company’s investments in overseas entities, where those exchange gains or losses are taken to reserves and matched with the corresponding exchange losses or gains on the assets. The tax treatment now simply follows the accounts. A matching election is no longer required as the rules are mandatory where the conditions are met.

The old matching regulations (SI3227/1994) have been replaced by new regulations (the Exchange Gains and Losses (Bringing into Account Gains or Losses) Regulations 2002). These set out how deferred gains or losses on matching liabilities are brought into account when there is a disposal of an asset.

Where exchange differences on a number of liabilities denominated in a particular currency, and on a number of assets, have all been taken to reserves, non-elective matching raises a problem of which liabilities should be regarded as matched to which assets. To simplify the issue, and to minimise the record-keeping burden on companies, the Regulations introduce a statutory order of priority when a deferred gain or loss is realised. It is attributed

  • first to loan relationship assets
  • second to assets giving rise to a chargeable gain or loss
  • third to assets treated as a substantial shareholding, or assets of foreign branches.

The new rules on matching can be found at CFM9300+.

Click on here to returnDeferred gains

Deferral relief under Sections 139 to 143 FA1993 is no longer available.

Any amount deferred at the end of the last accounting period within the FA 1993 rules is brought back into charge in the first accounting period beginning on or after 1 October 2002. However, the company can elect within 2 years of the end of that AP to spread the amount forward over 6 accounting periods instead. There are full details at CFM10000+.

Click on here to returnConvertible securities

S92/FA1996 is amended to include the exchange gains or losses arising on convertible securities, as well as interest.

The disposal of a convertible security is within the capital gains rules. Legislation is now needed to prevent double assessment or relief. Any accrued exchange losses that have been allowed under the loan relationship rules are added to the consideration disposal, and any accrued gains are deducted from it. See CFM9201a for full details.

Click on here to returnAnti-avoidance

FA 1993 contained anti-avoidance rules at Sections 135 to 138. These have been repealed along with the rest of the legislation. However, the unallowable purposes provision in FA96/SCH9/PARA13 now also applies to exchange gains or losses arising on loan relationships that are for unallowable purposes, which includes a tax avoidance purpose. Both exchange gains and exchange losses are ignored where the loan relationship is for an unallowable purpose.

There is a new provision at FA96/SCH9/PARA11A which results in exchange gains and losses being either wholly or partly disregarded in (almost exclusively) cross-border situations where either:

  • interest on an inward loan is, in whole or part, either treated as a distribution or adjusted under ICTA88/SCH28AA, or
  • the company has a creditor-loan relationship which is not on arm’s length terms, either because the loan would not have been made at all at arm’s length, or it would have been made in a lesser amount, and exchange gains and losses on the corresponding debtor relationship are not within the CT charge.

This provision will operate in some, but not all, cases where FA93/S136 previously applied. But it adopts a completely different approach from S136, and guidance and assurances given in relation to S136 and related provisions (for example, in the Explanatory Statement on FOREX and financial instruments issued by the Inland Revenue in 1994) do not apply to the new legislation.

See CFM9800+ for details.

Click on here to returnTransitional

Para 24, Sch23 FA 2002 prevents companies from shortening their accounting periods on or after 1 October 2001 in order to delay entry into the new regime. A company may want to delay because

  • an exchange gain would be larger
  • an exchange loss would be smaller

if taxed under the new rules.

For this to apply a company must have a shortened accounting period beginning on or after 1 October 2001 that ends before 30 September 2002. If the purpose of the shortened period is to avoid FA2002 changes, then the new rules will apply from the beginning of the accounting period beginning on or after 1 October 2001.

See CFM10000+ for details.

Click on here to returnCurrency accounting

The local currency rules in FA 1993 remain, but have been amended by FA02/SCH24 in order to clarify certain aspects and to align the rules more explicitly with GAAP. Companies can still compute their CT profits in a non-sterling currency where certain conditions are met. But these conditions are now more fully spelt out, and the position of companies with a non-sterling reporting currency which have branches that account in a different foreign currency, is clarified.

FA93/S94 previously determined the rate of exchange to be used when translating items, such as income and expenses, to which the FOREX legislation did not apply. With the repeal of the FOREX legislation, the rules have now been simplified and follow the principles of SSAP20. Two new sections have been substituted for S94: S94AA deals with translations made in accounts, and S94AB with translations into sterling where accounts are drawn up in a foreign currency.

Details are at CFM10500+.

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