CFM9376 - Taxing forex: bringing into account: statutory rule on order of matching

Statutory order of priorities

If a company disposes of an asset during an accounting period, it has to decide which liability matched, or partially matched, the asset being disposed of. The Regulations set out a statutory order of priority. Assets are matched by liabilities in the following order:

1. Assets that represent loan relationships (other than asset-linked securities within S93 FA1996) and ships/aircraft.
   
   
2. Assets on which CG would accrue (other than foreign business assets).
   
   
3. All

• assets within the substantial shareholdings exemption (TCGA92/SCH7AC) and assets potentially within the substantial shareholdings exemption if the company holds them for 12 months. Assets disposed of within 12 months are excluded from this category (and will therefore fall into category 2), and
• foreign business assets ( CFM9347).

This can be displayed graphically as follows.

It is helpful to think of all of a company's investments in foreign entities, denominated in a particular currency, as being in a column or silo, with loan relationships (and ships or aircraft) on the bottom, capital gains assets above them, and substantial shareholdings (and foreign business assets) on the top. Liabilities or currency contracts hedging those assets are placed alongside in a similar column.

In most cases, the hedging liabilities or contracts will be denominated in the same currency as the asset. But Reg 7(8) specifically allows a liability or contract to be treated as being in the same currency as an asset if it is denominated in a currency which provides an efficient hedge for the asset. Thus, in Example 2 at CFM9305a, Comtrek plc hedges its Hong Kong dollar denominated shareholding in Comtrek HK Ltd with US dollar borrowing. It would, for tax purposes, be able to match the US dollar borrowing with assets in a Hong Kong dollar silo.

If you visualise the company as having a column of assets and a column of liabilities for each currency where matching or partial matching is in place for accounting purposes, you match liabilities against assets from the bottom up.

The effect of the order of priorities is to maximise the number of cases in which a liability is fully matched, and a short method ( CFM9377) for computing aggregate gains or losses on the liability can be used.