INTM432130 - Schedule 28AA: how it works

FOREX: general

Exchange gains and losses are not directly subject to the transfer pricing regime because of ICTA88/SCH28AA/PARA8.

However, where there are non-arm’s length transactions, certain exchange gains and losses are to be disregarded. For accounting periods beginning after 30 September 2002 this is by virtue of a specific provision in the loan relationships rules (FA96/SCH9/PARA11A).

Inward loans

Where a company owes money, the exchange gains or losses on the debtor loan relationship are to be disregarded to the extent that a transfer pricing adjustment under Sch28AA would fall to be made in respect of any interest (or other outgoings or losses) on the debt. This is on the grounds that at arm’s length the loan would not have been made at all or would have been made in a lower amount. So, for example, FA96/SCH9/PARA11A will usually apply where a company is thinly capitalised.

The same adjustment to exchange gains and losses arises where all or part of any interest on the debt is to be treated as a distribution under ICTA88/S209(2)(da) or ICTA88/S209(2)(e)(vii).

But it is important to remember that not every debtor loan relationship on non-arm’s length terms comes within Sch28AA. For example, no adjustments to exchange gains and losses are made in respect of interest-free inward loans or where the amount of interest paid is below the arms length amount.

For further information see CFM9815.

Outward Loans

Where transfer pricing rules operate to impute interest (or a higher rate of interest) on the whole of an outward loan, all the exchange gains and losses will continue to be recognised in full. Exchange gains or losses on creditor loan relationships are to be disregarded only where, and to the extent that, the loan fulfils an equity function.

Note that, as far as outward loans are concerned, FA96/SCH9/PARA11A is not explicitly tied to the operation of ICTA88/SCH28AA.

For further information see CFM9820.

Loans for unallowable purposes

FA 2002 assimilated exchange gains and losses into the loan relationships regime and so the unallowable purposes rule at FA96/SCH9/PARA13 (see the Corporate Finance Manual at CFM6210+) now extends to exchange gains and losses on loan relationships for unallowable purposes.

For further information see CFM9820.

Treatment of loans [or derivatives] matching assets

Companies holding foreign assets may hedge their foreign currency risks by taking out matching loans[ or entering into currency swap contracts]. Guidance on the interaction between transfer pricing legislation and legistlation governing the treatment of exchange gains and losses on such loans or derivatives is given in INTM432135.

For accounting periods beginning on or before 30 September 2002.

FA93/S136 to FA93/S138 provide for the ring fencing of exchange losses on a loan or forward currency contract which is entered into otherwise than on arm’s length terms. Such losses are available for relief only against future exchange gains arising on the same loan or contract.

For outward loans where ICTA88/SCH28AA applies to impute interest or higher rate of interest any exchange losses will continue to be allowed in full.

Before financial instruments were brought within the loan relationship regime, losses on non- arm’s length transactions on financial instruments could be restricted under FA94/S167.