OT22110 - Interest and Financing

Swaps and other Hedging Instruments SP14/91

Companies may enter into a wide range of financial transactions designed to hedge their exposure on financing costs. These can include interest rate swap agreements, interest rate cap or collar agreements, forward rate agreements, interest rate option contracts and currency swap agreements.

These are aimed at fixing what would otherwise be variable costs or to limit the size of potential losses. Statement of Practice No. SP14/91 (Tax Treatment of Transactions in Financial Futures and Options) at Para 7 reads:

" However, a financial future or options transaction which is clearly ancillary to a trading transaction on current account will give rise to trading profits or losses... "

This paragraph refers to upstream oil companies as much as to other trading companies. Thus payments and receipts treated as Case I items by the Statement of Practice would be so treated for upstream oil companies and dealt with within or without the ring fence according to whether the related borrowing was or was not within ICTA88/s494.

The same principle would apply to financial instruments that restrict losses on exchange rate exposure. In addition it may be necessary to consider whether the related borrowing was on capital or revenue account. If it is capital borrowing then the related costs or receipts of the swap will be treated as capital costs or receipts and therefore not allowable Case I even if they are inside ring fence. It may be appropriate to consider the case of Beauchamp v F W Woolworth Ltd (61TC542) as a starting point in deciding whether the borrowing is on capital or revenue account.

The Statement of Practice also refers to a trader hedging against changes in the price of raw materials. Where such transactions are clearly ancillary to a ring fence trade any profits or losses should be taken into account in computing ring fence income.