The following Tax guidance note provides comprehensive and up to date legal information covering:
The derivative contracts rules:
form a self-contained, exclusive, regime for the taxation of a company's income, profits and gains (and relief for losses) arising from its holdings of derivative instruments, and
are, broadly, applied to what generally accepted accounting practice (GAAP) recognises as derivative financial instruments
A company may trade in derivative instruments but it is more usual to encounter derivative contracts which are held either as investments or as instruments intended to mitigate (ie hedge) a risk or potential liability exposure of the company.
Derivative contracts can be used to:
smooth volatility (eg in interest rates or currency), and/or
to give certainty to a company in respect of its financial position
especially in relation to future liabilities (eg a gas company which contracts to buy its future supplies at an agreed fixed price irrespective of movements in the market price of gas between the date of the contract and date of actual purchase).
A derivative will generally achieve this by fixing the rights and obligations of the parties under the contract to the fluctuations in the price or value of some underlying property, index or other factor (ie the 'underlying' is the reference point for calculating the receivables and payables under the contract)—broadly speaking, one party will assume the risk of such fluctuations in exchange for fixing the exposure of the counterparty.
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