Derivative contracts

By Tolley

The following Corporation Tax guidance note by Tolley provides comprehensive and up to date tax information covering:

Derivative contracts
Introduction
Overview of the legislation
Definitions
Basis of taxation
Connected party transactions
General anti-avoidance measures
Derivative contracts taxable on a chargeable gains basis

The taxation of derivative contracts tends to make tax practitioners nervous unless they are experienced in the financial markets. However, the tax rules governing the basic derivative contracts used in day-to-day treasury transactions (eg forward currency contracts and interest rate swaps) are relatively straightforward. This guidance note steers readers through the rules and provides an overview of the main provisions and their practical application. It includes comments on the main definitions, the basis of taxation and the core anti-avoidance rules.

Embedded derivatives, particularly convertible securities, are more complex and are the subject of a separate note. See the Embedded derivatives guidance note.

Special reliefs and exemptions, notably where derivative contracts form part of a company’s hedging arrangements, are also covered in a separate note. See the Hedging interest expense guidance note.

There is useful HMRC guidance on the commercial background to derivatives at CFM13000 onwards.

For HMRC’s guidance on the application of the tax rules, see CFM50000.

Finally, following the OECD’s work on Base Erosion and Profit Shifting (BEPS), there have been significant changes to the treatment of tax interest and similar amounts (including certain derivatives) under the corporate interest restriction (CIR) provisions, which restrict the amount of financing amounts that can be deducted for corporation tax purposes from 1 April 2017. See below for further details.

Introduction

The regime governing the taxation of derivative contracts is found in CTA 2009, ss 570–710 (Pt 7). Apart from some of the more complex rules governing convertible securities and other embedded derivatives, the rules follow the same principles as the loan relationship regime. It is an accounts based income regime, ie unless there is an express provision to the contrary, the amounts recognised in the statutory accounts of the company are taxed as income rather than capital.

For accounting periods beginning before 1 January 2016, the general rule was