Hedging interest expense

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

  • Hedging interest expense
  • Introduction
  • The Disregard Regulations
  • Interest rate contracts ― Regulation 9
  • Interest rate contracts ― Regulation 9A

This guidance note provides assistance with the rules governing the taxation of derivative contracts that are used to hedge monetary assets and liabilities. See the Derivative contracts guidance note for more general information on the taxation of derivative contracts.

Introduction
Old UK GAAP

Many groups choose to hedge the currency exposures on their loans and receivables, and variable cash flows such as interest. These exposures are typically hedged using derivative contracts, in particular forward currency and interest rate contracts.

Under old UK GAAP, hedging instruments were typically carried off balance sheet and the cash flows were taken to the profit and loss account in the period to which they relate using an accruals basis of accounting. The resultant income or loss was taxable / relievable in the period in which it was booked, but it typically netted against the exposure arising on the hedged item so that only the net economic effect was ultimately in charge to tax.

See Example 1.

Old UK GAAP cannot be used for accounting periods beginning on or after 1 January 2015. For accounting periods beginning on or after 1 January 2015 (or where new GAAP was adopted early) or for companies using IFRS ― see the section below.

New UK GAAP and IFRS

Under new UK GAAP and IFRS, derivative contracts must be shown on the balance sheet at their fair value and changes in the market value reflected in the income statement, unless hedge accounting is adopted.

Market value movements in interest rate hedges reflect changes in market interest rates and counter-party risk. The former risk in particular can fluctuate considerably. Although the fluctuations typically reverse over the life of a contract, such movements can cause volatility in the annual financing expense. Hedge accounting is designed to reduce this volatility.

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