Hedging overseas investments

By Tolley

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

  • Hedging overseas investments
  • Commercial scenario
  • Accounting treatment
  • Corporation tax treatment
  • The disregard regulations
  • Regulation 3 ― exchange gains or losses arising from liabilities or assets hedging shares
  • Regulation 4 ― exchange gains or losses arising from derivative contracts hedging shares
  • Further points to watch

This guidance note provides assistance with the rules governing the taxation of financial instruments that are used to hedge net investments in overseas operations.

Commercial scenario

Many groups choose to hedge the currency exposure that arises when translating the carrying value of net assets held by their overseas subsidiaries into sterling for inclusion in their consolidated group accounts.

In order to hedge these exposures the parent company will typically draw some of its loan finance in the currencies used by its operating subsidiaries.

Base Case

Accounting treatment
Group accounts

The shares in the US Subsidiary do not appear in the consolidated accounts. The only amounts which give rise to foreign exchange (FX) movements on consolidation are the loan and the net assets held by the overseas subsidiary. Where a liability provides an economic hedge of all or part of the group's overseas assets, the FX movements are treated in the same way under UK GAAP or IFRS. The movements on the liability are taken directly to other comprehensive income (OCI) where they are offset against the movements on the corresponding assets. The accounting rules can be found in FRS 102 , para 12.24 and in IAS 39 , para 102 as clarified by IFRIC 16  (interpretation on accounting for hedges of a net investment in a foreign operation).

In the above example, assuming the group accounts are prepared in sterling, a 5% movement in the US dollar would generate a movement of +5 on translating the loan into sterling, and an equal and opposite movement on translating the net assets of the US Subsidiary. Both these movements would be taken to OCI where they net off to nil.

Entity accounts

Where a company has a hedge of a net investment in a foreign operation it

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