Forex matching – hedging rules

The link between tax and accounting, and the almost never-ending changes to the accounting requirements as a result of the convergence with International accounting Standards (IAS) have led to numerous instances where the commercial effect of the transaction is no longer mirrored by the tax treatment.  This is particularly the case where the accounts are required to comply with IAS (which requires a greater use of market values for assets and liabilities).

Regular changes have been made to the rules dealing with various hedging transactions to ensure that they are effective for tax purposes.

A specific change proposed meets the needs of businesses raising funds through a rights issue and that are reported in the accounts at one exchange rate whilst the investments and hedging instrument are recorded in the accounts in another.

Foreign profits taxation

A wide-ranging consultation process has been under way for a number of years partly as a result of concerns that the UK taxation system does not meet our EU Treaty obligations and partly due to the concern that the UK tax system is, internationally, uncompetitive.  The main areas identified as in need of urgent change are:

1. Taxation of foreign dividends
2. Restriction on tax relief for borrowing – referred to as the 'debt cap' rules
3. Taxation of controlled foreign companies

Significant progress has been made on the first two topics, much less on the third.  There are, however, still major issues with the debt cap rules (which broadly propose to restrict tax relief on borrowing so as to base it on the amount of world-wide external borrowings).  It is likely that a compromise will be put place addressing many of the concerns.

Relief for foreign denominated losses

UK tax is, unsurprisingly, computed in sterling.  The profits (and losses) may, however, be computed in another currency (the 'functional' currency – broadly that in which the business operates).  As exchange rates vary over time and as the losses in one period may be available for use in another (later or earlier), the value of the loss relief will depend on the exchange rate in the period in which the profit arises.  This gives rise to uncertainty and the need to plan for the use of the losses.

The proposal is that the basis on which the losses available is to be computed is to be matched with the basis for computing the profits against which relief is sought.