Guidance

Overview of Disregard Regulations

Published 27 March 2015

Background

Under old UK Generally Accepted Accounting Practice (GAAP) (except where Financial Reporting Standard (FRS) 26 was applied) it was common for derivatives that were hedging one or more risks to be off balance sheet. The asset, liability or transaction being hedged by the derivative, and the derivative itself, may have been accounted for as a single item. For tax purposes, this equated to accounting for the derivative contract on an authorised accruals basis.

In contrast, under International Financial Reporting Standard (IFRS), FRS 101, FRS 102 and FRS 26 all derivatives are on the balance sheet at their fair value even if they are accounted for as a hedge. Companies could therefore (absent special rules) be subject to considerable volatility in their taxable profits because of fair value changes in derivatives. The Disregard Regulations (Statutory Instruments 2004/3256) were introduced in 2004 to address this issue.

Disregard Regulations

These act to largely restore the old UK GAAP position (except where FRS 26 was applied) where a derivative is part of a hedging relationship. The operation of the tax rules will depend on the type of hedge, whether it is designated as such for accounting purposes and whether the company has elected in to the particular regulation that applies to that type of hedge. There are 3 main regulations dealing with fair value accounting for derivatives:

• regulation 7: currency contracts
• regulation 8: debt and commodity contracts
• regulation 9: interest rate contracts

The criteria for all 3 regulations are broadly the same:

• there must be a designated or intended hedging relationship
• the hedged item must not be taxed on a fair value basis

The broad effect of these regulations is to disregard the fair value movements on the derivative and instead to bring profits and losses into account for Corporation Tax purposes in line with the hedged risk.

Mechanics

Regulations 7 and 8 work in a similar way. Fair value movements are disregarded and brought into account in line with regulation 10. This prescribes the time when amounts previously disregarded need to be brought into account for tax.

Regulation 9 works differently. Fair value movements are still disregarded but they are brought into account on the basis of an appropriate accruals basis. This broadly reflects the accounting that would have arisen had the hedging instrument and hedged item been a single instrument and accounted for on an accruals basis.

Elect into the disregards

For periods of account commencing on or after 1 January 2015, companies need to elect in to regulations 7, 8 and 9. These regulations also apply automatically (where the conditions in the relevant regulation are met) in case of designated fair value hedges; contracts which hedge loan relationships that are accounted on a fair value basis; and contracts that are part of certain avoidance arrangements. Companies which applied fair value accounting in earlier periods will continue with the same treatment without having to make new elections.

Regulation 9A provides an alternative mechanism for designated cashflow hedges where a company has not elected in to regulations 7, 8 or 9. This means the company will broadly just follow the amounts recognised in profit or loss.

Further guidance

Further guidance is available in the Corporate Finance Manual at CFM57000 onwards.