CFM50250 - Derivative contracts: accounting conditions: commodity contracts: example

Example of application of CTA09/S579(2)(a)

A company trades as a confectionery manufacturer. It regularly enters into forward contracts to buy sugar, with the price being fixed at the time of contract, for delivery in six months’ time. The amounts payable under such contracts are included in cost of sales in the company’s accounts.

For tax purposes, the forward contracts are derivative contracts. They fall within the definition of a future in CTA09/S581 and, because of the special provision in CTA09/S579(2)(a), they satisfy the ‘accounting conditions’.

If, in a period of account beginning on or after 1 January 2015, the company has adopted FRS102, it is likely that if the contract provides only for the physical delivery of sugar, it will not be treated as a derivative for accounting purposes (and thus it will not be carried at fair value). Debits or credits for the purposes of Part 7 will follow the accounts. Since the company is party to the derivative for the purposes of its trade, debits will be trading expenses and credits will be trading receipts (see CFM51030). This means that no computational adjustment will be needed in arriving at the company’s trading profits - there is, in practice, no need to identify separately such ‘derivative’ profits or losses in the computations.

The same treatment applies in periods beginning before 1 January 2015 under FRS25/26.

This rule will rarely have any practical effect because the company would normally not be required to disapply its actual accounting treatment (so long as in accordance with GAAP) and apply fair value accounting instead. However there is a rule at CTA09/S616 which might require a company to apply fair value accounting for tax in respect of certain embedded derivatives, see CFM52530. Subject to time limits, S617 allows a company to elect out of this rule.