CFM52020 - Derivative contracts: the matters and computational rules: mandatory fair value accounting

CTA09/S600-603

Circumstances in which fair value accounting must be used

There are two main scenarios in which credits or debits must be determined for tax purposes on the basis of fair value accounting, regardless of the actual accounting method adopted by the company.

Fair value accounting is defined at CTA09/S710. Following amendments made by F(2)A15, for company periods of account beginning on or after 1 January 2016, it is defined as a basis of accounting under which—

• assets and liabilities are measured in the company’s balance sheet at their fair value, and
• changes in the fair value of assets and liabilities are recognised as items of profit or loss.

For earlier periods, the definition did not include the requirement that the changes in value should be recognised in profit or loss.

The derivative contracts legislation differs from the loan relationships provisions in that there is no definition of an amortised cost basis of accounting - see CFM33130. This is because such a basis of accounting would rarely be applied to derivative contracts and there are no special rules requiring an amortised basis to be applied for tax, irrespective of the actual accounting basis applied. By contrast, there are extensive provisions in the loan relationships provisions requiring application of an amortised cost basis, mainly in related party situations.

Circumstances in which fair value accounting must be used for derivative contracts, are set out at CTA09/S600 - 602, as follows:

Where the contract comes within Part 7 because it passes the test in CTA09/S579(1)(b) - it is not treated as a derivative for accounting purposes, but is or forms part of a financial asset or liability, and would be a derivative were it not for there being a large upfront payment (see CFM50280). Contracts of this kind may be encountered as part of avoidance schemes, and the requirement to use fair value accounting is designed to ensure that economic profits or losses are brought into account in each accounting period.

Where the contract is treated as a derivative contract by CTA09/S587, because its underlying subject matter is a holding of shares in an open-ended investment company (OEIC), units in a unit trust or an interest in an offshore fund (CFM54040).

A transitional rule applies where a contract first comes within CTA09/S587, having been a chargeable asset in the previous accounting period. The company is treated for capital gains purposes as having disposed of the contract at market value at the end of the first accounting period; the resultant chargeable gain or allowable loss is brought into account when it ceases to be party to the contract (CTA09/S660). The contract is then brought into the derivative contracts rules at market value at the start of the second accounting period (CTA09/S602).

CTA09/S603 contains a further provision which is ancillary to the ‘shares as debt’ rules in Chapter 7 Part 6 CTA09 (see CFM45000+). If an ‘associated transaction’ (CFM45260) is not a derivative contract, it is nevertheless treated as such (CTA09/S588) and fair value accounting must be used in respect of it.