CFM57350 - Derivative contracts: hedging: regulation 9: further examples

This guidance applies to periods of account starting on or after 1 January 2015 where the company has elected for regulation 9 to apply.

Further regulation 9 examples

Hedges of interest rate risk: connected party debt

Assume that the basic facts are as in the example at CFM57330, but that:

  • in its statutory accounts Company X adopts fair value accounting in relation to the loan;
  • the loan is issued to a connected party.

For tax purposes Company X is required to use an amortised cost basis for the loan because it is connected with the creditor. Regulation 9 can still apply because:

  • there is a hedging relationship between the derivative contract and the forecast transaction;
  • fair value movements on the hedged item are not brought into account for the purposes of corporation tax.

The result is that fair value profits or losses on the swap (which in this case will have been taken to income statement along with fair value movements in the loan relationship) are again disregarded. An appropriate accruals basis is imposed with a fixed debit equal to 7% of the borrowing which will be brought into account either as a trading expense or a non-trading loan relationship debit.

The same analysis applies to regulatory capital securities.

Cross currency swap

Assume the facts are similar to those in the example at CFM57340 but that the company issues floating rate foreign currency debt which it hedges with a cross currency swap under which it pays fixed sterling and receives floating foreign currency. It designates the contract as a cash flow hedge of both interest rates and foreign exchange. In substance the hedge acts to convert the loan into a fixed rate sterling loan, which is how it would have been accounted for under Old UK GAAP (excluding FRS 26).

Fair value movements on the derivative contract are initially taken to equity and are recycled to profit and loss as the hedged item affects profit and loss. Regulation 9 can still apply because:

  • there is a hedging relationship between the derivative contract and the forecast transaction;
  • fair value movements on the hedged item are not brought into account for the purposes of corporation tax.

Regulation 9(4) in effect deems the hedged debt to be a sterling loan paying interest at a fixed rate equal to that on a loan that combined the terms of the actual loan and the hedging instrument. The appropriate accruals basis therefore replicates the hedge accounting treatment under Old UK GAAP (excluding FRS 26).