CFM62380 - Foreign exchange: matching: bringing amounts back into account: examples of statutory order of matching

Examples illustrating the priority rules for matching

Fynvane Ltd is a trading company which accounts to 31 December. On 1 January 2003, it acquires the following assets, all denominated in US dollars.

  • A shareholding in a trading subsidiary, costing $4 million and qualifying for substantial shareholding exemption on disposal.
  • A shareholding in a non-trading subsidiary, Fynvane A Inc, costing $2 million. This does not qualify for substantial shareholding exemption on disposal.
  • A shareholding in a second non-trading subsidiary, Fynvane B Inc, costing $500,000. This does not qualify for substantial shareholding exemption either.
  • A long-term loan of $3 million to a subsidiary.

US dollar/sterling exchange rates are assumed to be:

$1.60/£ at 1 January 2003

$1.45/£ at 1 July 2005

The following examples (which represent alternative scenarios) illustrate how the statutory order of priorities would apply in particular cases:

Example 1

On 1 July 2005, Fynvane Ltd disposes of the long-term loan.

The company hedged its US dollar investments with borrowings of $5 million, commencing on 1 January 2003. The amount borrowed has fluctuated between 1 January 2003 and 1 July 2005, but has never fallen below $3 million.

In accordance with rule 1 in regulation 7(7), the borrowing is regarded as matched to the maximum possible extent with the $3 million loan relationship. Since the liability has never fallen below $3 million, it follows that $3 million of the liability can be regarded as fully matched with the loan relationship. On disposal of the loan relationship, the exchange loss on the matched liability can be readily computed:

  • $3,000,000 at 1 January 2003 ($1.6/£) - £1,875,000
  • $3,000,000 at 1 July 2005 ($1.45/£) - £2,068,966
  • Exchange loss - £193,966

This loss is brought in as a loan relationships debit under regulation 6. However, since, the company must, under regulation 13 (CFM62470) bring in an exactly corresponding loan relationships credit on disposal of the loan asset, there will be no net effect. In practice, the company does not need to make a computation.

Example 2

The facts are as in Example 1, except that Fynvane Ltd disposes of the shares in the trading subsidiary on 1 July 2005.

The disposal qualifies for substantial shareholdings exemption, so under regulation 4(2), nothing needs to be brought into account in respect of exchange gains or losses on any matched liability. Thus it is unnecessary to consider to what extent (if at all) the borrowing should be regarded as matched to the substantial shareholding.

Example 3

Fynvane Ltd disposes of its holding in Fynvane A Inc on 1 July 2005.

The company has hedged its US dollar investments by borrowings of $6 million, commencing on 1 January 2003. The borrowing has remained constant at $6 million up to 1 July 2005.

The liability of $6 million is matched first of all against the $3 million loan relationship asset (rule 1 in regulation 7(2)), then against the $2.5 million chargeable gains assets (rule 2), with the remaining $500,000 matched against the substantial shareholding.

It is therefore unnecessary to determine an order of priorities as between the Fynvane A Inc shares and the Fynvane B Inc shares - both are fully matched. $2.5 million of the borrowing can be regarded as fully matched with the Fynvane A Inc shares disposed of. An aggregate exchange loss on the matched borrowing can be computed as follows:

  • $2,500,000 at 1 January 2003 ($1.6/£) - £1,562,500
  • $2,500,000 at 1 July 2005 ($1.45/£) - £1,724,138
  • Exchange loss - £161,638

This will need to be brought in as an allowable loss.