CFM62905 - Foreign exchange: matching: derivative contracts used to hedge share transactions: overview

Regulation 5ZA of the Disregard Regulations S.I. 2004/3256

Regulation 5ZA of the Disregard Regulations (‘REG 5ZA’) operates to remove the mismatch in tax treatment where a derivative contract is used to hedge the foreign exchange risk relating to a prospective share transaction. The regulation applies to derivative contracts entered into on or after 1 April 2022.

Conditions

REG 5ZA applies where a company uses a derivative contract to hedge foreign exchange risk on:

  • the acquisition cost of the anticipated transaction, together with any incidental costs (see CFM62920)
  • the subscription of shares in, or entering into a creditor loan relationship with, another company for the purpose of funding directly, or indirectly, the acquisition cost of the anticipated transaction (again see CFM62920)
  • the disposal proceeds of the anticipated transaction, or any relevant dividend paid as part of the anticipated transaction (see CFM62930)

In each case the hedged item must be a ‘forecast transaction’ or a ‘firm commitment’ of the company which is party to the derivative contract (see CFM62912).

The reference to the ‘anticipated transaction’ means the acquisition or disposal of a shareholding that constitutes a substantial shareholding for the purposes of the Substantial Shareholdings Exemption or is a holding of qualifying shares where the company is a Qualifying Asset Holding Company (see CFM62915).

In all of these cases the anticipated transaction in qualifying shares must not be between connected companies (see CFM35110).

Evidence of hedging intention

Where REG 5ZA is intended to apply, or the circumstances are such that the Regulation could be applicable, companies are expected to keep clear contemporaneous documentation of intention, see CFM62940.

The ‘disregard’

Where, and to the extent, the conditions apply, the relevant amounts on the derivative contract are excluded (‘disregarded’) from being brought into account by the company.

‘Relevant amount’ is defined in REG 5ZA(4) as:

  • all profits and losses from derivative contracts which are deal contingent forward contracts or options
  • exchange gains and losses in respect of all other derivative contracts

(See CFM62935 for further details).

Bringing back into account

Where amounts are disregarded, they will potentially be brought back into account at the time the shares being hedged are eventually disposed of as part of the chargeable gains calculation, through the operation of the EGLBAGL Regulations (S.I. 2002/1970).

However, no amounts will need to be brought back into account where:

  • the derivative is hedging an acquisition of shares that does not happen
  • the derivative is hedging a relevant dividend (except where the dividend adjusts the chargeable gains calculation under the value shifting or depreciatory transaction rules), see CFM62930
  • the derivative is hedging the company entering into a creditor loan relationship

In addition, no adjustment is needed if the disposal of shares is exempt, for example under the Substantial Shareholdings Exemption or the QAHC rules. This is because making an adjustment under REG 4(1) or (2) of the EGLBAGL Regs would have no effect due to the gain or loss being exempt.

(See CFM62950 for further details).