CFM62910 - Foreign exchange: matching: derivative contracts used to hedge share transactions: economic risk

REG 5ZA(2) S.I. 2004/3256

As explained in CFM62905, REG 5ZA operates to remove the mismatch in tax treatment where companies use a derivative contract to hedge the economic risk on:

• the acquisition cost of shares, together with any incidental costs of acquisition (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, an acquisition of shares (again see CFM62920)
• the proceeds from the disposal of shares, or any relevant dividend paid as part of the disposal (see CFM62930)

The economic risk

The economic risk which is intended to be hedged must be that attributable to fluctuations in exchange rates between the currency of the future acquisition cost, disposal proceeds, relevant dividend, share subscription or the advance under the creditor loan relationship and either:

• the company’s relevant currency (its functional currency or an elected designated currency); or
• the currency in which the company raises debt or equity financing for an anticipated share acquisition

Example

ABC Ltd has entered into heads of terms to acquire the entire shareholding in XYZ SA, a company based in France, for €500 million. ABC Ltd has a GBP functional currency and has raised debt finance of USD $600 million to fund the acquisition. ABC Ltd enters into a derivative contract to hedge the economic risk between the share acquisition cost of €500 million and the cash expected to be raised from the $600 million debt. There would be a relevant hedging relationship, between the derivative contract and the economic foreign exchange risk between the euro share purchase price and cash to be raised from dollar debt financing, so that profits or losses arising from the derivative contract may be disregarded.

Further guidance

Designated Currency Elections - see CFM64500.