CFM62930 - Foreign exchange: matching: derivative contracts used to hedge share transactions: disposals and relevant dividends

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

A derivative contract may hedge the foreign exchange risk to a company in relation to the disposal proceeds from an anticipated transaction. The derivative contract may also hedge the currency risk arising from a relevant dividend in relation the relevant shareholding paid as part of the anticipated share disposal. This should allow companies with cash reserves to distribute a dividend to its parent company.

The derivative contract may hedge a combination of disposal proceeds and relevant dividend. The dividend can arise from a disposal of shares by an overseas subsidiary company and through a chain of companies providing the relevant hedging relationship conditions are met. The dividend may be paid after the sale has completed and out of the disposal proceeds received from the sale, providing there was a relevant hedging relationship involving an anticipated transaction.

Relevant amounts arising across the lifetime of derivative contracts used to hedge currency risks relating to relevant dividends can be disregarded. Whether the entire amounts will be brought back into account on disposal of the shares are subject to provisions within the EGLBAGL Regulations, see CFM62950.

Relevant dividend

A dividend is a relevant dividend if it is exempt from corporation tax under CTA09/PT9A, or would be exempt dividend apart from an election under CTA09/S931R (see INTM655010).

Note the election does not prevent the amounts being disregarded under REG 5ZA, it is still treated as a relevant dividend.

Example 1

A Ltd has a wholly owned subsidiary, B Ltd, which holds 100% of the shares in US based C Inc. Both A Ltd and B Ltd have a GBP functional currency. C Inc has distributable reserves of $100 million. B Ltd agrees heads of terms with unrelated party Z Inc to sell C Inc for $400 million under which it is agreed that C Inc will distribute the $100 million reserves up to its parent company B Ltd prior to the disposal.

A Ltd enters into a derivative contract to hedge the $500 million sterling to USD currency risk. A Ltd then enters into an internal derivative contract to B Ltd to hedge the $500 million, being the $100 million pre-sale dividend and $400 million disposal proceeds. B Ltd has a derivative contract with a connected company on equivalent terms to the external contract.

B Ltd has a relevant hedging relationship in relation to the share proceeds and a pre-sale dividend. For the purposes of the EGLBAGL regulations the amounts arising on the pre-sale dividend would not need be brought into account on disposal of C Inc. However, B Ltd may need to bring the amounts arising on the $400 million back into account, unless an exemption applies.

Example 2

Alternatively, A Ltd has a wholly owned subsidiary, B Ltd, which holds shares in US based C Inc. B Ltd enters in into an agreement to sell C Inc to unrelated party Z Inc for $500 million. B Ltd intends to distribute the entire proceeds to A Ltd on completion of the transaction. A Ltd enters into a derivative contract to hedge the $500 million sterling to USD currency risk. There is therefore a relevant hedging relationship between the derivative and the relevant dividend arising from an anticipated transaction.