CFM62940 - Foreign exchange: matching: derivative contracts used to hedge share transactions: evidence and documentation

A ‘hedging relationship’ will exist where the hedging instrument is intended to act as a hedge of variation in fair value or cash flows, as well as where a hedge is accounted for as such.

A company’s intention in undertaking a financial transaction is expressed through the intentions of its directors, although in many cases decisions will be delegated to a lower level of management.

It is ultimately a question of fact as to whether the company had the necessary hedging intention. In the majority of cases, it will be clear that the company has entered into a particular derivative contract with the intention of hedging a particular asset, forecast transaction or firm commitment. This will particularly be so where:

• such hedges are in line with the company’s normal risk management policy, and
• there is a readily discernible relationship between the derivative and the hedged item.

It will be for the company to demonstrate whether the relevant hedging intention is or is not present. This could, for example, be evidenced through contemporaneous documentation. HMRC can be expected to take a risk-based approach with this, with increased focus on gains that have been disregarded and losses that have not be disregarded.

HMRC may ask during enquiries for evidence for the existence of a hedging intention where amounts have been disregarded. This might include, for example, detail why the derivative contract was entered into, what it is seeking to hedge and the company’s intentions to fall within the Disregard Regulations.

HMRC may also ask for evidence in cases where amounts have not been disregarded in a company’s tax return. Where a derivative contract has terms which indicate that it was suitable to hedge foreign exchange risk on an anticipated transaction falling within the ambit of REG 5ZA and there is no contemporaneous evidence that there was an intention to hedge some different risk or, alternatively, that the company was taking a speculative position, the working assumption is that any loss on the instrument should be disregarded.