CFM64120 - Foreign exchange: accounts drawn up in a foreign currency: where the presentation currency and the functional currency are different

CTA10/S6,S7

Company accounts prepared using a presentation currency that is not the functional currency

The basic rule is that the profits of a company should be calculated in sterling for the purposes of corporation tax. However, there are certain exceptions that can apply to the basic rule.

A company may prepare its accounts in a presentation currency other than its functional currency. CTA10/S6 addresses the case where a company's functional currency is sterling and its presentation currency is not. S7 addresses the case where a company's functional currency is a currency other than sterling and its presentation currency is a different currency.

For the application of S6 and S7 where a UK investment company has made a valid designated currency election, see CFM64500+.

CTA10/S6

This section applies where the functional currency is sterling but a presentation currency other than sterling is used. In this case, the tax rules override what is in the accounts, and profits and losses must be computed by reference to sterling. The company is required to calculate profits and losses, in accordance with generally accepted accounting practice, as if it had prepared accounts in sterling.

Example

Tychpin Ltd is the subsidiary of a company that prepares consolidated financial statements in Euros. It also draws up its single entity financial statements with the Euro as its presentation currency. (Note that this would simply be a matter of choice; there is no requirement under IAS or FRS 102 that it should do so.) However, the primary economic environment for Tychpin Ltd is the UK and under UK GAAP sterling is its functional currency. Tychpin Ltd therefore identifies sterling as its functional currency in its accounts. CTA10/S6 applies and Tychpin Ltd must calculate its profit or loss by reference to sterling for UK tax purposes.

Suppose, for example, the accounting records of Tychpin Ltd show profits of £1,500,000, measured in its functional currency of sterling. These profits will include any exchange gains or losses that arise on Euro-denominated assets, liabilities or transactions. In preparing its accounts, it will translate that £1,500,000 profit into Euros (either at the spot rate applicable to each transaction, or at an average rate for the year where that provides a reasonable approximation). It would also translate its opening and closing balance sheet into Euros at the prevailing rate at those respective dates.

Any exchange differences arising from retranslating its opening balance sheet, closing balance sheet and profits for the year into Euros would be items of OCI and therefore normally not taxable.

The effect of S6 is that its tax computations will need to start from the sterling profit of £1,500,000, and computational adjustments, capital allowances and so on will be computed in sterling.

CTA10/S7

This section applies where one currency other than sterling is the functional currency (as identified by the company in its accounts) and another currency is used to prepare the accounts.

The company must compute its CT profits or losses by reference to its functional currency. The profit or loss is then translated into sterling for tax purposes, normally at an average rate. For more on the rate to be used see CFM64310+.

Changes in functional currency

Where a company changes its functional currency, exchange differences resulting from the change will normally be items of other comprehensive income. Accordingly, for periods of account beginning on or after 1 January 2016, such amounts arising in respect of loan relationships and derivative contracts will not be taxable, because they are not recognised as items of profit or loss to which CTA09/S307(2) applies.

Special rules apply where an exchange difference arises to an investment company, which would not have arisen but for a change in functional currency. Such exchange differences are not taxed where the exchange gain or loss arises as a result of a change in functional currency occurring in the period of account in which the gain or loss arises or in the 12 months before the start of that period - S328(3B) and 606(3B). But this does not apply where a designated company election (CFM64500) has effect.

For investment company periods of account beginning before 1 January 2016, CTA09/S328(2A) for loan relationships and CTA09/S606(2A) for derivative contracts (repealed by F(2)A15) had a similar effect.  

Exchange differences arising on translation

Where a company translates profits from its functional currency into its presentation currency, exchange differences will arise (and will normally be recognised as items of other comprehensive income (OCI) see CFM64110). These exchange differences are ignored in calculating the profit or loss that arises when the profit is computed as if the company had prepared accounts in its functional currency (CTA10/S6(2) or S7(2) as appropriate). The tax computations must be based on deemed functional currency accounts, which would not show any such exchange differences.