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Amendments made to Disregard Regulations

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21 Apr 2015

Changes came into force on 31st December 2014 amending the Disregard Regulations 2004 (“DR”) and the Change of Accounting Practice Regulations 2004 (“COAP”). The amended DR and COAP are effective for periods beginning on or after 1 January 2015. They are particularly relevant to companies converting to IFRSs, FRS 101 or FRS 102 for the first time.

The DR govern the tax treatment of derivatives and loan relationships that are intended to hedge certain business risks. Gains and losses on such financial instruments are ordinarily subject to tax in the year in which they are recognised in profit or loss under the corporation tax regimes for loan relationships and derivative contracts. The DR modify this by taxing such gains and losses in a manner broadly equivalent to hedge accounting under ‘old’ UK GAAP – provided the hedging instrument is in one of the defined types of hedging relationship covered by the rules. The latter are not comprehensive but include most of the common kinds of commercial hedge. The effect is thus broadly to disregard fair value or exchange gains arising from a hedge until the hedged asset or liability is recognised in the accounts. In some cases disregarded exchange gains and losses do not reverse.

Prior to 2015, companies were automatically within the scope of the DR, if they had qualifying hedging relationships that satisfied the relevant conditions. However, for periods beginning on or after 1 January 2015 – post the December 2014 changes – companies will need to consider whether they should elect into the regime in respect of relevant hedging relationships. A single election can be made for all or any of DR7 (currency contracts), DR8 (commodity and debt contracts) and DR9 (interest rate contracts) to a company’s hedging instruments. Note that the tax “matching” of exchange gains and losses arising in respect of debt or derivatives against the currency risk implicit in the shares of subsidiaries under DR3 and DR4 continues to be mandatory, where the conditions are satisfied (i.e. no election is necessary).

The deadline for making an election is six months after the beginning of the first accounting period under the new GAAP (or, if later, six months after entering into the first relevant contract). Companies wishing to make an election that have a year-end of 31 December will need to do so by 30 June 2015 to avoid or minimise taxable transitional adjustments. Companies are, however, deemed to have elected into the amended Regulations, where they have previously applied “disregard” treatment under DR7 to DR9 – for example UK GAAP companies previously accounting for financial instruments under FRS 26 or IFRSs and not having elected-out of the DR. Elections are revocable (prospectively) in principle, but there are restrictions where elections are made by new adopters.

Fair value gains and losses recorded in OCI (as opposed to in profit or loss) in respect of designated cash flow hedges involving the types of instrument covered by DR7 to DR9 are mandatorily disregarded, thus they are not affected by the elect-in decision. Accordingly, the decision whether or not to elect-in in respect of DR7 to DR9 contracts would usually be driven by a company’s willingness (or otherwise) to tax fair value effects recorded in profit or loss – for example in relation to hedge inefficiency, or an inability to hedge account under new UK GAAP or IFRS.

The DR are also extended to grandfather the tax treatment of existing (but not new) ‘permanent as equity’ loans on the transition from old UK GAAP. This accounting treatment is not permissible at the entity level under IFRSs, FRS 101 or FRS 102.

The COAP govern the tax treatment of accounting restatements in relation to loan relationships and derivative contracts where there is a change in accounting practice. Taxable restatements are usually spread over the period of ten years. The COAP have been amended to exempt restatement credits arising from a substantial modification of loan relationships (e.g. in respect of amend–and-extend transactions) in the context of corporate rescue arrangements. Any debits effectively reversing such credits are likewise disallowed. This mirrors proposals for the eventual introduction of a general corporate rescue exemption for release and substantial modification credits (and reversing debits) recognised in profit or loss.

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