. FOREIGNEXCHANGE GAINSANDLOSSES DRAFT CLAUSES ONTHETAXTREATMENT OF FOREIGN EXCHANGE GAINS AND LOSSES ACONSULTATIVEDOCUMENT Representationswouldbewelcomeonthematters discussedinthisdocument Theyshouldbesentto: SueCooper Room9 NewWing , SomersetHouse Strand LONDONWC2RILB by31 March 1993 ..I..*.-*.-*!-. , rmm rv*' Price: £4.00 PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit 1 CONTENTS PAGE INTRODUCTION 1 COMMENTARY - Overview 2 BasicRules 3 LocalCurrency 5 DeferralofUnrealisedGains 8 Matching 9 Anti-avoidance 1 SpecialProvisions 12 CommencementandTransitional Arrangements 13 ANNEXA - PressReleasedated 11 August 1992 19 ANNEXE - DraftClauses 21 PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit INTRODUCTION 1. In March 1991 a Consultative Document was published containing the Government's proposals for reform of the taxation of foreign exchange gains and losses. Theoverall responseto theproposals wasfavourable, subjectto some specific changesbeing made. TheGovernmentannouncedthatdraftclauseswouldbepublished forfurtherconsultation. (A copy ofthePressReleasecontaining theannouncementis attachedasAnnexA). 2. Comments arenow invited onthe draft clauses attached as Annex B. In some cases, the clauses contain references to regulations, which have not yet been drafted. Thesewillbepublishedforconsultationinduecourse. Thecommentarywhichfollows includesdetailsofwhatitisenvisagedtheregulationswillachieve. 3. Representationsshouldbesentto SueCooper Room9, NewWing SomersetHouse Strand LONDONWC2R ILB by 31 March 1993. 1 PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit COMMENTARY OVERVIEW 1. Themainelementsoftheschemeareasfollows: for qualifying assets and liabilities (clause 49) and forward contracts to buy or sell currency (clause 22), exchange gains and losses are recognised as they accrue between one "translation time" and the next (clauses21 to23and54); trading exchange gains and losses are taken into account in the computationoftradingprofitsorlosses(clause24); netnon-tradeexchangegains areassessed under CaseVI ofScheduleD (clauses 25 and 26), and there are special rules for non-trade exchange losses(clauses25and27to29); where unrealised exchange gains on long-term capital items exceed 10 percentoftheprofitofanaccountingperiod, theexcesscanbedeferred untilthefollowingaccountingperiod(clauses35 to39); exchange differences are generally to be calculated by reference to sterling, butthereisprovision fortradingprofitsorlossesbeforecapital allowances to be calculated by reference to other currencies in certain circumstances(clauses45and71); there are regulatory powers (in Schedule 1) to make provision for "matching" of exchange differences on borrowings with exchange differencesoncertainnon-qualifyingassets; qualifying assets which are currently subject to capital gains tax (CGT) willceasetobeso(clauses66to68); thereareanti-avoidanceprovisionsatclauses31 to34; 2 PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit authorised unit trusts, approved investment trusts and charities are excludedfromthescheme(clause48); thereisprovisioninSchedule 1 forexchangegainsandlosses relating to exemptactivities (mainlylong-termand mutualinsurancebusiness) tobe disregarded; there is provision for special rules for exchange differences relating to insurancebusiness(clause64). BASICRULES Qualifyingassetsandliabilities 2. The scheme applies where a qualifying company (clause48) is entitled to a qualifying assetorsubjecttoaqualifyingliability (clause49), orenters into aforward contracttobuyorsellcurrency(clause22). 3. Qualifyingassetsincludecurrencyintheformofcash, anddebts (includingforeign currency bankaccounts). Debts are qualifying assets only to the extent that they are recoverable. Insomecircumstances, sharesarealsoregardedasqualifyingassets: this willonlybethecasewhere any profits on disposal ofthe shares would be assessable as part of the company's trading profits (as in the case of banks and other financial concerns); and exchange differences on the shares are included in the profit and loss accountonthetranslationbasis. 4. Qualifying liabilities include debts and, in certain circumstances, provisions for contingentliabilities. 5. Clauses 66 to 68 provide thatqualifying assets and forward currency contracts heldbyqualifyingcompaniesarenolonger subjectto CGT. Currencyanddebtsother than debts on a security (but including foreign currency bank accounts) are exempt from CGT on disposal. Foreigii currency debts on a security generally become qualifyingcorporatebonds underSection 117 oftheTaxation ofChargeableGains Act PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit 1992andanygainondisposalisthereforeexemptfollowingSection 115. 6. Computationandtreatmentofexchangedifferences Clause54 provides thatforqualifying assetsand liabilities therearetranslation timeswhen the companybegins or ceases tobe entitled or subject to the qualifying assetorliability, or anaccountingperiodofthecompanyends. Ateachtranslationtimethelocalcurrencyequivalentofthebasicvaluationoftheasset orliabilityisfound (clause55)bytranslatingtheforeign currencyassetorliabilityinto thecompany'slocalcurrencyusingtheexchangeratespecifiedinclause46. Clause21 provides forexchangegainsorlosses tobecomputedby comparing the local currency equivalentatsuccessivetranslationtimes. 7. Clause23 provides a modified rule for debts which vary in amount between translation times. Thisapplies wherepartofadebtis repaid, oran additionaltranche is borrowed. Clauses 40 and 41 enable the modified rule to apply in a similar way wherethereisachangeintheamountregardedasrecoverable. 8. For forward currency contracts, clause22 provides for exchange differences to be computed by comparing, at successive translation times, the local currency equivalent of the amount of foreign currency to be transferred under the contract. Wheresuchacontractis terminatedwithoutdeliveryofthecurrency, the netexchange gain orloss assessed or relieved overthe lifeofthe contractis to be recovered at the dateoftermination(clause42). Itisintendedthatanyterminationreceiptsorpayments willbeassessedorrelievedundertheproposedfinancialinstrumentslegislation. 9. Trading exchange gains and losses are taken into account in the computation of tradingprofitsorlosses (clause24). Non-trading exchangegains andlosses (including those accruing to trading companies from non-trade assets and liabilities) are aggregatedforeach accountingperiod. Any surplus ofnon-tradegains overnon-trade losses is chargedunderCaseVIofScheduleD (clause26). Clauses 27 to 29 provide thatanysurplusofnon-tradelossesovernon-tradegainscanbe 4 PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit setagainstotherprofitsofthesameaccountingperiod, or surrenderedasgrouprelief, or carriedbackagainstexchangegainsofthethreeprecedingyears, or carriedforwardagainstexchangegainsonly. LOCALCURRENCY Non-sterlinglocalcurrency: conditions 10. The 'localcurrency" byreferenceto whichexchangegains and losses are to be computedis generally sterling (clause 45). However, for the purposes ofcomputing tradingprofitsbeforecapitalallowances ("basicprofitsand losses") regulations (under clause71) willprovide that an election maybe made to adopt a local currency other thansterlingwhereprescribedconditionsarefulfilled. Theconditions, whicharetobe prescribedinregulations, wiUrequirethat a. fora tradecarriedonwholly outsidetheUK. orpart ofatradecarried onthroughanoverseasbranch: i. that currency is the currency of the primary economic environmentinwhichtheoverseas trade, orthepartofthetrade carriedonthroughtheoverseasbranch, is operated andin which netcashflowsaregenerated; and ii. the whole, or substantially the whole, of the expenses and receiptsofthetrade, orofthepartofthetradecarriedonthrough thebranch, aregeneratedinthatcurrency; and iii. accounting records for the trade orpart trade are maintained in thatcurrency, andthecompany preparesaccountsinthatcurrency, or S , PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit incorporates theresults ofthe trade, orofthepartofthe trade carried on through the branch, into its accounts using the "closingrate/netinvestment" method referredto inSSAP20, or elects, in a case where the temporal method is used to incorporate the results ofthe trade or of the part of the trade carried on through the overseas branch, to continue the existing tax treatment that applied in the two years immediatelybeforethelegislationcomesintoforce. foratradecarriedonwhollywithin theUK. orthatpartofatradewhich iscarriedonintheUK>ie.* i. that currency is the currency of the primary economic environment in which the trade, or the part ofthe trade carried onintheUK, is operated andin which the netcash flows ofthe tradearegenerated; and ii. the whole, or substantially the whole, of the expenses and receiptsofthetrade aregeneratedinthatcurrency; and iii. inthecaseofaUKresidentcompany: accountsareprepared in that currencyin accordance with acceptedUKaccountingpractice; and the whole, or substantially the whole, ofthe company's aggregate share and loan capital is denominated in that currency; and iv. inthecaseofaUKbranchofanon-UKresidentcompany: the branch accounting records are maintained, and the branchaccountsprepared, inthatcurrency; AnyelectioninrespectofthepartofatradecarriedonwithintheUKmustapplytotheprofits ofthewholeoftheUKactivitiesofthattrade: itisnottobepossibleforanelectiontoapplyonlytothe profitsofoneofseveralUKbranches. 6 PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit the whole, or substantially the whole, of the aggregate liabilities ofthebranch, including amounts owed to Head Office, isdenominatedinthatcurrency. Non-sterlinglocalcurrency: elections 11. To make an election, the company must have reasonable grounds for believing that all the relevantconditions will be fulfilled throughout the first accounting period forwhichtheelection willapply. Theelection willbe effective from the start ofthat accounting period unless the Inspector notifies the company at any time up to three months from receiving the first accounts affected that the criteria for a valid election have not been established. (There will be a right of appeal against any such notification). 12. An election will normally take effect from the start of an accounting period whichbeginsonorafterthedateon whichtheelection is made. However, there will betwocircumstancesinwhichtheelectioncantakeeffectfromanearlierdate: ifacompanymakesanelectionwithin threemonths ofthebeginning of the first accounting period for which the new rules apply, the election maytakeeffectfromthestartofthataccountingperiod; ifacompanymakesanelectionwithinthreemonths ofthedateitcomes within the charge to corporation tax, the election may take effect from thatdate. 13. Theelectionwillneed to specify whetherthecompany's trading income is to be translated into sterling for corporation tax purposes at the average or closing rate of exchange. Whichevermethodisspecifiedmustthenbeusedconsistently. A 14. validelectionwillremaininforceuntil thecompany * withdraws the election on sterling becoming (in fact) the local currency, or 7 PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit * makesavalidelectiontoadoptadifferentlocalcurrency; or the relevant conditions cease to be satisfied and the Inspector gives 15. noticethattheelectionisnolongereffective. Ifanelectioniswithdrawnorthereisachangeinthelocalcurrency, thechange will be effective from the first accounting period beginning after the notice of withdrawal or the fresh election is received. If the relevant conditions cease to be satisfiedandtheInspectorgivesnoticethattheelectionisnolongereffective, the election will cease to apply from the end of the accounting period in which the conditionsceasedtobesatisfied. TherewillbearightofappealagainsttheInspector's decision. DEFERRALOFUNREALISEDGAINS 16. Clauses35to39containprovisionswhichenablecompaniestodefertaxationof long-term unrealised exchange gains on long-term capital borrowings and advances where those gains form a significant proportion of the taxable profit. The amount available for relief is the excess of the net unrealised exchange gains on long-term capitalborrowingsandadvancesfortheaccountingperiod- or, iflower, theaggregate net realised and unrealised exchange gains on all borrowings, advances and forward currency contracts- over 10 per cent of the profit of the period (clause37). The excess, orsuchpartoftheexcessasthecompanyclaims, maybecarriedforwardtothe nextaccountingperiod. 17. A borrowing or advance will be "long-term" ifits original term was not less than one year (clause39(4))(b)). "Profit" means the taxable profit ofthe accounting period afterdeductionofcharges onincome and any loss relieffrom laterperiods but before group relief(clause37(3)). Regulations under clause39(5)(c) willprovide for exclusion from profit of any overseas income or chargeable gains to the extent that corporationtaxthereoniscoveredbycreditforforeigntax. 18. Where a claimant company is a member of a UK group of companies, regulationsunderclause39(5)(b) willprovideforthetwofiguresofnetexchangegains described in paragraph 16 above to be calculated by aggregating the net exchange differences of those group companies that have exchange exposures on long-term 8 PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit