Foreign exchange : proposals for reform of the tax treatment of foreign exchange gains and losses [consultation paper]

30 Pages·1991·1.3 MB·English

by  Inland Revenue

FOREIGNEXCHANGE
GAINSANDLOSSES
PROPOSALSFORREFORMOFTHETAXTREATMENT
OFFOREIGNEXCHANGEGAINSANDLOSSES
A CONSULTATIVE DOCUMENT
Representationswouldbewelcomeonthematters
discussedinthisdocument
Theyshouldbesentto:
TheBoardofInlandRevenue
ExchangeConsultation
Room9
NewWing
LONDON
WC2R1LB
*fvi 5s
by30September1991 ... • -
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CONTENTS
PAGE
INTRODUCTION 1
CHAPTER1: Background 3
CHAPTER2: Proposalsforcomprehensivereform 7
CHAPTER3: Particularcases 15
ANNEXA: Issuesraisedinrepresentations 17
ANNEXB: Matchingofassetsandliabilities 22
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INTRODUCTION
1. InMarch1989,aconsultativedocumentwasissuedonthetaxtreatmentofforeignexchange
gains and losses. The Government’s objectives were to examine the scope for
comprehensivelegislativereforminresponsetocallsforchangefromanumberoftradeand
professionalbodies. Theaimwas to seewhethersolutionscouldbe foundtothevarious
problems identified in the present regime which would command a broad measure of
acceptancebybusiness,wouldbeworkableinpracticeandwouldnotinvolveunacceptable
Exchequercost. Commentswereinvitedonvariousoptionsandparticularproblems. The
Government has decided that, as the next stage in this consultative process, the Inland
Revenuewouldpublishtheseproposalsforcomprehensivereforminthecorporatesector.
2. Theproposalsareconfinedtothecorporatesector. TheGovernmentwillconsideratalater
datethepossibleadaptationofanyreformtotradersinthenon-corporatesector.
ScopeandContent
3. This document looks at the current tax treatment offoreign exchange gains and losses,
outlines some ofthe representations made in response to the March 1989 consultative
document, sets out the Government’s detailed proposals for change and considers the
possiblecostsoftheseproposals.
4. UnderthepresentUKtaxsystem,exchangedifferencesoncapitalborrowingsaregenerally
notrecognisedfortaxpurposes. Andexchangedifferencesonotheritemscanbedealtwith
indifferentwayswhich canleadto asymmetryinthetaxtreatment oflinkedtransactions
such as hedging operations. The Government’s proposals provide for the recognition as
incomeofexchangedifferences on all monetary assets and liabilities as they accrue (the
"translation basis") with a partial deferral of unrealised exchange gains in certain
circumstances. Therewouldalsobespecialrulestodealwithparticulartypesofcompanyso
astotakeintoaccounttheiraccountingproceduresandexistingtaxtreatment.
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5. Byrecognisingexchangedifferencesoncapitalborrowing,theGovernment’sproposalswill
removeapotentialdisincentivetotheuseoftheECUforcorporatefinancing. Andindue
courseMinisterswillconsiderwhatfurthersteps mightbetakeninthedirect taxfieldto
encouragewideruseoftheECUinbusinesstransactions.
6. TheGovernmentconsidersthattheacceptanceofthetranslationbasisintherecognitionof
7. exchange differences is an essential requirement ofany workable reform ofthe existing
arrangements.
Draftclauses
8.
Iftheproposalscommand abroadmeasureofsupportfromindustry and commerce, the
Governmentintendstoconsultfurtherondraftclausessettingoutthefulldetailsofthenew
regimebeforefinallycommittingitselftolegislationinaFinanceBill.
9.
Compliance
Itisnotexpectedthattheseproposalswillhaveanysignificanteffectonbusinesscompliance
costs and may in fact reduce them in some areas. The Government would particularly
welcomecommentsonthecomplianceaspectsoftheproposals.
Representations
Representationsareinvitedontheproposals. Theyshouldbeforwardedto:-
TheBoardofInlandRevenue
ExchangeConsultation
Room NewWing
9,
SomersetHouse
LONDON WC2R1LB
tobereceivedby30September1991.
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CHAPTER BACKGROUND
1:
1.1
UK
This chapterbrieflysummarises thebroadprinciples ofthe taxsystem as they affect
foreign exchange gains and losses and the Inland Revenue’s application of the law in
practice. ItalsolooksatthemainissuescoveredintheMarch1989consultativedocument
andsomeoftherepresentationsreceived.
UKTaxLaw
1.2 Under existing law, non-trading income received in foreign currency is translated into
sterlingattheexchangerateprevailingwhentheincomearisesfortaxpurposes. Statutory
deductions arecomputedbytranslating foreigncurrencypayments into sterling using the
exchange rate prevailingwhen the expenditure is incurred for tax purposes. Gains and
losses onforeigncurrency assets and liabilities are not recognised inthe computation of
incomeunlesstheyfalltobetakenintoaccountincomputingtradingprofits. Butgainsand
losses oncapital ornon-tradeassets andliabilities are excluded fromthe computation of
tradingprofits,unlesstheycanbematchedwithcurrentitemsontheprinciplesestablished
in the case ofPattison v Marine Midland Ltd (57 TC 219). Generally, the timing of
recognitionofprofitfollowsacceptedaccountingprinciples,althoughitisopentotaxpayers
toargueinanyparticularcasethatadifferentbasisshouldapply.
1.3 Receipts andexpensesnottakeninto accountincomputingincomemayberecognisedin
capitalgainstaxcomputations. Companies arechargeabletocorporationtaxon gainsbut
forsimplicitythedocumentrefers to CGT. Becauseofindexation and other features of
CGTrules,exchangedifferencesreflectedinCGTcomputationscanbeverydifferentfrom
thoserecognisedunderincometaxrules and incommercial business accounts, and CGT
lossescannotberelievedagainstincome. Exchangedifferencesoncapitalliabilitiesandon
certaincapitalassets,primarilydebts(otherthandebtsonasecurity-broadlydebtswhich
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aremarketable)arenotrecognisedforCGTpurposesatall.
1.4
AnexchangegainorlosswhichisnotrecognisedundereithertheincometaxorCGTrules
iscommonlyreferredtoasa"nothing”.
UKTaxPractice
1.5 Following the House of Lords’ decision in Pattison v Marine Midland Ltd, the Inland
Revenueengagedinaperiodofconsultationwithinterestedpartieswhichconcludedwith
theissueofaStatementofPracticeinFebruary1987(SP1/87).
1.6 TheStatementofPracticewaspublished as apracticalguideto facilitatethepreparation
andagreementoftaxcomputationsoftradingtaxpayers. Itconsideredanumberofissues
includingthetimingofrecognitionofexchangedifferences,thedistinctionbetweencapital
1.7 andcurrentliabilitiesandtheapplicationoftheprinciplethatexchangegainsandlosseson
assetsandliabilitieswhicharematchedshouldbeignoredfortaxpurposes.
DifficultieswiththePresentSystem
The Government recognises thatcertain features ofthepresent taxtreatment offoreign
exchangegainsandlossesareseenasunsatisfactory. Theseare,verybroadly:
Fortradingcompanies: exchangedifferencesoncapitalliabilities(loanswhichaddto
the capital ofthe company such aslongtermborrowing) and on capital monetary
assets(suchasadvancestosubsidiaries)arenotrecognisedfortaxpurposes;
Forinvestmentcompanies: exchangedifferencesonliabilitiesarenotrecognisedfor
tax purposes at all,but exchange differences on investmentswhich are chargeable
assets for capital gains taxpurposes are recognised in calculating capital gains or
lossesonrealisation;
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For both kinds of company: the hedging of currency exposures may be made
ineffectivebecausetheexchangegainorlossarisingonthehedginginstrumentmay
betreateddifferentlyfromtheexchangegainorlossontheunderlyingtransaction(eg
a gain on the hedging instrument might be taxed but a loss on the underlying
transactionnotallowed);
Forcompanieswithsharecapitaldenominatedinforeigncurrency: suchcompanies
seeitasaproblemthatexchangedifferencesonthesharecapitalarenotrecognised
fortaxpurposes;
ForcompaniesoperatingintheUKwhichprepareaccountsinforeigncurrency,the
correctmethodofcomputingtheirsterlingtaxableprofitisuncertain.
Representations
1.8 The consultative document discussed these features ofthe present system and analysed
possibleoptionsforreform. Itinvitedcommentsontheseissuesandonhowfarthepresent
systemwasinhibitingordinarycommercialtransactions.
1.9 Representationswerereceivedfrom30representativebodies, companies andindividuals,
buttherewasnoconsensusonthewayforward. Therepresentations astotheappropriate
method and timing ofrecognition ofexchange differences were a reflection ofthewide
rangeofviewswhichexistsinthisdifficultarea. Therewas,however,broadagreementthat
somethinghad to be done about the non-recognition ofexchangedifferences oncapital
borrowingandaboutthefragmentedtreatmentofhedgingtransactionswhichwereseenas
hinderingnormalcommercialoperations. Manyoftherepresentations also acceptedthat
therewerenoeasyanswersinthisareaandmostaskedforfurtherconsultationbeforeany
legislationwasbroughtforward.
1.10 The Government was grateful for the helpful and constructive representations on the
consultativedocument. Itisrecognisedthatthedifferentinterestsofcompaniesindifferent
sectorsmeanthatitisunlikelythatasingleagreedapproachorrecommendationforchange
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willcomefromindustryandcommerce. InthelightofthistheGovernmenthasdecidedto
putforwardaschemeofreformwhichitbelieveswillcomeclosesttosatisfyingthecriteria
forchange set out in theMarch 1989 consultative document. Whileit is clear that any
solutionwillnotsatisfyeveryone,theGovernmentseesitasessential,ifproposalsforreform
inthisareaaretobeimplemented,thattheyshould:-
canyasubstantialmeasureofsupportacrossallsectorsofindustryandcommerce;
beworkableinpractice; and
notinvolveunacceptableExchequercosts.
1.11 Inbringingforwardtheseproposals, theGovernmenthasconsideredcarefullythevarious
pointsraisedintherepresentations,particularlythosediscussedinAnnexesAandB. For
thereasonsgiven,however,itconcludedthattheproposalsintheseAnnexescouldnotbe
accepted.
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CHAPTER PROPOSALSFORCOMPREHENSIVEREFORM
2:
2.1 Provideditwouldcommandasubstantialmeasureofsupportfromindustryandsubjectto
some further work on costs (paragraph 2.24), the Government proposes to introduce a
schemeofreformwhichwouldrecogniseasincomeexchangedifferencesonallmonetary
assetsandliabilitiesastheyaccrue. Theschemewouldprovideforapartial,butsignificant
deferral of unrealised gains in certain circumstances and for special rules to deal with
particular types ofcompanyso as to take into account their accounting procedures and
existingtaxtreatment. Themainobjectivesofthisreformwouldbetodeviseasensibleand
practicablenewregimewhichwould:-
bring into the tax system foreign exchange gains and losses which are currently
"nothings",primarilythosearisingoncapitalborrowing;
removedistortionsinthesystembyrecognisingwhataregenuinebusinessexpenses
and receipts and thus put UK companies on a par with their international
competitors;
provideareasonabledegreeofprotectionfortheExchequeragainstexploitationand
abuse;
dealwiththefragmentationofcurrencyhedgingtransactionsfortaxpurposes; and
providegreatercertaintyoftreatmentinthiscomplexarea.
2.2 Anoutlineoftheproposalsissetoutatparagraph2.3below; detailedexplanatorymaterial
iscontainedatparagraphs2.4-2.23.
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