Clause 600: Contract which is or forms part of financial asset or liability

1618.     This clause provides that fair value accounting is used in the case of certain contracts for the purposes of the general rule in clause 595(2). It is based on paragraph 17A(1A) of Schedule 26 to FA 2002.

1619.     The contracts to which this clause applies are those that are not treated as a derivative for accounting purposes because they fail the requirement of the relevant accounting standard as regards the initial net investment required by the contract but are nevertheless treated as a financial asset or liability. See the commentary for clause 579.

Clause 601: Contract relating to holding in OEIC, unit trust or offshore fund

1620.     This clause applies fair value accounting in determining the credits and debits to be brought into account in respect of a contract that is treated as a derivative contract because of clause 587. It is based on paragraph 36(1) and (2A) of Schedule 26 to FA 2002.

1621.     Clause 587 applies if the underlying subject matter of a contract includes a holding in a collective investment scheme that fails to meet a “qualifying investments” test. Because this clause operates by reference to clause 587, Change 63 in Annex 1 (reference to a “relevant holding” is to a holding which is the underlying subject matter of the contract rather than a holding of the company which is a party to the contract) applies here as well.

Clause 602: Contract becoming one relating to holding in OEIC, unit trust or offshore fund

1622.     This clause determines the opening valuation of a derivative contract for the purposes of clause 601. It is based on paragraph 37(1), (2), (3), and (4) of Schedule 26 to FA 2002.

1623.     The accounting period to which this clause applies is that in which a relevant contract is treated as a derivative contract because of clause 587 if that period immediately follows another in which it was not so treated. The clause applies only if the relevant contract was a “chargeable asset” (defined in clause 703) at the end of the earlier period.

1624.     For the meaning of “market value” for the purposes of corporation tax on chargeable gains, see in particular section 272 of TCGA.

Clause 603: Associated transaction treated as derivative contract

1625.     This clause applies fair value accounting in determining the credits and debits to be brought into account by virtue of clause 588 in respect of an “associated transaction” that is treated as a derivative contract because of that clause. It is based on section 91B(5) of FA 1996.

1626.     For the circumstances in which clause 588 applies and for the meaning of “associated transaction”, see the commentary on that clause.

1627.     Subsection (1) provides that this clause must be construed as if it were part of Chapter 7 in Part 6 (shares with guaranteed returns etc). That Chapter rewrites sections 91A to 91G of FA 1996.

Clause 604: Credits and debits treated as relating to capital expenditure

1628.     This clause brings a credit or debit that is treated in the accounts as part of a fixed capital asset or project into account under this Part in the same way as a credit or debit that is brought into account in determining the company’s profit or loss. It is based on paragraph 25 of Schedule 26 to FA 2002.

1629.     Generally accepted accounting practice may permit a credit or debit of an income nature to be included in the value of a fixed capital asset or project. If this happens, the credit or debit bypasses the statements mentioned in clause 597. This clause overrides that treatment, except in the cases mentioned in subsections (3) and (5).

1630.     Subsection (5) prevents any debit being taken into account under this Part that writes down the value of the asset or project in question, or creates a reserve for amortisation or depreciation of that asset or project, so far as the write down etc is attributable to a debit brought into account under this clause. As this clause overrides the accounts treatment of the capitalised debit, this rule in this subsection prevents a double deduction should the asset or project be written down, or a reserve created for its amortisation or depreciation, whether in the same or a later period, if the amount taken to profit and loss is attributable to the amount brought into account under this clause.

1631.     The source legislation for subsection (5) refers to “so much of any amortisation or depreciation as represents a writing off of the interest component of the asset”. The rule is identical to that in the equivalent rule for loan relationships (clause 320(6)). But the “interest component” of the asset refers to something that is dealt with by the loan relationships provisions and has no relevance to the derivative contracts provisions. The emphasised words have therefore not been reproduced in this clause. See Change 65 in Annex 1.

Clause 605: Credits and debits recognised in equity

1632.     This clause brings a credit or debit that is recognised in equity or shareholders’ funds, rather than in one of the statements mentioned in clause 597(1), into account for the purposes of this Part in the same way as a credit or debit that is brought into account in determining the company’s profit or loss. It is based on paragraph 25A of Schedule 26 to FA 2002.

1633.     As in the case of clause 604, this clause overrides the accounts treatment.

Clause 606: Exchange gains and losses

1634.     This clause provides that exchange gains and losses arising from a derivative contract are included in the profits and losses mentioned in clause 595(3). It is based on paragraph 16 of Schedule 26 to FA 2002.

1635.     Subsection (1) does not rewrite the words “and related transactions” in paragraph 16(1) of Schedule 26 to FA 2002. They are not considered to add to the effect of this provision.

1636.     Subsection (3) excludes exchange gains and losses arising in two circumstances from the basic rule in subsection (1) if those gains and losses are recognised in the company’s “statement of total recognised gains and losses”, “statement of recognised income and expense”, “statement of changes in equity” or “statement of income and retained earnings”. Those terms are defined in clause 710 as having the meaning they have for accounting purposes. Some are taken from UK generally accepted accounting practice and the others from international accounting standards, but are otherwise equivalent terms. This subsection is subject to the effect of any regulations made under the power in subsection (5).

1637.     The clause contains two regulatory powers. The first is in subsection (4). It concerns exchange gains and losses from a derivative contract whose underlying subject matter is wholly or partly currency. Regulations may exclude such gains from the scope of subsection (1). For regulations made under this power, see the Loan Relationships and Derivative Contracts (Disregard and Bringing into Account of Profits and Losses) Regulations 2004 (SI 2004/3256), as amended.

1638.     The second is in subsection (5). Regulations may countermand the effect of the rule in subsection (3) or of regulations made under subsection (4). Where the regulations apply, the affected amounts are brought into account under this Part as credits or debits arising from a company’s derivative contracts or for the purposes of corporation tax on chargeable gains. (The Exchange Gains and Losses (Bringing into Account Gains or Losses) Regulations 2002 (SI 2002/1970), as amended, are made partly under the power rewritten in subsection (5). But, as amended by regulation 5 of SI 2005/2013, SI 2002/1970 now has no direct impact on the source legislation for this clause.)

1639.     The source legislation for this clause was repealed by paragraph 9 of Schedule 6 to F(No 2)A 2005, subject to the making of an order for the repeal to have effect. That prospective repeal is preserved by the paragraph “repeal of provisions concerning exchange gains and losses from derivative contracts” in Part 10 of Schedule 2.

Clause 607: Pre-contract or abortive expenses

1640.     This clause adds pre-contract and abortive expenses to the expenses that are taken into account under clause 595(3) in determining a company’s profits and losses under this Part. It is based on paragraph 15(5) of Schedule 26 to FA 2002.

Clause 608: Company ceasing to be party to derivative contract

1641.     This clause brings into account amounts recognised in accounts in respect of a derivative contract after the accounting period in which the company ceases to be a party to that contract. It is based on paragraph 53(3), (4), (5) and (6) of Schedule 26 to FA 2002.

1642.     The accounting policies of a company may treat part of the profit or loss in respect of a contract as deferred income or loss to be brought into account in accounting periods later than that in which the company ceased to be a party to the contract. This clause identifies amounts to be treated as credits and debits in subsequent periods until all the deferred income or loss has been brought into account under this Part.

1643.     Subsections (3) to (6) set out how certain conditions in this Part may be treated as satisfied in respect of the former derivative contract. Those are conditions that may need to be satisfied for a particular provision to apply in respect of post-cessation credits or debits. For examples of the conditions to which subsection (3) or (5) may apply, see clauses 573 and 690.

1644.     Subsection (7) makes clear that the deeming effect of subsections (3) to (6) carries through for any question of what a company’s derivative contracts are or whether a company is a party to a derivative contract (see clause 578).

Clause 609: Company ceasing to be UK resident

1645.     This clause and the next apply if a derivative contract moves out of the scope of corporation tax because the company holding it is no longer within the charge to tax in respect of it. This clause treats a company as making a deemed disposal and reacquisition of the contract at its fair value immediately before the company ceases to be UK resident. It is based on paragraph 22A(1), (2) and (3) of Schedule 26 to FA 2002.

1646.     “Fair value” is defined in clause 710.

1647.     Subsection (1) provides that the company is treated for the purposes of this Part as reacquiring the derivative contract for the same amount. This deemed value will be taken into account should the derivative contract re-enter the scope of corporation tax because of a further change in the residence status of the company or otherwise.

1648.     Subsection (2) has an exception to the general rule. This applies if a company moves abroad but leaves behind such a business operation as amounts to a permanent establishment and that operation includes at least some of the rights and liabilities under the derivative contract. In effect, the contract has not left the scope of corporation tax. (“Permanent establishment” is defined in section 832(1) of ICTA by reference to the meaning provided by section 148 of FA 2003.)

1649.     Subsection (3) provides an order of priority if this clause would apply in relation to the same circumstances as trigger clause 631 or 632. There is an equivalent order of priority in clause 333 in Part 5. There is no reason for the two sets of provisions to differ in this respect. This subsection brings the provisions for loan relationships and derivative contracts into line. See Change 66 in Annex 1.

Clause 610: Non-UK resident company ceasing to hold derivative contract for UK permanent establishment

1650.     This clause treats a non-UK resident company as making a deemed disposal and reacquisition of a derivative contract at its fair value if and to the extent that some or all of the rights or liabilities under a contract held or owed for the purposes of a permanent establishment of that company cease to be so held or owed. The clause is based on paragraph 22A(1) and (4) of Schedule 26 to FA 2002.

1651.     The circumstances in which this clause applies include where the contract is now held for the purposes of another part of the company’s business (which is not a permanent establishment) or where the permanent establishment ceases to be such. In those cases the derivative contract has left the scope of corporation tax.

1652.     A significant difference between the conditions for the application of this clause and those for the preceding clause is that this clause does not apply if the rights and liabilities under the contract cease to be held or owed for the purposes of the permanent establishment because of a “related transaction” (defined in clause 596). That is, it does not apply when the contract ceases to be held because it is disposed of. That disposal is itself an occasion leading to amounts being brought into account under this Part.

1653.     Subsection (3) introduces the same priority rule as is introduced in the preceding clause. See again Change 66 in Annex 1.

Clause 611: Release under statutory insolvency arrangement of liability under derivative contract

1654.     This clause exempts from the scope of this Part any credit arising on the release of a company’s liability to pay an amount under a derivative contract, if the release is part of a statutory insolvency arrangement. It is based on paragraph 22(5) of Schedule 26 to FA 2002.

1655.     A “statutory insolvency arrangement” is defined in section 834(1) of ICTA by reference to the Insolvency Act 1986 and other provisions having a similar effect.

Chapter 4: Further provision about credits and debits to be brought into account

Clause 612: Overview of Chapter

1656.     This clause describes the purpose and content of the Chapter. It is new.

Clause 613: Introduction to sections 614 and 615

1657.     This clause sets out when clauses 614 and 615 apply. It is based on paragraph 50A(1) and (1A) of Schedule 26 to FA 2002 and paragraph 7(6) of Schedule 6 to F(No 2)A 2005.

1658.     A company may decide to apply a different set of standards to the presentation of the company’s results. Regulatory rules may also require that a company switches to a different set of standards. If there is such a change of accounting policy, the value of the company’s assets and liabilities at the start of the first period of account to which the change applies are restated in accordance with the standards adopted.

1659.     This clause applies only if the change is from an accounting policy that “accords with the law and practice applicable” in relation to the earlier period to another such policy in relation to the next. The law and practice in question is that provided in particular by the Companies Acts and the Accounting Standards Board (or their equivalents in its country of residence if the company is non-UK resident but within the charge to corporation tax in respect of a derivative contract).

1660.     Clauses 614 and 615 prescribe the credit or debit to be brought into account on a change of accounting policy, according to whether the value of the company’s assets and liabilities increases or decreases on the change.

1661.     Subsection (4) treats a particular situation as a change of accounting policy although there is no change in the actual accounting policy used by the company from one period to the next. International accounting standards and new UK generally accepted accounting practice require a company, in certain circumstances, to divide a loan relationship between rights and liabilities under a loan relationship and rights and liabilities under one or more derivative financial instruments or equity instruments (see clause 585(1)).

1662.     Clause 416 allows a company subject to old UK generally accepted accounting practice (which does not permit it to divide a loan relationship in that way) to elect that a loan relationship is treated as divided as mentioned in clause 415(1) (the equivalent for loan relationships of clause 585(1)), if division would be permitted under new UK generally accepted accounting practice or international accounting standards. Clause 416 applies an election made under it for the purposes of this Part as well as for Part 5.

1663.     The result of such an election is a change in accounting policy for the purposes of clauses 614 and 615, but only in relation to all the derivative financial instruments or equity instruments in the company’s affected loan relationships. This rule applies from the date the election has effect. Broadly, the election has effect from the beginning of the period of account in which the first loan relationship is acquired to which an election can apply.

Clause 614: Change of accounting policy involving change of value

1664.     This clause treats the increase or decrease in the carrying value of a derivative contract on a change of accounting policy as a credit or debit to be brought into account in the later period. It is based on paragraph 50A(2), (3) and (5) of Schedule 26 to FA 2002.

1665.     “Carrying value” is defined in clause 702.

1666.     Subsection (3) makes an exception to the general rule in so far as a credit or debit arising from the change of accounting policy is brought into account for the purposes of this Part under another provision. For example, a prior period adjustment brought into account under clause 597(2) would be excepted from the general rule in this clause.

Clause 615: Change of accounting policy after ceasing to be party to derivative contract

1667.     This clause requires a credit or debit to be brought into account, similarly to clause 614, in a case where clause 608(2) applies. It is based on paragraph 50A(3C), (3D) and (5) of Schedule 26 to FA 2002.

1668.     Clause 608 applies if profits and losses arising to a company from a derivative contract for the accounting period in which the company ceases to be a party to the contract are not wholly reflected in credits and debits brought into account under this Part for that period. In effect, it is a “post-cessation receipts” provision.

1669.     Because the derivative contract from which the income or loss derived is either no longer in existence or no longer held by the company, clause 613 cannot apply in this case. Clause 615 deals with the amount by which the value of the residual deferred income or loss in respect of the former contract alters as a result of the change of accounting policy affecting a subsequent period.

1670.     Subsection (4) corresponds to the rule in clause 614(3).

1671.     Subsection (6) corrects a minor error in the source legislation. Paragraph 50A(3D) of Schedule 26 to FA 2002, in defining the “amount outstanding”, refers to an amount recognised “in respect of the profits, gains or losses that arose from that relationship or a related transaction in the cessation period (within the meaning of section 103(6))”. The words with emphasis are of course appropriate to the loan relationships provisions and not to those for derivative contracts. They reflect the wording of paragraph 19A(4C) and (4D) of Schedule 9 to FA 1996 (rewritten as clause 318 in Part 5), on which paragraph 50A(3C) and (3D) of Schedule 26 to FA 2002 was modelled. More appropriate wording has been substituted.

Clause 616: Disapplication of fair value accounting

1672.     This clause reverses the effect of clauses 584 and 586 if certain conditions are met by reference to an embedded derivative identified by either of those clauses. It is based on paragraphs 45L(1), (1A), (1B), (1C), (2) and (3) of Schedule 26 to FA 2002.

1673.     Because the contract out of which the embedded derivative arose is treated as one that is not split in accordance with clause 584 or 586, the clause disapplies clauses 573 and 574 to that derivative.

1674.     It also sets aside fair value accounting as an accounting basis in calculating profits and losses on the contract in question. For contracts to which this clause applies, splitting of the contract under clause 584 or 586, or the use of fair value accounting, may produce unacceptably volatile results for tax purposes.

1675.     The clause does not apply to an embedded derivative within clause 584 that comes within clause 592 (so that it may meet the “excluded property” conditions in clause 589). Nor does it apply if regulation 9 of the Disregard Regulations applies (SI 2004/3256, as amended). That regulation prescribes credits and debits, in the case of derivative contracts that are interest rate contracts, for the purposes of paragraph 17B of Schedule 26 to FA 2002 (rewritten in clause 597).

1676.     Nor does the clause apply if an election is made under clause 617 for this clause not to apply. A company may choose to make such an election if it prefers to retain fair value accounting for contracts within clause 584 or 586.

1677.     Subsection (3) treats the relevant contract that was divided under clause 584 as not so divided. It is therefore treated as a single derivative contract for the purposes of this Part. But again the contract is treated as one to which fair value accounting does not apply.

1678.     Subsections (4) and (5) treat the contract that was divided under clause 586 as not so divided. The contract is therefore outside the scope of this Part. It is dealt with for tax purposes according to what sort of contract it is. Subsection (5) also provides that clause 46 in Part 3 of this Bill (calculation of trade profits in accordance with generally accepted accounting practice) applies as if fair value accounting was not generally accepted accounting practice for that company.

1679.     Subsections (3) and (4) apply to the “original contract” (defined in subsection (7)) rather than (as in the source legislation) the “contract” to avoid confusion with the relevant contract referred to in subsection (1)(a).

Clause 617: Election for section 616 not to apply

1680.     This clause allows a company to elect that clause 616 does not apply to its contracts. It is based on paragraph 45L(2A), (2B) and (2C) of Schedule 26 to FA 2002.

1681.     For some companies the benefit afforded by clause 616 may be disproportionate to the administrative and accounting burden of distinguishing and tracking affected contracts. Or the degree of volatility in the tax consequences of splitting the contract or using fair value accounting may be acceptable to the company holding the contract.

1682.     An election under this clause applies to all of a company’s contracts. Clause 618 contains further provisions modifying or extending the effect of an election made by a member of a group of companies.

1683.      Subsection (2) excludes two types of contract from an election. They are, first, a “contract of long-term insurance” (defined in section 431(2) of ICTA) and, second, a contract where the embedded derivative identified by clause 584 or 586 has commodities as its underlying subject matter.

1684.     Subsection (2)(b) says “embedded derivative” rather than “embedded derivative contract”. The Finance Act 2002, Schedule 26, (Parts 2 and 9) (Amendment) Order 2006, SI 2006/3269 omitted the definition of “embedded derivative contract” from the source legislation. But the use of the term in paragraph 45L(2A) of Schedule 26 to FA 2002 was missed. “Embedded derivative” matches the amendments introduced in this respect by that Order. See in particular clauses 584 and 586.

1685.     Unlike the source legislation, the clause does not specify how the election must be made. See Change 1 in Annex 1.

Clause 618: Elections under section 617: groups of companies

1686.     This clause applies or disapplies the effect of an election under clause 617 in a number of cases where a party to a contract is a member of a group of companies. It is based on paragraph 45LA of Schedule 26 to FA 2002.

1687.     In the first case, subsection (1) treats the group member who is a counterparty to a contract to which a fellow group member is a party as having made an election in relation to that contract if that fellow group member has made an election. This rule ensures parity of treatment of the contract within the group.

1688.     In the second case, subsection (2) provides that a group member to whom a fellow group member has transferred a contract is treated as having made an election in relation to that contract if the fellow group member makes an election. This rule applies even if that fellow group member makes the election at a time after the transfer has been made or at a time when the companies are no longer members of the same group. This rule ensures that a company cannot exclude some of its contracts from the effect of an election by first transferring them to another group member.

1689.     The reference in subsection (2) to a contract “to which section 584.. or section 586.. applies” corrects a missed consequential amendment to paragraph 45LA(3)(b) of Schedule 26 to FA 2002. The reference there to “paragraph 2(3)” is otiose following the replacement of that provision by paragraph 2(2A) of Schedule 26 to FA 2002 (by article 3 of the Finance Act 2002, Schedule 26, (Parts 2 and 9) (Amendment) Order 2006, SI 2006/3269) and the insertion of paragraphs 2A and 2B of Schedule 26 to FA 2002 (by article 4 of that Order). Clauses 584 and 586 apply to the types of contract to which paragraph 2(3) of Schedule 26 to FA 2002 applied.

1690.     The third case is if:

• B becomes a party in place of A to a relevant contract treated as such by clause 584 or 586, at a time when they are members of the same group;

• that contract was within clause 616 in A’s hands (that is, A had not made an election); and

• B’s other contracts are outside clause 616 by virtue of an election B has made (whether an election made before B has succeeded A as a party to the contract or one made later).

1691.     Subsection (4) ring-fences the contract in question, so that any existing or later election by B is ineffective in relation to that contract. This rule ensures that a contract cannot be selected for preferential treatment under another group member’s election if the member who is the original party to the contract does not otherwise wish to make an election. This rule is however disapplied if A makes an election in respect of its contracts subsequent to B becoming a party to the contract in place of A.