Background Note
41.Hedging the exchange risk that arises from investment in “foreign operations”, such as overseas subsidiaries, is an important commercial activity for many large groups of companies. The UK first introduced tax rules dealing with net investment hedging in 1993, and subsequently the Government has worked with industry and the professions to remove tax obstacles that might otherwise limit the effectiveness of such hedging. In particular, secondary legislation was introduced in 2004, and has subsequently been developed, to cater for the introduction of International Financial Reporting Standards (IFRS), and new UK accounting standards aligned with IFRS.
42.The “forex matching” rules operate by disregarding exchange gains or losses that arise on financial instruments used to hedge shareholdings in overseas subsidiaries. The disregarded amounts may be brought back into account, as a capital gain or loss, on disposal of the shares, but only where the disposal does not qualify for Substantial Shareholdings Exemption.
43.These rules are intended to operate even-handedly, in other words it is equally probable that a gain or a loss may be left out of account. In a minority of case, however, the rules have been abused. Typically, these avoidance arrangements have no effect on the foreign exchange differences reported in the consolidated accounts of a group. However, the effect on the UK taxable profits is that, where a currency moves in one direction, an exchange loss is brought into account, whereas if the currency moves the other way, there is no corresponding gain brought in for tax. Schemes generally rely on sheltering an exchange gain through matching, while an exchange loss appears in another group company and is claimed for tax.
44.Regulations introduced in 2006 targeted two particular schemes. Subsequently, however, other schemes have been developed that circumvent this legislation. This measure therefore revokes the 2006 Regulations and instead introduces an anti-avoidance rule designed to counteract “one-way exchange effect schemes” more generally, while having minimal impact on the majority of groups that do not use such schemes.
