UK: Too Important to Disregard - Securities and Banking Update May 2005

Last Updated: 11 May 2005
Article by David Ireland

Most Read Contributor in UK, August 2017

The tax Disregard Regulations, developed as a foil to the volatility in tax cash flow requirements based on IAS 39 fair value results, will require companies to keep a vast amount of information on which transactions should be treated as hedges for tax purposes. So much so that many companies are electing to opt out of them. It’s a complex assessment and either way, companies have only one chance to decide – and most have to do it by 1 July 2005.

Decisions over highly complex tax matters are often left to in-house tax specialists or external tax advisers to wrestle with. They come up with a straightforward choice – more tax or less tax – and any necessary approvals are given with minimal effort from treasurer or finance director. When the matter is highly complex and yet only affects the timing of cash payments of tax, even the tax specialists may have better things to occupy them.

When the issue at stake relates to IAS 39 (Financial Instruments: Recognition & Measurement), however, alarm bells ring and suddenly the issue gets a much higher profile. Or at least it should. For many organisations, the accounting implications of IAS 39 are hard enough to deal with, and the task of dealing with the tax implications are firmly within the "too hard" category.

Unfortunately, there is a vital choice to consider, it is a choice that can be made once and once only, and it is a choice that must be made before 1 July 2005 for most listed entities.

The old way

UK corporation tax takes as its starting point a company’s reported profit before tax. For pre-IFRS periods, some further adjustments were required for financial instruments, such as bringing into account deductions for interest charged to reserves or to fixed assets. The majority of hedging transactions were taxed in line with the accounts, such that foreign exchange movements taken to reserves were only taxed on realisation (if at all).

The arrival of IAS 39

As has been widely, and often sensationally, reported, accounting under IAS 39 means lots of big fair value movements creating wild swings in reported profits that bear little relation to a company’s underlying trading result. Whatever one’s view of that statement, and calming announcements accompanying many results reports so far this year may expose it as somewhat melodramatic, the Inland Revenue listened to taxpayers telling it that basing taxable profits on results affected by IAS 39 was unacceptable.

The result is a set of rules known as the Disregard Regulations. The broad objective of these regulations is to disregard, naturally, much of the volatility introduced by IAS 39. Broadly, the regulations attempt to recreate the taxable result under "old" UK GAAP (i.e. that applying before FRS 26 Financial Instruments: Measurement) for arrangements that would have been accepted as hedges under UK GAAP, but fall short of the prescriptive requirements of IAS 39. They apply in three specific areas: investments in overseas shares, currency and commodity contracts hedging anticipated transactions, and interest rates. In essence this is achieved by stripping out the fair value movement required by IAS 39.

The choice

Given the task set of them, the Disregard Regulations are not a bad result. However, in order to work out their effect, someone has to keep a vast amount of information about what transactions should be treated as hedges for tax, notwithstanding their treatment under IAS 39. Such record keeping may bring a cost well beyond any benefit that the regulations may confer, and in recognition of this the Inland Revenue have allowed taxpayers to opt out of the regulations.

Choosing to opt out puts the taxpayer back at square one: computing taxable profits based on accounting profits. This means that any volatility in the profit and loss account extends into the tax computation. A further problem is that one of the ways in which some organisations have sought to reduce volatility in the reported profit is by designating cash flow hedges, which transfer some of the volatility to equity. As the calculation of taxable profits will pick up these equity movements, the current tax charge may be even more volatile than accounting profits, if the opt out election is made.

However, making the opt out election does reduce the compliance burden which could be a mountainous record keeping requirement for, say, a large bank. It sounds like a difficult choice, and one that should be given due consideration.

But here’s the rub. The election can only be made before 1 July 2005 in many cases (although a later date may apply in some circumstances and companies should check their position). And, if made, it can only be revoked in respect of new contracts entered after the revocation – that is, it sticks to current contracts for ever.

Making a decision

It may be possible now to judge the relative balance between the costs and benefits of the election for the year just reported. The starting point of this article, however, was of course that IAS 39 made accounts less predictable and more susceptible to market movements around the balance sheet date. Thus the impact of IAS 39 on the tax computation is inherently difficult to predict, and thus the cost/benefit analysis of the opt out election is almost impossible to complete.

The effect of making the election would be felt in tax cash flows (whilst the cash cost of tax is directly related to the tax computation, the accounting cost is likely to end up very similar as a result of the equalisation effect of deferred tax). Thus the tax side effectively becomes a treasury decision – is it acceptable to have a volatile tax cash flow requirement based on IAS 39 fair value results, or is the arguably more predictable result of a wider application of hedge accounting preferable?

The effect that can more easily be measured, or at least envisaged, is the cost of creating and maintaining records, just for tax purposes, to allow the appropriate financial instruments to be treated as hedges and accounted for as such for tax purposes. Perhaps because this cost seems more real, many organisations that have formed a view so far have been led by the compliance cost of living with the Disregard Regulations and have opted out of them.

Too hard?

Ultimately then, this highly complex matter is of sufficient importance to be considered outside the tax department. Treasurers need to have a say on the cash flow implications, and financial controllers need to explain whether systems can manage the record keeping requirements. Opting out is right for many, but will not be right for all. Either way a decision is made: doing nothing means choosing the record keeping burden. What is clear is that the issue has to come out of the "too hard" pile and go on to the "too important to disregard" pile.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.