Measures against corporate tax Risk Transfer Schemes ('overhedging' and 'underhedging')
The measure
Following an announcement in the 2009 Budget, HMRC have released revised draft legislation setting out its latest proposals for removing the risk to the Exchequer from 'overhedge' and 'underhedge' transactions.
In broad terms the objective of these structured transactions is to generate enhanced returns (or reduced borrowing costs) for a group by creating a synthetic asset in a high-yield currency (eg Turkish Lira) or a synthetic borrowing in a low-yield currency (eg Japanese Yen) using taxable profits as a hedge of the resulting foreign exchange exposure. This concept is also used to overhedge overseas investments (eg US Dollars) using currency contracts referred to as "tax equalisation swaps". Using the group's taxable profits as a hedge effectively transferred the foreign exchange exposure to HMRC by increasing or reducing tax receipts depending on whether a currency weakens or strengthens.
The measure ensures that a portion of any tax deductible losses (i.e. the net loss on the arrangements which does not represent a 'real economic' loss on a consolidated group basis) from these arrangements will be ring-fenced such that they can only be relieved to the extent the group has taxable profits from the same overhedging or underhedging arrangement to which the rules apply in either earlier or later periods. This effectively transfers the underlying currency risk back (from HMRC) to the group concerned. It is not proposed that taxable gains are to be ringfenced except for the purposes of determining whether ring fenced losses from the same arrangement in earlier or later periods may be brought in.
Who will be affected?
Medium and large multinational groups of companies who have entered or are proposing to enter into such arrangements, as well as groups that use over/under hedges as a means to achieve effective post tax currency hedges where the foreign currency investment tax matching rules are ineffective, will be affected.
When?
The measures will be included in the Finance Bill 2010 and take effect for accounting periods beginning on or after 1 April 2010. Transitional rules will apply to periods that straddle that date. The rules will apply to arrangements in place on the commencement date, but will only affect tax losses accruing from that date onwards. A further period of consultation with HMRC is expected before the rules are finalised.
Whilst the revised draft legislation deals with some of the concerns raised in the earlier consultation period, a number of concerns remain:
- the measures only operate to remove Exchequer risk on a one-sided basis in favour of HMRC;
- the measures may inadvertently catch groups who have not entered structured arrangements which are the target of the rules; and
- the commencement rules for existing arrangements operate asymmetrically ie they impose an inability to deduct future losses even to the extent gains on the same arrangement have already been taxed prior to the commencement date.
Groups that have implemented, or are considering entering into transactions that could be caught by the measures are advised to speak to their usual Deloitte contact.
