The measure

HMRC propose to introduce powers to amend the rules concerning the taxation of financial instruments, to ensure that these rules can be aligned with anticipated changes to the accounting treatment of such instruments under IAS 39 and FRS 26.

The IASB is proposing changes to IAS 39 which will affect how financial instruments (e.g. loans, securities, derivatives) are accounted for.

In particular, the IASB has issued (or is expected to issue) Exposure Drafts in relation to:

• the way that financial instruments are classified and measured for accounting purposes;
• when financial instruments are recognised on the balance sheet;
• how impairment losses are quantified; and
• how hedging arrangements should be accounted for.

It is anticipated that the UK's Accounting Standards Board will make corresponding changes to FRS 26.

Since, broadly speaking, the taxation of financial instruments is determined by the accounting treatment, this means that changes may be necessary to the tax rules.

HMRC have therefore announced that legislation will be introduced in Finance Bill 2010 to respond to the accounting changes.

Specifically, it is proposed to insert powers to amend the loan relationships and derivatives contracts regimes (which are contained within Parts 5 and 7 CTA 2009 respectively) through secondary legislation.

HMRC state that any amendments made will be limited to those necessary to ensure the tax rules continue to operate "fairly and efficiently" where companies adopt the modified accounting standards.

The following proposals are currently being discussed by HMRC:

• changes to the ways that convertible and share-linked securities are taxed, following proposals that companies will no longer have to account separately for the equity derivative feature embedded in such instruments;
• given the abolition of the Available For Sale assets category, ensuring that the accounting adjustments on reclassification of such assets is correctly taxed;
• the tax effects if companies are required to measure more of their financial liabilities (e.g. subordinated loans) at fair value;
• the tax rules on repos, given proposed changes to when assets should be derecognised for accounting purposes; and
• the effect of changes as to how impairment losses on financial assets are calculated.

Who will be affected?

Companies that have adopted IAS 39 or FRS 26 for accounting purposes and hold financial instruments (e.g. loans, derivatives).

The use of FRS 26 is currently only mandatory for listed UK companies - broadly, those with shares or securities listed on an EU exchange. However, certain UK companies may have early adopted this accounting standard.

When?

The secondary legislation will be introduced by HMRC in Finance Bill 2010 and will have effect for accounting periods beginning on or after 1 January in the calendar year in which it is made. (For example, regulations made in 2010 will have effect for accounting periods beginning on or after 1 January 2010.)

Since the IASB has proposed that certain accounting changes can be applied retrospectively for periods of account beginning in 2009; Finance Bill 2010 will include measures to ensure tax changes can also apply retrospectively.