Foreign exchange losses: targeted anti-avoidance rules
The measure
A Targeted Anti-Avoidance Rule ('TAAR') to counter-act tax planning arrangements that use the corporation tax regime relating to the hedging of currency risk ('FOREX matching') in an asymmetric manner. FOREX matching defers the taxation of (and in many cases ultimately does not tax) exchange gains and losses from loans and derivatives that hedge currency risk arising from a company's investments in subsidiaries or branches operating in a different functional currency.
The new TAAR will operate to counter-act two types of planning arrangements. The first of these is arrangements that procure a 'one-way exchange effect' - one giving rise to an asymmetrical outcome compared with the hypothetical alternative outcome, i.e. if the currency in question had been subject to the opposite degree of strengthening or weakening in a period. For example, an arrangement might give rise to an allowable loss, where (given the opposite currency movement) a gain would have been matched. The rules should only apply where the arrangements give rise to a tax advantage and utilise FOREX matching. The second type of planning ensured that the forward points in a currency contract (which reflect the inherent interest rate differential between different currencies) were accounted for as part of a matched exchange difference and therefore not taxed.
The TAAR will apply, such that where a financial instrument is part of an arrangement that has a 'one way exchange effect', the exchange gains and losses on that instrument will not qualify for FOREX matching. The TAAR will also restrict FOREX matching where the exchange gain or loss is not computed with respect to spot rates of exchange (e.g. where forward or contract rates are used).
Who will be affected?
Companies with operations in different currencies that have arrangements, or enter into arrangements that are defined to have a 'one way exchange effect', or where companies are currently FOREX matching with exchange gains or losses calculated other than using spot rates. Please note that our initial understanding is that the TAAR may not include a purpose test, rather it will be based on a complicated definition that requires various 'testing dates' of whether there is a one way exchange effect. This could include complex, but commercially driven hedging transactions.
When?
The TAAR will take effect from 22 April 2009. In the case of currently open accounting periods, it will take effect with respect to exchange gains and losses arising on or after that date.
Our main concern with the TAAR is that there is some potential for commercial hedges to be caught, whereupon companies may be involved in extremely onerous compliance obligations. We would rather that this legislation was consulted on more widely to ensure that only targeted transactions are caught, and that grandfathering for existing commercial arrangements was included to give companies certainty on their current hedging position.
In addition, we are concerned that where a company is currently hedging based on calculating its exchange gain or loss, other than from spot rates, the entire instrument may not qualify for FOREX matching. The Budget release proposes only the interest rate differential is restricted but it will be important that is correctly reflected in the resultant legislation..
