CFM50070 – Corporate Finance Manual – HMRC Internal Manual

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Cases in which the rules on derivative contracts do not apply

The vast majority of derivative products held by companies will fall under the rules on derivative contracts in Part 7 CTA09. Some contracts, however, may not meet any of the accounting conditions of CTA09 / S579, or they may be equity derivatives that are excluded because they meet one of the conditions of CTA09 / S591.

Other ways in which these derivatives might be taxed are discussed below. These alternative possibilities also apply to derivatives held by persons other than companies under the control of CT, for example, if an individual entrepreneur is a party to a derivative for the purposes of its commercial activity.

Business benefits

When a company uses a futures contract or an option to buy or sell commodities as part of a normal incident in its trade, it will not normally be recognized as a derivative and therefore will not meet the requirement. of CTA09 / S579 (1) (a) – see CFM50210.

In many cases, the underlying object (CFM50510) will be a commodity – for example, if a farming company enters into a forward contract with a grain wholesaler to sell its wheat crop. In this case, the contract satisfies condition CTA09 / S579 (2) (a) and falls under Part 7.

When this is not the case – for example, if a construction company enters into an option agreement to purchase land for the purpose of its trade – the profits or losses on the contract will generally be part of the trading profits of the company. business. Since these will be calculated on the basis of the accounts, it is in most cases immaterial whether the contracts are taxed under Part 7 or under the rules on commercial income.

A non-business trader can use derivatives to hedge interest rates or other risks, just like a business. As long as the derivative is held for trading purposes, the profits will be trading profits. An individual can claim that their derivatives transactions constitute a transaction in themselves – see BIM56880.

Real estate companies

The profits of a real estate company subject to corporation tax are to be calculated without taking into account the elements giving rise to credits or debits within the CTA09 / PT5 or the PT7. Thus, the amounts relating to derivative contracts will give rise to non-commercial amounts taken into account within the framework of CTA09 / PT5.

When a taxpayer uses a swap to hedge interest rate risk, currency risk, credit risk, etc. arising from assets, liabilities or transactions that are an integral part of a real estate business, the profits or losses of the swap will be part of the profits or losses of the real estate business.

The rules on derivative contracts do not apply to derivatives that fall under the tax-exempt activity of a UK Real Estate Investment Trust (REIT). There is more on this from GREIT04020.

Capital gains

When a derivative does not fall under Part 7 and is not held for commercial or real estate purposes, two possibilities of taxation remain: the profits can constitute miscellaneous income (formerly case VI, annex D), or they may be taxable as capital gains. Normally, taxation as miscellaneous income would take priority over any charge on capital gains. However, CTA09 / S981 provides that gains made by companies on futures, traded options or financial options are not taxable as miscellaneous income. ITTOIA05 / S779 makes a similar provision for income tax.

Gains on futures contracts and traded or financial options are charged as capital gains under TCGA92 / S143. (The same goes for commodity futures contracts held by individuals for non-trading purposes – for businesses, these will always be derivative contracts.) There are full guidelines from CG55400 onwards. Options other than traded or financial options will nonetheless fall under first principles capital gains rules – see GC12300 et seq.

Miscellaneous income

If the derivative you are considering is not a financial future (for example, a swap), the profits and losses are likely to be taxable as miscellaneous income. HMRC’s views on this point were contained in the Tax Bulletin article (TB66, September 2003), which is reproduced in CFM50080.

A “no tax”?

The legislation in Part 7 CTA09 forms a comprehensive code that supersedes all previous case law principles. But when a derivative does not fall under Part 7 (normally because it is not owned by a company), the profits may not be taxable and the losses may not be refundable, in accordance with the principles. established by case law. The most common example is split bets entered into by an individual only as a bet – see BIM22020. (This will not apply if the spread bet is used for commercial purposes, for example as a hedge.) Note, however, that a spread bet entered into by a company will be a contract for differences and therefore a relevant contract and, unless the underlying object is excluded, a derivative contract.

When a derivative is entered into for no other reason than to obtain a tax benefit, the profits (or, more importantly, losses) may not appear in Schedule D, based on cases such as Lupton v FA & AB Ltd (47TC580) – see BIM20105.

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