CFM51050 | Derivative contracts: the matters and computational rules: 'fairly represents'

CTA09/S595(3) (before amendment by F(2)A15)

This page of guidance only applies for company periods of account beginning before 1 January 2016.

Amounts fairly representing profits or losses

Under CTA09/S307, as it stood before amendment by F(2)A15, the amounts to be brought into account as credits and debits for tax purposes were those which ‘when taken together, fairly represent for the accounting period in question’:

• all the profits or losses of the company which arise from its derivative contracts and related transactions; and

• all expenses incurred for the purposes of those contracts and transactions.

(After the F(2)A15 revisions these have become the “matters” set out in S594A - see CFM51032.

Fairly Represents

The use of the formulation ‘fairly represents’ in S595(3), as it stood before amendment by F(2)A was a matter of some controversy. One view, generally taken by HMRC was that the ‘fairly represents’ rule was a ‘general principle’ that meant that the accounts did not necessarily have to be followed in all cases. The ‘fairly represents’ rule, was seen as capable of taking precedence over the accounting treatment.

It was argued that, important as the company’s accounts are, they do not provide the last word on the tax treatment of a company’s derivative contracts. CTA09/S595(3) imposes an additional requirement - the credits and debits to be brought into account must, when taken together, ‘fairly represent’ the company’s profits or losses on its derivative contracts.

It was not considered that the reference to “fairly represents” meant that it was possible arbitrarily to set aside the accounts in any case where the treatment accorded to a derivative contract appears - either to HMRC or to the taxpayer - to give an unfair tax result. However, it was argued that the reference to “fairly represents” imposed certain limitations to the ‘follow the accounts’ approach.

Rather the argument was that the requirement was that the credits or debits must be those that, taken together, represent a profit or loss of the company, as the terms ‘profit’ or ‘loss’ are generally understood. For example, a company may transfer an in-the-money derivative contract to its parent company as a dividend-in-specie. This is reflected as a debit in the accounts. But even if the debit appears in one of the statements listed at CTA09/S597(1), it does not fairly represent any ‘loss’ of the company - rather, it is a distribution of profits already made. The debit cannot be deducted under CTA09/Part 7.

The alternative interpretation was that the requirement that debits and credits should fairly represent those matters was no more than a means of identifying the debits and credits to be taken into account.

It is arguably consistent with both views that where a debit or credit in a company’s accounts bundles together items that related to a derivative contract and something else, arising from the context of a transaction or instrument, those amounts should be capable of analysis into amounts that do fairly represent the derivative contracts matters and are taken into account under CTA09/PT7 and those which do not and therefore do not fall to be taken into account.

To fall within CTA09/PT7, the profit or loss must relate to the company’s derivative contracts, and not to some other matter. For example, a company using a derivative contract as a hedge of interest rates may show, as one line of its published accounts, a composite of the interest payable (or receivable) and amounts payable or receivable under the hedging derivative. In many cases it will not be necessary to identify separately ‘loan relationships’ and ‘derivative contracts’ credits and debits; amounts relating to both will be taxed under CTA09/PT5, or PT3 if trading amounts. But where it is necessary, the legislation sanctions looking below the surface of the accounts to pick out those credits or debits that together make up the derivative contract profit or loss.