Following a change in their functional currency from sterling to US dollars after an intra-group company reorganisation at the end of the period to 31 December 2008, and the subsequent elimination of sterling loan relationship assets, three members of a corporate group claimed foreign exchange losses on the sterling loan relationship assets in their corporation tax returns for the period to 31 December 2008. These losses were included in each company’s accounts within the statement of total recognised gains and losses, described as a ‘Revaluation loss on change in functional currency’. HMRC issued closure notices which sought to disallow these losses on the basis that the exchange differences shown in the accounts did not represent losses and that the correct accounting treatment had not been followed. The taxpayer appealed.
In reaching its conclusion, the First-tier Tribunal considered three factors:
Were the accounts GAAP compliant?
Both parties called accounting experts to support their positions, who differed in their conclusions on which of two methods should be used to account for a change in financial currency. The FTT preferred the evidence of the taxpayers’ expert and concluded that the accounts were therefore GAAP compliant.
Were the exchange differences ‘exchange losses’ for the purposes of the loan relationship rules?
The FTT rejected HMRC’s argument that these differences could not be ‘exchange losses’ because there was no actual economic loss, finding that the legislation only required there to be a comparison at different times the expression in one currency of the valuation in another currency. Therefore, as there was a fall in the value of the assets between 31 December 2007 and 31 December 2008, these exchange differences were indeed exchange losses.
Do the exchange differences ‘fairly represent’ a loss arising to the taxpayers during the period ending 31 December 2008 as required by the loan relationship rules?
The FTT also rejected HMRC’s contention that the use of the words ‘fairly represent’ is a ‘fail-safe’ to prevent such arithmetic differences giving rise to a loss. Instead, the ‘fairly represents’ wording was included in the legislation for an identification and/or timing attribution purpose to identify from entries in the accounts those credits or debits which arise from a loan relationship/derivative contract or to something else and which entries are appropriate in a particular period.
The taxpayer’s appeal was therefore allowed.
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