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An anomaly has been identified in the regulations that deal with the taxation consequences of a change of accounting practice with regard to financial instruments.

The Loan Relationships and Derivative Contracts (Change of Accounting Practice) Regulations 2004 SI2004/3271 (COAP Regulations) were introduced to ensure that most changes to the measurement or recognition of financial instruments as a result of a change of accounting policy, in particular on the adoption of International Financial Reporting Standards (IFRS) or their UK equivalents, would be taxed or relieved for corporation tax purposes. Most such transitional adjustments were to be taxed or relieved on a spreading basis over ten years.

The anomaly relates to exchange gains and losses on certain foreign denominated financial instruments, which were not taxed before the change of accounting practice due to the tax rules relating to foreign exchange hedging transactions (the tax matching provisions).

Where these instruments were being treated for accounting purposes as a hedge of a company's economic risk from holding foreign investments (net investment hedge) prior to the change of accounting practice, the exchange movements were not taxed under the tax matching provisions.

However the COAP Regulations, as presently worded, will tax or relieve the reversal of these exchange movements on change of accounting practice even where the amounts in question were not previously taxed or relieved due to the tax matching provisions. This can result in double taxation (where there is a transitional credit to reverse forex losses not previously relieved) or double relief (where there is a transitional debit reversing forex gains not previously taxed).

Regulations are to be laid, to take effect on and after 1 January 2009, to prevent further double taxation or double relief with regard to foreign exchange gains and losses under the COAP Regulations as a result of a change of accounting practice, to the extent that an amount would otherwise be brought into account under the COAP Regulations during the proportion of the ten year spreading period arising after 31 December 2008.

Draft regulations will be published shortly to allow taxpayers a brief period to comment on the detail of these changes before the regulations are laid.