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The measure

Companies that undertake a share rights issue in a currency other than their functional currency may use derivative contracts to hedge the value of the proceeds received. Currently foreign exchange gains and losses on the derivative hedge are taxable or deductible while the exchange movements on the shares themselves are not. There is therefore a mismatch for tax purposes between the treatment of the hedge and the hedging instrument which renders the hedge ineffective after tax.

As already announced in a statement on the 10 March, the Government intends to extend tax hedging rules to cover hedging transactions described above. Thus where a company enters into a derivative transaction to hedge the exchange rate risk from the proceeds of a future rights issue any exchange gain or loss on the derivative contract will be disregarded (to the extent the derivative is hedging the proceeds).

Gains and losses on such derivatives will be permanently disregarded unless overall there is an exchange gain and that gain is subsequently distributed to shareholders. The rationale here is that tax hedging treatment applies only where the gain on the derivative remains in the business to compensate for the reduction in the value of the capital raised.

Who will be affected?

Companies that raise capital through issuing shares denominated in a currency other than their functional currency.

When?

The new rules will apply to all currency derivative contracts entered into on or after 1 January 2009. However this is subject to a complicated transitional rule which requires that a derivative entered into before 10 March must still have been current on the 10 March. In that case any exchange loss up to the 9 March is deductible provided there is an exchange loss when the contract is closed out. If this final loss is lower then the level of the loss at 9 March the deductible loss is restricted to the final loss.