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4 Int'l Tax Rev. 12 (1992-1993)
Confusion Reigns in UK Forex Proposals

handle is hein.journals/intaxr4 and id is 14 raw text is: Confusion reigns in UK forex proposals The UK tax regime applicable to foreign ex- change gains and losses has always been a complex subject and riddled with anomalies. The proposed new legislation announced in the recent press release is intended to simplify matters; but a recent case before the Special Commissioners suggests that received wisdom in this area may be wrong. It is highly probable that tax can be avoided on certain commonly arising capital exchange gains. This is despite the fact that, for capital gains purposes, taxpayers cannot as yet apply the principle whereby foreign exchange gains and losses can be offset where they arise on matched assets and liabilities. FORWARD CONTRACT The case concerned a company which had borrowed US dollars on capital account to make a sterling investment which was again a capital transaction. The taxpayer had wanted to borrow sterling but because for various reasons it had to borrow dollars, it simultaneously took steps to cover its position by entering into a forward contract to buy enough to repay the dollar loan at the required future date. To understand the potential complications of this case, a summary of the current state of play on the UK taxation of exchange differences is given below. The difficulties inherent in the UK system of taxation of foreign exchange differences stem from two main sources: * The Inland Revenue's insistence that deal- 12 ings involving foreign currency must be analysed into their component transactions; 0 The need to determine whether each trans- action is on capital or revenue account and then to apply a different tax regime accord- ingly. CAPITAL OR REVENUE? Another contributory factor is that apart from overdrafts and other fluctuating short term facilities, borrowings are frequently on capital account unless the taxpayer is a bank or other financial concern; but because the proceeds of borrowings are frequently used to fund activi- ties on revenue account, different rules apply to each side of the equation. For example, a long term borrowing of dollars by a UK company which is not a bank or financial institution would be a borrowing on capital account. Thus, if the company sustained exchange losses on the borrowing, no relief for the losses would be available through deduc- tion against taxable income profits. Further, because the capital gains regime only taxes gains or allows relief for losses derived from assets, no allowable capital loss would result because the dollar borrowing would be a liability. It also follows that a gain achieved in identical circumstances would be a tax nothing. On the other hand, a UK trading company which sustained a loss on realisation of, say, some dollar trade debts would be able to deduct that loss from its trading profits; conversely, if the reverse occurred, it would have to include any exchange gain in its taxable profits. If, however, the company in the first example had undertaken the borrowing to fund trading activities resulting in the dollar trade debts in the second case above, it would need to analyse or dissect its foreign currency dealings into their component parts. This would result in capital treatment applying to the borrowing leg of its activities but ordinary income or revenue treatment for the exchange difference arising on the trade debts. This means that the company could sustain a non-allowable loss on its dollar borrowing but suffer taxation on the exchange gains it would have made on its trade debts, even though the loss on the one hand and the gain on the other would cancel each other out at least in part. INTERNATIONAL TAX REVIEW • NOVEMBER 1992

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