Corporation Tax - Change in Functional Currency

Corporation Tax - Change in Functional Currency

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 I do the CT but not the audit for a company.  It has changed functional currency.  Previously records were maintained in USD but statutory accounts were prepared in Sterling.  Now accounts are being presented in USD.

Previously fixed asset additions were translated into £ at the rate applying when they were acquired.  This meant that the £ figure in the accounts was "out of synch" with the underlying USD fixed asset register (because the £ fixed asset figures were not revalued each year with changing exchange rates.) When the decision was made to present the accounts in USD the opening balance used for fixed assets was the amount in the USD fixed assets register (rather than the previous years £ balance translated at the opening rate).  This gave a substantially higher opening balance.  A corresponding notional increase in the company's opening reserves was made ie the opening reserves are the prior year's closing reserves at the closing rate plus the notional uplift in the fixed asset valuation.

The question is whether the notional uplift in the value of reserves has any CT implications.  I would have thought not, but I'd welcome any thoughts anyone else may have.

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By thisistibi
21st Feb 2011 14:09

Interesting

This is an interesting question.  s308 CTA 2009 specifies that forex taken to reserves must still be taken into account for corporation tax (via the loan relationship rules) except if one of the two exceptions in s328 are met:

1) exchange gains or losses on a loan relationship taken to the statement of total recognised gains and losses (STRGL) or to equity;

2) where exchange profits or losses arising on translation of part of a company’s business from one currency to another are taken to reserves.   This will happen where the results of an overseas branch, or other part of a company’s business that is conducted in a different currency, is incorporated into the company’s accounts using the closing rate/net investment method.

This is discussed in the HMRC manuals CFM61140.

I don't think the situation you specify falls into either of the exceptions in s328, which suggests the forex must be taken into account.  HOWEVER, I can tell you that when my company switched from GBP to USD functional currency about 10 years ago, we didn't take all the forex into account.  We only took forex on monetary items into account, and treated the forex adjustment on non-monetary assets (including fixed assets) as non-taxable/non-deductible.  The rules might have changed since then, but I never got to the bottom of the treatment.

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By WaldoLydecker
22nd Feb 2011 14:54

Thanks

 Thanks for that.  I think the counterargument is that nothing is taken to reserves.  For example, imagine a balance sheet Fixed Assets, £1000, other net assets £1000.  The closing rate is 1.5, but the Fixed Assets cost $2,000 (the difference being exchange).  Following a change in functional currency the opening balance sheet for the following period is shown as FA $2000, Other assets $1500.  At the closing rate reserves have increased, but it's a non-sequitur to think in these terms as this is no longer a £ company.  The new balance sheet is simply the restatement of the old balance sheet using a different functional currency, and the correct starting point for measuring profit for the year in $ functional as the rules prescribe.  Tax was correctly assessed during the years the company was £ functional currency, and it is now being assessed correctly as a $ functional currency.  The only bit of the past that's relevant is the brought forward capital allowances position, and you simply start from the correct position, ie the closing figures in the previous year's return.

I'm not saying this is the answer (if I knew the answer I wouldn't need to ask the question!) but I'm now starting to think it's the likely answer.  I can't find guidance anywhere and a couple of friends who're CT practitioners don't know either. It does seem to be a major problem with our tax system that it's so hard to get a definitive answer to this type of question.

 

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By thisistibi
22nd Feb 2011 16:10

Yes I think I agree with you, but there isn't any solid ground to walk on so I feel a bit uncomfortable here.  I think, which is basically what you are saying, that you need to make sure that nothing has fallen outside the charge of CT as a result of the change in functional currency. 

Somehow, although I don't have it totally straight in my mind, I think that the restatement recorded on a change of functional currency for monetary assets DOES cause an issue for what has been charged to CT (because forex on monetary items would normally have been taken to the P&L) whereas the restatement of non-monetary items is what you describe - just a restatement in another currency; it's not forex as such since non-monetary assets on the balance sheet are not normally revalued (and therefore no amounts have escaped a CT charge in respect of such assets)...

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By WaldoLydecker
23rd Feb 2011 12:07

Some further thoughts

 I've now spoken informally to an International Tax specialist from one of the Big 4.  He said that in similar situations he's seen the BS has always been uniformly translated at the closing rate.  The fact that the new $ fixed asset balance didn't tie in with the $ fixed asset register would be disregarded (in effect the exchange difference is booked in the FA register, not the accounts).  He's a tax specialist not an accountant so he's not offering an opinion about the accounting treatment, just reporting what he's seen in practice.   With that accounting treatment no exchange differences arise.  He thinks that's why I can't find any guidance on this - with the "normal" accounting treatment, no exchange differences arise.  He wasn't able to offer a strong opinion about whether the alternative treatment actually adopted causese a tax problem.  I suppose it helps my case (for disregarding these exchange movements) that with "normal" accounting treatment they would not have arisen.

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By thisistibi
23rd Feb 2011 12:46

You're onto something there.....

I should have realised from our company's accounts when we changed functional currency.  It says:

"At the beginning of the year the company changed its functional currency from sterling to USD. [Reason for change]

The opening balance sheet previously prepared in sterling has been restranslted into USD by applying the closing exchange rate prevailing at [opening BS date].  Non-monetary assets previously purchased in USD would have been carried at that historical amount without further adjustment had the functional currency at that date been USD.  These assets have therefore been restated at their historic rates with any required adjustment being taken to reserves."

Therefore I think there would be something taken to reserves for non-monetary assets (due to using historic value rather than revalued) but that it must be non-taxable/non-deductible - it's not forex as such.  And nothing has fallen out of account for tax purposes.

In view of this, I think your tax expert is wrong (it is correct to use the FA register value as that uses the true, historic exchange rates for these non-monetary assets), but you are still correct with the tax treatment.

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