Gabelle Tax Analysis: Consultation on foreign currency and chargeable gains
HMRC is consulting on whether or not companies with a non-sterling functional currency should continue to be required to compute their chargeable gains and allowable losses in sterling. The consultation was published on 20 July 2012 and runs to October 2012.
Why are the rules changing?
At present, the current rules require a company to calculate its capital gains and losses in sterling. This rule applies even if the company draws up its accounts in a foreign currency (also known as its functional currency). The Government is considering changing this rule because it has been told that “shares in group companies that are no longer needed for commercial or business purposes are being retained unnecessarily because of potential exposure to gains arising from foreign exchange movements since acquisition.”
Who is affected?
The proposed changes will affect non-UK headed groups with a UK sub-group, in which the sub-group holds less than 10% of the shares in a UK company. Where the shareholding is more than 10%, the substantial shareholding exemption should provide relief from capital gains tax on the disposal of shares. Complaints have been made by these organisations that they cannot liquidate dormant companies because this would trigger a tax charge as a result of currency fluctuations.
How will the new rules work?
The Government proposes that the new rules should be limited to companies with a non-sterling functional currency. Functional currency is defined by (FRS) 23 as “the currency of the primary economic environment in which the entity operates.” The proposals would apply to the disposals of shares only. It is not yet known if the regime will be mandatory or elective.
The rules apply not only to ‘real’ third party disposals of shares by a group but also to intra-group transfers within the group. Companies in the same group may have different functional currencies. For example, where there is an intra-group transfer the transferor’s functional currency may be sterling but the transferee’s functional currency may not be. Under the proposed rule, “the foreign currency base and enhancement costs would be translated into the transferee’s functional currency at the time of transfer. This includes where the transferor uses sterling; the transferee would take on its functional currency equivalents of those costs at the date of transfer.”
The Government is considering including an anti-avoidance rule so that functional currencies cannot be manipulated to gain an unfair tax advantage.
What does this mean for accountants?
If you have a client who wants to liquidate a UK company in which it owns less than 10% of the shares but is afraid to do so because it would give rise to taxable foreign exchange gains, they may wish to consider waiting until we know the outcome of this consultation.