Company loses tax appeal over ‘functional’ currency

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A company that reported its accounts in US dollars did not comply with UK GAAP, according to the First Tier Tax Tribunal. Nick Huber and Tom Herbert report.

The firm, Ball UK Holdings Limited (BUKH), claimed that although its accounts for 2006 showed its currency as dollars it still complied with UK GAAP.

However, HMRC disagreed, arguing that because Ball Holdings’ ‘functional’ currency was UK sterling it was not complying with UK GAAP − in this case FRS 23.

Ball Holdings’ 2006 accounts showed a foreign-exchange loss when its currency was changed to dollars. The loss gave it a tax advantage of about £25m, which HMRC was keen to cancel out

The company’s argument in the first-tier tribunal, (Ball UK Holdings Limited and HMRC, TC05920,) relied heavily on one word, “autonomy”, to show that it complied with FRS 23.

Tribunal judge Barbara Mosedale disagreed, stating that BHUK’s argument was “flawed”.

“All the other relevant factors also pointed to sterling as functional currency,” she said. “As all relevant factors pointed to sterling, the only possible conclusion in accordance with UK GAAP was that BUKH’s functional currency was sterling.”

Certain disclosures

A Financial Reporting Council spokesperson told AccountingWEB that accounting standards require companies to identify the currency in which they primarily operate and record transactions in that currency.

“Most companies will present their financial statements in that currency,” continued the statement, “but there is also choice to use another currency provided certain disclosures are made.”

‘Tricky judgement’

Julia Penny, technical director at SWAT UK, commented that the issue around the functional currency of an entity can be complex. It relies on a judgement about the currency of the primary economic environment in which the entity operates. Whilst this is usually straightforward for a standalone entity, or a group operating entirely in one jurisdiction for currency purposes, it can often be a tricky judgment in other situations.

In this particular case, a clear analysis of the factors set out in FRS 23 indicating which was the likely functional currency revealed it to be, in the view of the tribunal, sterling. Ball had sought to rely, among other things, on a more general interpretation of the phrase “autonomous” (or rather the lack of autonomy) apparently downplaying the more specific list of indicators given in FRS 23.

Issue ‘more important than ever’

Whilst the circumstances of this case might seem somewhat remote, especially as they refer to a now replaced GAAP, Penny noted that the issue of functional currency is even more important for UK GAAP reporters today than in the past.

“FRS 102, unlike SSAP 20 which most UK GAAP reporters previously used, also requires a company to establish its functional currency,” said Penny. “For those with significant foreign currency transactions, influence from parent companies, or prices denominated in dollars etc., careful consideration should be given to the functional currency, as it may not be as expected.

“Both auditors and preparers of accounts may find the analysis of the case informative, where a particular tricky judgement is required”.

Interpretation of terminology

For Steve Collings, audit and technical partner at Leavitt Walmsley, the case highlights issues where the interpretation of accounting standards terminology can lead to the incorrect application of the standard.

“In this case,” said Collings, “HMRC acknowledged that financial statements must be prepared in accordance with GAAP, and the fact that some accountants have misapplied the provisions in an accounting standard (due to their interpretation of what the standard requires) does not mean that the financial statements have actually been prepared in accordance with GAAP.

“This case confirmed that GAAP is to apply the standard. In more complex cases, it is always advisable to get a second opinion if there are any uncertainties (such as consulting the technical advisory department of your professional body). 

Taken out of context

For Collings, the word 'autonomy' in paragraph 11 of FRS 23, which outlines additional factors to consider in the determination of an entity's functional currency of a foreign operation, was taken out of context and the firm also failed to consider the two examples in paragraph 11(a) of FRS 23 which provides guidance on how to apply the principle of considering '... whether the activities of the foreign operation are carried out as an extension of the reporting entity, rather than being carried out with a significant degree of autonomy'.

“The appellant appeared to take the test of autonomy as a test of autonomy where decision-making is concerned,” said Collings, “rather than considering its main principle which is to search for a primary economic indicator and hence the principle of autonomy is much wider.”

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