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Corporate Non-Resident Landlords: Derivative Contracts

Corporate Non-Resident Landlords: Derivative Contracts

New HMRC guidance on taxation of corporate non-resident landlords in respect of interest rate swaps and other derivatives from 6 April 2020.

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From 6 April 2020, corporate non-resident landlords (CNRLs) that were previously subject to income tax (IT) on the profits of their UK property rental business are now subject to corporation tax (CT) on those profits. This means CNRLs that are party to interest rate swaps and other derivatives now need to apply the complex CT rules for derivative contracts, and also the special transitional rules that apply solely to CNRLs. New HMRC guidance provides a helpful overview of these rules, together with simple worked examples of how they might apply.

The most common scenario where a CNRL is party to a derivative contract is where the CNRL borrows on floating rate terms, but then enters into an interest rate swap to ‘swap’ that floating rate into a fixed rate.

The IT treatment of the swap prior to 6 April 2020 will have depended on:

  • Whether the swap was regarded as capital or revenue in nature;
  • Whether cash flow hedge accounting applied; and
  • Whether the hedging was fully effective.

For example, where the swap was regarded as revenue in nature, IT recognition of the swap would normally follow the P&L. In this respect, the main potential benefit of applying cash flow hedge accounting was that fair value movements on the swap recognised in the cash flow hedge reserve were not brought into account for IT purposes. Hence if the hedge was 100 percent effective, broadly only the net fixed rate expense was recognised in the P&L and hence brought into account for IT purposes. If cash flow hedge accounting was not adopted then volatile fair value movements on the swap would also be recognised in the P&L and hence be brought into account for IT purposes.

For CT purposes from 6 April 2020, the general rule is to tax derivative amounts recognised in the P&L. Hence the tax treatment of the swap will continue to depend on the second and third factors listed above. However, the CNRL may also be able to elect into Regulation 9 of the Disregard Regulations (an election may also be deemed to have been made in certain circumstances). The main potential benefit of making an election would be that, even if no cash flow hedge accounting applied (or it was not fully effective), it may still be permissible to disregard any fair value movements recognised in the CNRL’s P&L for CT purposes, and instead obtain tax relief for the net fixed rate expense on an accruals basis.

If the tax treatment of the swap under IT vs CT (pre- and post- 6 April 2020) is not consistent then transitional rules apply to make sure that no amounts fall out of the charge to tax or are taxed twice. For example, the transitional rules are relevant where no hedge accounting applies and the swap was previously recognised at fair value through the P&L and hence taxable for IT purposes, but the swap is now subject to tax on an accruals basis under the Disregard Regulations for CT purposes.

The new HMRC guidance (available via HMRC’s main CNRL guidance page) provides a helpful overview, and worked examples, of how the CT rules and special transitional rules will apply to CNRLs, and the deadlines for electing into the Disregard Regulations.

However, there are a number of potential scenarios and complexities that are not covered by the new guidance, including:

  • Special transitional rules for (i) derivative contract losses crystallised post-6 April 2020 that are referable to pre-6 April 2020, and (ii) cases where the derivative was regarded as being of capital nature for IT purposes;
  • Scenarios involving fair value hedging of interest rate risk (e.g. swapping a fixed rate to a floating rate);
  • Derivatives with an underlying subject matter other than interest rates (e.g. property-based total return swaps); and
  • The way interest rate swaps and other derivatives are treated under the corporate interest restriction (CIR) rules, which can sometimes give rise to unfavourable mismatches between tax-interest and group-interest unless care is taken to ensure symmetry.

CNRLs with derivatives would therefore be well-advised to undertake a detailed review of their position and determine what actions may be required.

For further information please contact :

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