Annex 1: Minor Changes in the Law Change 106: Derivative contracts: contracts which became derivative contracts on 16 March 2005: assumption in respect of consideration on deemed disposal: Schedule 2
This change clarifies what accounting period is relevant to the calculation of the deferred capital gain to be brought into account when a company ceases to be a party to a contract that became a derivative contract as from 3.00pm on 16 March 2005.
Paragraph 4A of Schedule 26 to FA 2002 provides for a chargeable gain or allowable loss to be brought into account when a company ceases to be a party to a relevant contract (an option, future or contract for differences) that became a derivative contract on 16 March 2005 but was a chargeable asset immediately before then. “Chargeable asset” is defined in paragraph 4A(4) of that Schedule as one where a gain on its disposal would be a chargeable gain for the purposes of TCGA.
A contract to which paragraph 4A applies became a derivative contract on 16 March 2005 as a result of amendments to the definition of a derivative contract in Part 2 of Schedule 26 to FA 2002 introduced by the Finance Act 2002, Schedule 26, Parts 2 and 9 (Amendment) Order 2005 (SI 2005/646).
The assumed consideration, for the purposes of the calculation of the gain or loss to be brought into account under paragraph 4A of Schedule 26 to FA 2002, is an amount “equal to the value (if any) given to the contract in the accounts of the company at the end of the company’s accounting period immediately before its first new period”. Neither in paragraph 4A nor anywhere else in Schedule 26 to FA 2002 is there any guidance as to what a company’s “first new period” is. The term occurs, in connection with provisions applying to derivative contracts, only in Schedule 28 to FA 2002 (transitional provisions on the implementation of Schedule 26 to that Act). It is defined for that purpose in paragraph 7 of Schedule 28 to FA 2002 as “its first accounting period to begin on or after” 1 October 2002, that is, the day that Schedule 26 to FA 2002 came into force.
The amendments made by the Finance Act 2002, Schedule 26, Parts 2 and 9 (Amendment) Order 2005 (SI 2005/646) have effect in relation to periods of account beginning on or after 1 January 2005 and ending on or after 16 March 2005. If a company makes up its accounts to, say, 31 December, its accounting period ended 31 December 2005 will be the first accounting period to which paragraph 4A of Schedule 26 to FA 2002 can apply. Logically, the chargeable gain (or allowable loss) to be brought into account under the paragraph should therefore be that which had accrued immediately before that period began, that is, at the end of the accounting period ended 31 December 2004. The consideration used in the calculation of the gain (or loss) will therefore be the value of the contract in the company’s accounts at 31 December 2004, even though the deemed disposal date is 16 March 2005. If a company makes up its accounts to, say, 30 September, the first accounting period to which the paragraph applies is that beginning on 1 October 2005. The accrued chargeable gain (or allowable loss) to be brought into account will therefore be calculated by reference to the value shown in the accounts at 30 September 2005 (but again the deemed disposal date is 16 March 2005). If the company made up accounts for a period of a few weeks early in 2005, the second leg of the commencement rule for the amendments made by the Order, that the first period to which the amendments apply must end on or after 16 March 2005, ensures that the amendments do not have effect in relation to an accounting period ending before they came into effect. “First new period” means in effect the first accounting period to which the amendments made by the Order apply.
This change repairs an omission in the Finance Act 2002, Schedule 26, (Parts 2 and 9) (Amendment) Order 2005 (SI 2005/646). It gives certainty for the calculation of the chargeable gain or allowable loss to be brought into account under paragraph 4A of Schedule 26 to FA 2002. The application of Schedule 26 to FA 2002 to accounting periods of the company in respect of the contract in question begins with the period immediately following that identified for the purposes of finding the consideration relevant to the calculation under paragraph 4A of Schedule 26 to FA 2002.
In principle, this change is favourable to some and adverse to other taxpayers as it may identify an amount of consideration for the calculation of the deferred chargeable gain or allowable loss that differs from the amount an alternative reading of “first new period” would identify. But it is unlikely to affect significantly the aggregate profits chargeable to tax in respect of the relevant contract, whether as a chargeable gain or as credits and debits arising on a derivative contract, as regards any company to which it applies.
This change is in principle and in practice adverse to some taxpayers and favourable to others. But the numbers affected and the amounts involved are likely to be small.