The single European currency will be introduced on 1 January 1999. Although the UK will not be joining immediately (if ever), the creation of the euro will affect every business with assets which are in some way denominated in or related to one or more of the participating currencies. As a matter of technical tax law the object is to ensure that the conversion of a participating currency into the euro will not trigger unintended tax charges. A process of public consultation took place earlier this year, resulting in the Inland Revenue taking powers in the Finance Act to introduce the necessary regulations by secondary legislation.
A new consultation paper has now been published setting out the main issues that have been identified in the course of consultation. There is no sign as yet of any draft regulations. Key issues which have been identified include:
Assets Denominated in Foreign Currencies
If an asset (i.e., a debt security, instrument or contract) is re-denominated from a participating currency into euros, this could give rise to a disposal of the old asset and the acquisition of a new asset for capital gains tax purposes. This is not an issue where the asset or derivative is taxed under the foreign exchange, financial instruments or loan relationships rules. In these cases the taxation generally follows the accounts and so, subject to specific exceptions, should not result in a taxable disposal.
Any asset or derivative falling outside these rules would be taxed unless for tax purposes the "old" participating currency asset is deemed to continue into the "new" euro asset. It is intended that the regulations will provide for such continuity, provided that the post-redenomination asset is in all material respects the same as the pre-redenomination asset. If changes are simultaneously made to the asset beyond those associated with a straightforward redenomination, then tax may be payable.
Any cash-outs received as a result of redenomination will be taxed in accordance with existing principles, depending on whether the underlying asset is held on trading or capital account. Cash-outs in relation to the redenomination of equities will be likely to be taxed as distributions for tax purposes.
Options and other derivatives give rise to their own problems regarding continuity of existence. For example, the redenomination of a swap involving a variable rate of interest on a participating currency may cause that specified rate to cease to exist, which could trigger a tax charge on the existing contract as it is deemed no longer to exist. New rules will provide, therefore, that when such a bilateral contract "continues" (even if an express bilateral agreement is necessary to achieve such continuation, as the existing contract has ceased to exist as a matter of contract law) there will be no taxable event provided the economic substance of the contract is not materially altered.
Options are generally treated under UK tax law as assets which are separate from the underlying assets they relate to for tax purposes. The new regulations will provide that the continuity treatment described above regarding redenominated assets will also be followed for options in relation to such assets.
Financing Transactions
Repo and stocklending transactions involving assets denominated in participating currencies will give rise to taxable events under the special legislation which deals with such transactions unless the continuity treatment described above relates through to the repo or stocklending transaction itself.
The new rules will provide for this, provided the type of "same asset" tests referred to above are met. Sums paid on in respect of amounts received as a result of cashing out (for example, due to rounding) will follow the tax treatment of such amounts - they should not, therefore, be treated as manufactured payments for tax purposes.
The treatment of the redenomination of repos and stocklending involving equities has still to be considered. Broadly speaking, it is expected that the treatment here will be similar to that described in relation to financing transactions.
Costs of Redemonination
Costs incurred on redenomination of a company's loan relationships are already deductible under existing legislation. As far as the costs of redenomination of other non-sterling assets is concerned, the government proposes to introduce a new relief that applies so long as the redenomination involves only the replacement of existing stock and not the issue of increased amounts or stocks of greater value. This will not apply to costs not directly attributable to the redenomination itself.
As far as the costs of redenomination of investments are concerned, some costs may be allowable under current law as trading expenses or as an expense of management of an investment company, but others will not. Regulations will make explicit what exactly will be allowable.
Foreign Exchange: Functional Currency
Unlike trading companies, non-trading companies will not be able to adopt the euro as their functional currency rather than sterling.
Where the profits of a controlled foreign company are computed in a participating currency, the currency to be used in computing future profits will switch automatically to the euro.
Comment
We await final details of the regulations. The aim is to achieve tax neutrality but this cannot be guaranteed. In relation to sterling, the euro will be a foreign currency, even when used by UK companies. The tax implications of this should not be ignored and assets that will switch into euros on 1 January should be reviewed now.
For further information please contact Mark Simpson, e-mail: Click Contact Link , 2 Park Lane, Leeds LS3 1ES, UK, Tel: + 44 113 284 7000
This article was first published in the Autumn 1998 Hammond Suddards Tax Newsletter Update
The information and opinions contained in this article are provided by Hammond Suddards. They should not be applied to any particular set of facts without appropriate legal or other professional advice.
A new consultation paper has now been published setting out the main issues that have been identified in the course of consultation. There is no sign as yet of any draft regulations. Key issues which have been identified include:
Assets Denominated in Foreign Currencies
If an asset (i.e., a debt security, instrument or contract) is re-denominated from a participating currency into euros, this could give rise to a disposal of the old asset and the acquisition of a new asset for capital gains tax purposes. This is not an issue where the asset or derivative is taxed under the foreign exchange, financial instruments or loan relationships rules. In these cases the taxation generally follows the accounts and so, subject to specific exceptions, should not result in a taxable disposal.
Any asset or derivative falling outside these rules would be taxed unless for tax purposes the "old" participating currency asset is deemed to continue into the "new" euro asset. It is intended that the regulations will provide for such continuity, provided that the post-redenomination asset is in all material respects the same as the pre-redenomination asset. If changes are simultaneously made to the asset beyond those associated with a straightforward redenomination, then tax may be payable.
Any cash-outs received as a result of redenomination will be taxed in accordance with existing principles, depending on whether the underlying asset is held on trading or capital account. Cash-outs in relation to the redenomination of equities will be likely to be taxed as distributions for tax purposes.
Options and other derivatives give rise to their own problems regarding continuity of existence. For example, the redenomination of a swap involving a variable rate of interest on a participating currency may cause that specified rate to cease to exist, which could trigger a tax charge on the existing contract as it is deemed no longer to exist. New rules will provide, therefore, that when such a bilateral contract "continues" (even if an express bilateral agreement is necessary to achieve such continuation, as the existing contract has ceased to exist as a matter of contract law) there will be no taxable event provided the economic substance of the contract is not materially altered.
Options are generally treated under UK tax law as assets which are separate from the underlying assets they relate to for tax purposes. The new regulations will provide that the continuity treatment described above regarding redenominated assets will also be followed for options in relation to such assets.
Financing Transactions
Repo and stocklending transactions involving assets denominated in participating currencies will give rise to taxable events under the special legislation which deals with such transactions unless the continuity treatment described above relates through to the repo or stocklending transaction itself.
The new rules will provide for this, provided the type of "same asset" tests referred to above are met. Sums paid on in respect of amounts received as a result of cashing out (for example, due to rounding) will follow the tax treatment of such amounts - they should not, therefore, be treated as manufactured payments for tax purposes.
The treatment of the redenomination of repos and stocklending involving equities has still to be considered. Broadly speaking, it is expected that the treatment here will be similar to that described in relation to financing transactions.
Costs of Redemonination
Costs incurred on redenomination of a company's loan relationships are already deductible under existing legislation. As far as the costs of redenomination of other non-sterling assets is concerned, the government proposes to introduce a new relief that applies so long as the redenomination involves only the replacement of existing stock and not the issue of increased amounts or stocks of greater value. This will not apply to costs not directly attributable to the redenomination itself.
As far as the costs of redenomination of investments are concerned, some costs may be allowable under current law as trading expenses or as an expense of management of an investment company, but others will not. Regulations will make explicit what exactly will be allowable.
Foreign Exchange: Functional Currency
Unlike trading companies, non-trading companies will not be able to adopt the euro as their functional currency rather than sterling.
Where the profits of a controlled foreign company are computed in a participating currency, the currency to be used in computing future profits will switch automatically to the euro.
Comment
We await final details of the regulations. The aim is to achieve tax neutrality but this cannot be guaranteed. In relation to sterling, the euro will be a foreign currency, even when used by UK companies. The tax implications of this should not be ignored and assets that will switch into euros on 1 January should be reviewed now.
For further information please contact Mark Simpson, e-mail: Click Contact Link , 2 Park Lane, Leeds LS3 1ES, UK, Tel: + 44 113 284 7000
This article was first published in the Autumn 1998 Hammond Suddards Tax Newsletter Update
The information and opinions contained in this article are provided by Hammond Suddards. They should not be applied to any particular set of facts without appropriate legal or other professional advice.
