U.K. corporates will have to pay tax on mark-to-market gains on derivatives hedges--which could result in volumes plunging--if the government does not amend its finance bill, warn bankers. Under a worst-case scenario corporates could be forced to unwind derivatives as a result of the tax bills from in-the-money derivatives hedges. The massive changes in prices of cable swaps over the last year shows this is not impossible.
Under the proposed International Accounting Standards, corporates would be required for the first time to bring hedging positions and derivatives on balance sheet. In the U.K., corporates would then be liable to pay tax on in-the-money hedges. A working group with the Inland Revenue, the U.K. tax authority, last week sent proposals to the government to ask for changes to the proposed tax treatment of derivatives. The government is expected to announce its decision when it reviews the 2004 Finance Bill next month. "We are well aware of its importance for U.K. industry," said Richard Thomas, assistant director in business tax at the Inland Revenue in London. A Government spokeswoman declined comment.
If the tax principles are not changed, there is no doubt that corporates will think twice before hedging and may ultimately decide against it, noted Stephen Robbins, an accounting and tax specialist in the global risk solutions group at BNP Paribas in London. "This could be very painful for many corporates," he added. A further difficulty is that with aspects of the International Accounting Standards still under discussion, the Inland Revenue's proposals may not cover all of the potential areas of concern, noted Robbins.