The Inland Revenue, the U.K.'s tax authority, has proposed a change to the way it taxes equity derivatives that could mean corporates will stop using derivatives to hedge equity investments. One banker said this rule change is critical because tax and accounting issues are at the forefront of corporates' minds when looking to use derivatives. The proposal appears to have gone largely unnoticed, according to corporates contacted by DW.
The proposal was published in last month's pre-budget report and states that non-trading gains will be subject to capital gains tax on an annual mark-to-market or income basis. At the moment, corporates only pay tax when they execute derivatives. The new rules will mean that if the stock falls in value and the option appreciates, the corporate will have to pay tax on the option and will not be able to offset that against the loss it has made on the stock, explained David Morgan, senior manager in the tax group at PricewaterhouseCoopers in London.
Some corporates hold equity options off-balance sheet and these may be excluded from the proposed tax rule. Accountants, however, are unclear as to how this would work because the details of the rules have not been drafted. One such corporate is Vodafone, which owns a put option to sell half its 45% stake in Verizon Wireless. Tim Brown, treasurer at Vodafone in Newbury, U.K., said it holds these options off balance sheet. He was unaware of the proposed tax change.
The proposal, however, could be dropped, according to Roger Murray, partner at Ernst & Young in London. There had been little consultation with the industry about these changes and he expects that when the Inland Revenue reviews the industry's comments it will amend the rules. Comments are due on Tuesday. Other market professionals are less optimistic that the Inland Revenue will soften its position. An official at the Inland Revenue declined comment.
