U.K. tax rules on functional currency significantly liberalized.

• Author: Weinberger, Mark
• Position: United Kingdom

New rules were recently introduced in the United Kingdom (U.K.) on the use of a functional currency other than the Pound Sterling (sterling) for calculating taxable income. For example, passive affiliates of U.S. companies may wish to use the U.S. dollar as their functional currency; under the new rules this may be possible, although previously it frequently was not. In general, the rules apply retroactively for tax years beginning after 1999 and ending on or after March 31, 2000. It may be possible in limited circumstances to defer implementation of these rules until the first tax year beginning on or after July 1, 2000.

Previous Rules

Under previous rules, it was only possible for a U.K. resident company or U.K. branch of a nonresident company to elect to use a nonsterling functional currency (such as the U.S. dollar) in relation to its trading profits; thus, foreign exchange differences would arise for tax purposes on any nontrading dollar-denominated monetary balances. Under U.K. rules, "trading" activity is analogous to the U.S. concept of an active trade or business, as distinguished from passive investment activities.

While many financial services companies may fulfill the trading requirement, a pure cash management or treasury function may not be a trading company and an investment or holding company would not, under the old rules, have been able to calculate its taxable income in dollars. For example, a U.K. branch of a U.S. investment management company would generally not be a trading company for these purposes; under prior rules, the branch would be obligated to use sterling as its functional currency and to compute taxable income in sterling.

Other than the trading condition, a company seeking to elect a different currency had to meet various other conditions concerning the primary economic environment of the company's business and had to prepare its financial statements in dollars. Further, an election, which generally was only prospective, had to have been made to the U.K. tax authorities (Inland Revenue) if a company wished to calculate its trading profits or losses in dollars.

New Rules

Under the new rules, companies can have a nonsterling functional currency for all profits (with the exception of capital gains, which are still calculated in sterling), provided they meet two conditions--the U.K. company (or U.K. branch of a nonresident company) must carry on a business and the financial accounts must be prepared in the...