Tribunal allows taxpayers' appeal in foreign exchange losses case

16 March 2017. Published by Alexis Armitage, Senior Associate

In Smith and Nephew Overseas Limited and others v HMRC [2017] UKFTT 151, the First-tier Tribunal (FTT) allowed appeals against HMRC's disallowance of foreign exchange losses incurred as a result of a change in functional currency following a company reorganisation.


Smith and Nephew Group is a multinational group engaged in the development, manufacture and marketing of medical devices. The first and second appellants, Smith and Nephew Overseas Limited (SN Overseas) and T P Limited (TP), respectively, are UK incorporated companies which were at all material times resident in the UK. The third appellant, Nephew Finance Holdings Limited (SN Finance), was incorporated in the Cayman Islands but resident in the UK for the purposes of corporation tax.

Following a change in their functional currency from sterling to US dollars, as the result of a company reorganisation, SN Overseas, TP and SN Finance, claimed foreign exchange losses of £445,868,096, £138,188,096 and £90,652,234, respectively. The appellants claimed that their exchange losses, which were included within the statement of total recognised gains and losses in each of their respective accounts (where they were described as a “Revaluation (loss)/gain on change in functional currency”), arose as a result of the fall in value of the pound against the US dollar.

HMRC did not accept that the exchange differences shown in the appellants' accounts represented losses, or that the correct accounting treatment had been applied by the appellants, and issued closure notices pursuant to paragraph 34(2), Schedule 18, Finance Act 1998, disallowing the losses claimed by the appellants.

The appellants appealed to the FTT.

FTT's decision

There were three issues before the FTT.

1.  Were the appellants' accounts compliant with GAAP?

The first issue for the FTT to determine was whether the appellants' accounts complied with the UK generally accepted accounting practice (GAAP) for the purposes of section 85A, Finance Act 1996[1]. Both the appellants and HMRC relied on expert evidence. In essence, the difference between the experts was in relation to the approach adopted by the appellants for accounting for a change in their functional currency. The appellants' expert considered that the appellants had been correct to adopt the foreign operation method whereas HMRC's expert was of the view that only the single rate method was appropriate. The FTT preferred the expert evidence relied upon by the appellants and concluded that the appellants' accounts were GAAP compliant.

2. Were the exchange differences "exchange losses" within section 103, Finance Act 1996?[2]

The FTT noted that "an exchange loss is the comparison at different times of the expression in one currency of the valuation put by the company in another currency in relation to an asset". The FTT therefore agreed with the appellants that this was an arithmetic exercise and that the legislation does not require any exposure to exchange rates between two dates, just a comparison at different times first in one currency and then in another. The FTT concluded that because there was a fall in the value of the assets (the intercompany receivables), it followed that the exchange differences were exchange losses within section 103, Finance Act 1996.

3.  Did the exchange differences "fairly represent" a loss arising to the appellants as defined by section 84(1) Finance Act 1996?[3]

The FTT rejected HMRC’s argument that "fairly represents" required an overarching ‘sanity check’ to prevent an arithmetic difference from giving rise to a loss. The "fairly represents" rule did not override the appellants' accounts and the FTT concluded that the exchange differences did "fairly represent" losses.

The FTT allowed the appellants' appeals.


As debits are now calculated with regard to profit and loss entries and the "fairly represents" rule has been abolished, this decision is largely of historic interest. However, it does provide helpful guidance on the meaning of "fairly represents" for cases which are working their way through the appeal process and have yet to be determined. The decision also suggests that the FTT will, in general, be slow to upset GAAP compliant accounts. 

A copy of the decision can be found here.

[1] Rewritten to Corporation Tax Act 2009.

[2] Rewritten to Corporation Tax Act 2009.

[3] Rewritten to Corporation Tax Act 2009.

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