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A derivative contract is a financial instrument, or security, whose price is dependent on, or derived from, one or more underlying assets or indices. It is simply a contract between two or more parties whose value is determined by fluctuations in the underlying asset or index.

The taxation of derivative contracts tends to make tax practitioners nervous unless they are experienced in the financial markets. However, the tax rules governing the basic derivative contracts used in day-to-day treasury transactions (eg forward currency contracts and interest rate swaps) are relatively straightforward. Many companies will have these types of basic derivative contracts without realising they fall within the derivatives rules, so it is worth discussing specific types of arrangement rather than derivatives generally when initially advising on derivatives.

This guidance note steers readers through the rules and provides an overview of the main provisions and their practical application. It includes comments on the main definitions, the basis of taxation and the core anti-avoidance rules.

The rules governing the taxation of derivative contracts generally follow the same principles as the loan