Hedging gain not taxable with main transaction

The Supreme Tax Court has held that the gain from the early abandonment of a hedge is to be taxed as a separate item, rather than as part of the results of the main Transaction.

A privately held asset management business held a number of properties for letting. These properties were primarily financed from bank loans at fixed or variable interest rates. The business hedged its interest rate risks with a series of interest swaps. These swaps were set to coincide with the individual risks. However, at one point, the management reassessed its view of the market situation and concluded that the hedges were no longer necessary. It thus took advantage of early break clauses in the contracts to wind up the hedged transactions. A series of gains resulted. The tax office saw these gains as part of the rental activities and taxable as such. The business saw them as short term gains from speculation in other assets that were only taxable if wound up within one year of opening. However, the one-year period had already passed in each case.

The Supreme Tax Court has now held that the gains from the release of the hedges are to be taxed as short-term gains from speculation. They were achieved from the sale of the asset – the claim to an interest swap – and were thus not, or no longer, linked to the property or the income therefrom. This applied even if one took the view that the hedge had been made for the sole purpose of protecting the income from the property. Winding up the hedge destroyed the link to its original purpose and thus to the property income.

Note: following a change in the law, these gains would now rank as investment income and be taxable regardless of the holding period of the security.

Supreme Tax Court judgment IX R 13/14 of January 13, 2015