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HMRC internal manual

Capital Gains Manual

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HM Revenue & Customs
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Qualifying corporate bonds: loan relationships: convertible securities

This paragraph describes capital gains aspects of the regime for convertible securities for companies for accounting periods ending on or after 26 July 2001 unless the company ceased to be a party to the relationship before that date. For such cases and for periods ending before 26 July 2001 see CG54025.

FA96/S92 excludes from the loan relationships rules the profit or loss on redemption or other disposal of an asset representing a creditor loan relationship, where

  • the rights attaching to the debt include provision whereby the creditor is, or may become, entitled to acquire qualifying ordinary shares or mandatorily convertible preference shares in any company, whether by conversion or exchange of the debt or otherwise, and
  • at the time the debt was created there was a more than negligible likelihood that the right to acquire the shares would in due course be exercised to a significant extent.The exclusion does not however apply if

  • the extent to which shares may be acquired is determined using a cash value specified in, or ascertainable by reference to, the terms of the provision; or
  • the asset is a relevant discounted security; or
  • the terms of the asset require the holder to sell it to another person for an amount equivalent to a deep gain; or
  • the conversion rights when exercised to their full extent result in the loan being wholly replaced by shares, but a minor cash adjustment is allowed
  • a disposal of the asset would fall to be treated as a disposal in the course of activities forming an integral part of a trade carried on by the company.There is advice on the meaning of relevant discounted security at CG54210+. For the interpretation of these conditions generally, see the detailed advice on loan relationships in CFM6100+.

Because the value of convertibles securities will reflect in part the value of the underlying shares, only amounts relating to interest and (for periods beginning on or after 1 October 2002 only) exchange gains and losses on these debts are brought into the income regime. Any profits or losses on disposal remain to be dealt with under capital gains rules. These rules are, however, modified to ensure that gains on debts within FA96/S92 are always chargeable, as described below.

TCGA92/S251 (7) and TCGA92/S251 (8) ensure that where the disposal of a debt within FA96/S92 gives rise to a gain, the debt is treated as a security. So the exemption for simple debts in TCGA92/S251 (1) does not apply in these cases. See CG53444+.

Any charge, or allowance, on disposal would also be lost if the debt was a QCB. This is prevented by FA96/S92 (4) and TCGA92/S117 (A1). The combined effect of these Sections is that the debt is not treated as a QCB.

When computing any chargeable gain or allowable loss you should adjust the consideration for the acquisition or disposal of the debt to exclude any amounts which relate to interest or exchange gains and losses. This applies also to events that would have been an acquisition or disposal but for TCGA92/S127 or TCGA92/S116 (10). There is an example at CFM6151a.

The gain or loss on disposal of a convertible security may be within the exemption for substantial shareholdings in TCGA92/SCH7AC (see CG53010).

A convertible security may cease to be within FA96/S92. In that case, FA96/S92 (7) provides that there shall be a deemed disposal of the security at that time, but the gain is held over under TCGA92/S116 (10) until the security itself is disposed of. There is an example at CFM5932a.

FA2002 also introduced a further new condition for the application of FA96/S92 to convertible securities from 19 December 2001, if a company holds a convertible security issued by a connected company, that security remains within the loan relationships regime and is treated as a QCB for CG purposes (CFM6110+). This meant that on 19 December 2001 certain existing securities ceased to be within the CG regime. The treatment outlined above for securities that cease to be within FA96/S92 applies to these securities.