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HMRC internal manual

Capital Gains Manual

Conversion of securities: change in status of debt S88 FA 1997

The purpose of these rules was to provide a clear legislative counter to schemes under which it was for example claimed that

  • an alteration in the terms of a debt, or a change in the practical effect of the debt’s terms during its life, can turn a debt which is a chargeable asset into a capital gains exempt qualifying corporate bond (QCB);
  • there is no disposal of the debt when its tax status changes;
  • any gain which would have been chargeable on a disposal of the debt at the time of the change is not taxable when the debt is later disposed of.

The debt may have been issued in respect of shares on a reorganisation of share capital within TCGA92/S126, or on a company takeover, reconstruction or amalgamation treated as a reorganisation by TCGA92/S135 and TCGA92/136, see CG52500+. The result of TCGA92/S127 would be that the reorganisation is not a disposal of the shares, but the shares and the debt are treated as the same asset for capital gains purposes. This means the gain or loss when the debt is disposed of takes account of the overall gain or loss on the shares and the debt taken together. These rules do not apply where the shareholder acquires newly issued debt in the form of capital gains exempt QCBs. In that situation TCGA92/S116 may apply, see CG53709+. The effect of Section116 is to compute the gain or loss on the shares as at the time of the reorganisation, and to bring the gain or loss into charge when the QCBs are disposed of.

Where on a reorganisation shares are replaced by debt, which later changes its status from non-QCB to QCB, the taxpayers’ argument is that

  • there is no disposal of the shares at the time of the reorganisation, because of the no disposal fiction in TCGA92/S127
  • there is no charge under TCGA92/S116 when the QCBs are disposed of, because they were not QCBs at the time of the reorganisation.

There may also be cases where taxpayers argue that a QCB changes its status to a non-QCB.