Loan relationships: special types of security: gilt-edged securities: taxing gilt strips
Taxing gilt strips
Both the stripping and reconstitution of gilts are related transactions.
When a gilt is stripped, the aggregate of the individual strips may be worth more than the market value of the original gilt, perhaps because they are more marketable. CTA09/S401(3) treats the gilt as having been redeemed for its market value at the time of the strip - so crystallising any gain or loss that has arisen since acquisition. This amount is then apportioned between the strips, in proportion to their actual market value, to arrive at the deemed acquisition cost for each strip.
JP Ltd acquires a gilt for £40,000, which pays fixed interest of £2,400 each year for 3 years plus £40,000 repayment of principal at the end of Year 3.
The market value of the gilt is £40,500. JP Ltd exchanges the gilt for four strips - one payment of £40,000 (representing repayment of the principal) and three payments of £2,400 each (representing interest payments). The market value of each strip is calculated.
The gilt is treated as redeemed, so there is a taxable credit of £500, the difference between acquisition price and market value.
The acquisition cost of the individual strips is calculated in proportion to their market value. As a consequence the acquisition cost of all the strips when taken together will equal the ‘redemption’ value of the gilt. Thus no amount falls out of taxation.
When a gilt is reconstituted, each strip is deemed to have been redeemed at market value, so crystallising any gain or loss that has arisen since the strip. The debit or credit arising from the difference between the deemed acquisition and disposal value is brought into account. The deemed acquisition cost of the gilt is the aggregate of the market value of the strips.
JP Ltd has five gilt strips with the appropriate redemption dates and redemption amounts to be reconstituted into a single gilt. JP Ltd arranges with the Bank of England to reconstitute the gilt.
JP Ltd will be treated as disposing of each of the strips it holds at market value. The reconstituted gilt will be treated as acquired at a value that is equal to the sum of the market values of the strips. In this way no amounts fall out of taxation.