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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Loan relationships: ‘hybrid’ securities with embedded derivatives: accounting treatment: bifurcation

The accounting treatment of bifurcation

CFM25040 outlines the accounting principles that decide whether a company must bifurcate. Broadly, bifurcation allows different accounting methods to be used for the two components. This is necessary because IAS 39 generally requires derivatives (such as options and ‘contracts for differences’) to be accounted for at ‘fair value’, whereas most companies will account for the loan element on an amortised cost basis.

In practice, not all holders of convertibles and exchangeables will bifurcate - even when those companies that have not adopted IAS 39 or FRS 26 are excluded from consideration. The asset may be classified as ‘held for trading’ (CFM21530). This exception will apply mainly to banks and other financial traders holding securities on trading account. Alternatively, the security may be accounted for at fair value through profit and loss (FVTPL) because it has been so designated.

All issuers (borrowers), except those continuing to use ‘old UK GAAP’ (for securities containing embedded derivatives) will bifurcate unless, exceptionally, there is no readily available way of attributing a ‘fair value’ to the embedded option or equity component, or they are issuing the security in the course of a financial trade. See CFM37730 regarding possible tax consequences where the holder and issuer are in the same group and use different methods of accounting.


Where a company accounts for the security as a single instrument, it is taxed as a normal loan relationship, with all profits, gains and losses taxed or relieved as income in the usual way.

However, a company that continues to use ‘old UK GAAP’ may elect for its hybrid securities to be treated for tax purposes as if split accounting had been used, see CFM37720.

It should be noted that in legal form, a compound or ‘hybrid’ security is a single instrument, not two. Bifurcation should be thought of as an accounting device only.