Loan relationships: 'hybrid' securities with embedded derivatives: pre 1 January 2005 securities - holders
Convertibles to which FA96/S92 previously applied, and asset-linked securities previously within FA96/S93
For holders of a convertible security, under the former rules in FA96/S92 the only amounts brought in under the loan relationships rules were interest receivable, and exchange gains and losses, in respect of the security. All other gains and losses were taxed under the chargeable gains rules.
Broadly, this tax treatment is continued, notwithstanding the repeal of FA96/S92. The treatment of the host contract is given by regulation 11 of the Disregard Regulations (SI 2004/3256). This has effect where FA96/S92 applied to the security immediately before the start of its first accounting period to begin on or after 1 January 2005, and either
- FA96/S94A (now CTA09/S415) subsequently applied, or
- the company did not bifurcate the security in its accounts so that, without any special provision, all credits or debits would be brought into charge as income.
The effect of regulation 11 is that only interest, and exchange gains and losses, on the security are brought into account under loan relationships. Where the company accounts separately for the host contract, taxable interest must be ascertained without regard to amounts given by the effective interest rate method. This means that the interest credit shown in the accounts must be ‘unpicked’. If, for example, the company holds £1 million nominal of a convertible security paying 3 per cent per annum interest, the taxable interest credits will be £30,000. Any other credits (or impairment debits), apart from exchange differences, are disregarded.
The disregard extends to transitional credits or debits where the company adopts IAS 39 or FRS 26 for the first time (see CFM37680).
In addition, no amounts are brought in under the derivative contracts rules in respect of the embedded derivative - see CFM55240 for full details.
Under the former rules in FA96/S93 the only amounts brought in under the loan relationships rules were interest receivable. All other gains and losses were taxed under the chargeable gains rules.
Here again, the previous tax treatment is continued for a share-linked security held by a company both before and after the start of its first period of account to begin on or after 1 January 2005. This is achieved by two separate provisions - one relating to the embedded derivative, and one to the host contract.
For loan relationships purposes, regulation 12 of the Disregard Regulations (SI 2004/3256 - see CFM37710) applies to any asset-linked security that was within FA96/S93 immediately before the start of the company’s first accounting period beginning on or after 1 January 2005. It does not matter whether or not the company subsequently accounts separately for the host contract and the embedded derivative. The only loan relationships credits (or debits) brought into account are those relating to interest; where the company uses an effective interest rate method, this is ignored when ascertaining the interest credits. As under FA96/S93, any exchange differences, and any impairment of the security, are swept up into the final capital gains computation.
See CFM55540 for the tax treatment of the derivative element.