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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Loan relationships: ‘hybrid’ securities with embedded derivatives: anti-avoidance: connected debtors and creditors: conditions

Conditions for the section to apply: debits and credits arising after 12 March 2008 but before 22 April 2009

CTA09/S418 applies where all of the following conditions are met:

Condition 1:

One of the companies is party as debtor to a loan relationship and in accordance with generally accepted accounting practice (GAAP) treats its rights and liabilities under the loan as divided between a ‘host contract’ and a derivative financial instrument or equity instrument.

Condition 2

The other company, in accordance with generally accepted accounting practice does not treat its rights and liabilities under the loan relationship as divided between a ‘host contract’ and a derivative financial instrument or equity instrument.

Condition 3

The debits brought into account by the debtor under the loan relationships regime in respect of the ‘host contract’ exceed the credits brought into account by the creditor as respects the loan relationship when looked at for the corresponding accounting period. Note that this test is carried out without reference to any credits the creditor may be required to bring into account under S418.

See CFM37750 where the two companies have accounting periods that do not coincide.

Debits and credits arising on or after 22 April 2009

The three conditions are reduced to two. As before, the loan relationship must be between connected parties, but there is no longer any requirement that the debtor company should ‘bifurcate’ the security for accounting purposes while the creditor does not. Instead, it is necessary for the loan relationship in question to include provision under which the creditor will or may acquire shares in any company. It does not matter whether the security converts into shares or is exchangeable for shares, or whether the shares are acquirable by some other means.

The change enables CTA09/S418 to apply to avoidance arrangements where the mismatch between one party’s taxable credits and the other party’s allowable debits does not depend on the two companies adopting different accounting treatments.

The second condition remains very similar to ‘condition 3’ above - the debits brought into account by the debtor company for any accounting period must exceed the credits brought in by the creditor company for the corresponding accounting period or periods. Since, however, the legislation no longer requires the debtor to account separately for a host contract and an equity element (or embedded derivative), CTA09/S418(3) refers only to loan relationships, not to a host contract.

CTA09/S418A, inserted by FA09, makes it clear where a company does ‘bifurcate’, the loan relationship referred to is the host contract. Otherwise, it means the security as a whole.

The comparison only involves loan relationships credits or debits - any profits, gains or losses brought in by a company under the derivative contracts rules on an embedded option are ignored for this purpose.