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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Deemed loan relationships: alternative finance: investment bond arrangements: conditions: accounting test

‘Financial liability’ test

Alternative finance investment bonds must be wholly or partly treated as a financial liability of the issuer under international accounting standards (IAS), on the assumption that the issuer uses IAS.

The definition of ’financial liability’ under IAS includes a contractual obligation to deliver cash or another financial asset (such as shares) to another entity - see CFM21070. Although the obligation to repay sukuk is not contractual, where the sukuk are functionally equivalent to debt securities, the issuer will account for the substance of the transaction and recognise the sukuk as a financial liability.

A person holding sukuk will not necessarily know how the issuing company accounts for them. HMRC will regard the test as satisfied in any case where the holder reasonably believes that the instrument would be treated as a financial liability as in IAS 32. For most listed sukuk, it will be clear from the issue terms that this is so. It will only be necessary for a holder to seek an accounting opinion, or to approach the issuing company for information, in an exceptional case where the sukuk has ‘equity’ features that would put the accounting treatment in doubt. Such an instrument, however, is likely to fail one of the other tests of S507.

An alternative finance investment bond which is exchangeable for shares would be treated as a hybrid instrument (a host contract plus an embedded derivative - see CFM37600) under IAS. Provided that the host contract represents a financial liability under IAS, the sukuk will be partly treated as a financial liability and will thus satisfy the CTA09/S507(1)(i) condition.