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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Derivative contracts: relevant contracts: options

What is an option?

Beyond making it clear that ‘option’ includes a warrant, CTA09/S580 does not define option, and the word must be understood in its normal market meaning.

CTA09/S580(1) provides that the term ‘option’ includes a warrant. A ‘warrant’ is defined in CTA09/S710 as an instrument entitling the holder to subscribe for shares in a company or assets representing a loan relationship of a company. S710 makes it clear that the statutory definition includes covered warrants, whose underlying subject matter is shares or bonds that already exist, and warrants which give the holder a right to subscribe to as yet un-issued shares or bonds.

The key feature of an option is that the holder has a choice of whether or not to exercise it. The holder can secure a profit, but cannot make a loss in excess of the premium paid for the option. Some options, however, are automatically exercised - the holder reaps any benefits of the contract without needing to give notice of exercising the option. Such contracts are still options for the purposes of Part 7 CTA09.

The most important difference between the market usage of the term ‘option’ and the meaning given by CTA09/S580 is that, for tax purposes, a contract which can only be cash settled is not an option - it is a contract for differences. This follows from CTA09/S580(2), which says that any contract which

  • provides that full settlement of obligations under the contract will be effected, either by each party making a payment to the other or by the netting-off of obligations followed by one party making a net payment to the other, and
  • does not provide for the delivery of any property

cannot be an option. But a currency option which is settled by one or both parties paying an amount of foreign currency is not debarred from being an ‘option’ for tax purposes. The foreign currency is the property that is delivered.

A cash-settled option is, however, still an ‘option’ for the purposes of particular pieces of legislation: CTA09/S695, dealing with transfers of value to connected companies (CFM56070), and S652 to S665, which deal with issuers of securities containing embedded options (CFM55400 onwards).

There are examples at CFM50350.