Derivative contracts: underlying subject matter: income streams
Rent or dividends as an underlying subject matter
Someone who invests in shares will benefit both from any growth in the capital value of the shares, and from any dividends that are paid. Similarly, someone investing in a rental property will both receive rents and realise a capital gain or loss when they sell the building. The question therefore arises whether, if you are looking at a derivative over shares or over rental property, the income from the asset - dividends or rents - is a separate underlying subject matter from the asset itself.
Legislation was introduced in 2004 to clarify the point. CTA09/S583(7) provides that where an USM of a relevant contract is income from land, shares or units in a unit trust, the subject matter of the contract is not treated as land, shares or unit trust units just because of that income.
This means that where, for example, a derivative is based on an index of property values that reflects the total return from investment property - both the changes in capital value and rental yields - the derivative’s USM will be both rents and land.
Where a derivative contract has shares (or units in a unit trust) as its underlying subject matter, the ‘dividend’ element may be small or subordinate in relation to changes in the capital value of the shares (see the example at CFM50590). In such a case, the dividend element is disregarded under CTA09/S590 when deciding whether the contract is within Part 7 CTA09 (see CFM50730+ for guidance on equity derivatives excluded from Part 7). If, however, the dividend element cannot be so disregarded, the contract as a whole will always be within Part 7.
There is a similar provision at CTA09/S644 which allows rental income that is small or subordinate to the ‘land’ element to be ignored in determining whether credits and debits under the contract should be brought into account as capital gains or losses. The judgement on whether the rental element is small or subordinate has to be made at the start of the contract (see CFM50580).