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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Derivative contracts: exclusions from regime: contracts over shares

Shares as an underlying subject matter

These rules apply only if you are looking at an equity derivative in an accounting period beginning on or after 1 January 2005 and ending on or after 16 March 2005. If you are looking at an earlier period, or the company was no longer party to the derivative at 3 pm on 16 March 2005, see CFM83070.

Meaning of ‘shares’

‘Shares’ is defined at CTA09/S710 to mean any shares in a company under which an entitlement to receive distributions may arise.

Distribution is not specifically defined in Part 7 so you need to look primarily at CTA10/Part 23 to find out what is a distribution. Fixed-rate preference shares, for example, give an entitlement to receive distributions and are therefore an excluded subject matter. On the other hand, shares which only give the holder a right to receive capital distributions in a winding-up will not be excluded. This is because CTA10/Part 23 says that such capital distributions are not distributions for the purposes of the Taxes Acts.

A building society share is not a share for the purposes of Part 7. This is because CTA10/S1055 says that dividends or interest payable on a building society share are not distributions - so no ‘entitlement to distributions’ can arise on such shares.

Where a company has no share capital (for example, a company limited by guarantee), the definition includes any interests in the company possessed by members of the company.

It also includes a depositary receipt for shares. A depositary receipt is a certificate that represents ownership of a certain number of shares, and which in many cases can be traded independently of the shares.

Units in a unit trust

The rights of a unit holder under a unit trust scheme are also an excluded subject matter (unless the holding is one that is treated as a creditor loan relationship under CTA09/S490). The same rules apply to derivatives over unit trust units as apply to derivatives over shares, and where the following guidance refers to share-based derivatives, it should be read as also applying to derivatives over unit trust units.

Summary of tax treatment of share-based derivatives

If the underlying subject matter of a relevant contract is shares (and nothing else) it will in many cases still be within the derivative contracts rules.

There are, however, five cases in which a contract over shares is excluded. These are set out in CTA09/S591, as conditions A to E. Briefly, they are:

  1. Certain equity derivatives held by life assurance companies (CFM50750).
  2. Equity derivatives (other than embedded derivatives) that hedge shares held by the company, or a company’s own share capital (CFM50760).
  3. A quoted option to subscribe for shares in a company (CFM50790).
  4. An option or future that may result in delivery of shares that would constitute a substantial shareholding (CFM50800).
  5. Equity derivatives that hedge convertible or asset-linked securities (CFM50810).

Conditions B and E rely on the concept of a ‘hedging relationship’, which is defined at CTA09/S707. There is guidance on the definition at CFM50770 - 50780.

Where any of these exclusions apply, you will need to consider how the ‘excluded’ derivative will be taxed. In many cases, capital gains treatment is likely to be appropriate.

Shares that are not an excluded subject matter

But there are some circumstances in which these exclusions can never apply:

  • where the shares that constitute the underlying subject matter are treated as debt for tax purposes, or
  • where the relevant contract is designed to produce an interest-like return.

These will mainly be relevant in avoidance cases. Guidance on these circumstances is at CFM50740.