Derivative contracts: exclusions from regime: contract becomes a derivative contract
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CTA09/S661: chargeable asset becomes derivative contract
Where (on or after 30 December 2006) a relevant contract becomes a derivative contract, having previously been a chargeable asset, CTA09/S661 will apply.
The company is deemed to have disposed of the contract at its ‘notional carrying value’ immediately before the ‘relevant time’. The ‘relevant time’ is the time at which it first becomes a derivative contract.
‘Notional carrying value’ takes its meaning from CTA09/S622(4). It is the amount that would have been the carrying value of the contract in the company’s accounts if a period of account had ended immediately before the relevant time.
The company must bring into account any chargeable gain or allowable loss that would be treated as accruing on the deemed disposal, but only in the accounting period when it ceases to be party to the derivative contract.
The facts are as in example 1 at CFM50820. Suppose that on 1 February 2009, in its accounting period ended 31 December 2009, the company sells 1,000 futures contracts over Y plc shares for £1,560 per contract. On 1 June 2009, the company sells its shares in Y plc, without closing out the futures position. At that date, Y plc futures are quoted at £1,410 per contract.
Before 1 June 2009, the exemption at CTA09/S591(3) applies, and the futures are not derivative contracts - instead, they are ‘financial futures’ within TCGA92/S143. They become derivative contracts on 1 June.
The company accounts for its derivatives position at fair value. Its obligations under the futures contracts are to deliver a certain number of shares of Y plc (this obligation may be purely nominal if the futures can only be cash settled). The futures contracts therefore represent a liability of the company. At 1 February, the fair value of the liability is £1,560,000 (£1,560 x 1,000). At 1 June, it is £1,410,000.
Thus if on 1 June the company closed out its position at the ‘notional carrying value’ of £1,410,000, it would have a profit of £150,000 (its liability has decreased from £1.56 million to £1.41 million). Under CTA09/S661, the company is deemed to have made such a disposal. A chargeable gain of £150,000 arises under TCGA92/S143(5) (see CG56080).
Suppose that the company actually closes out the position on 1 September 2009, when the market price of the future is £1,630 per contract. Between 1 June and 1 September, the futures are derivative contracts. The company has sustained a loss of £220,000 on those derivative contracts (£1.63 million less £1.41 million).
For tax purposes, the company will therefore have a derivative contracts debit of £220,000 in its accounting period ended 31 December 2009. But, since it ceased to be party to the contracts in that same period, it must also bring in a chargeable gain of £150,000.