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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Derivative contracts: chargeable gains on derivatives: overview

Chargeable gains treatment: when does it apply?

‘Annual’ chargeable gains treatment under S641

In general, credits and debits arising on derivative contracts are brought into account in the same way as loan relationships credits and debits (CFM51000+). There are, however, certain exceptions, listed below:

  • contracts relating to land or certain tangible moveable property (S643) (CFM55080);
  • equity options embedded into convertible or exchangeable securities (creditor relationships only) (S645) (CFM55200);
  • ‘exactly tracking’ contracts for differences that are embedded in a share-linked security (creditor relationships only) (S648) (CFM55290);
  • property based total return swaps (S650) (CFM55100).

The middle two bullet points apply for accounting periods beginning on or after 1 January 2005, when share-based derivatives were brought into the derivative contracts regime. Guidance on transitional provisions is at CFM55240.

The first and last bullet points apply to contracts entered into on or after 1 August 2004, in an accounting period ending on or after 17 September 2004. A property derivative entered into before 1 August 2004 will continue to be taxed under whatever ‘old’ rules apply, so no transitional provisions are necessary. See CFM83060.

For each of these four exceptions, non-trading credits and debits are computed in the normal way but are brought into account as chargeable gains or allowable losses under S641. (For property based total return swaps, only part of the overall credit or debit is brought into account in this way. CFM55100 provides more detail.)

For an overview of the accounting and taxation of hybrid securities refer to CFM25000+ and CFM37600+ respectively. Guidance on the old FA96/S92 to 93B rules is at CFM82000+.

Where the holder of a convertible or exchangeable security accounts separately for the embedded derivative, it ascribes an initial fair value to it. Any subsequent changes in the fair value of the derivative must be recognised at each accounting date. Its value at any one time will reflect, among other factors, the value of the shares into which the security may convert or exchange. If their value rises, the value of the derivative will also tend to increase and may give rise to a net credit. If their value falls, so may the value of the derivative, giving rise to a net debit. However other factors will also affect its value, including how long the derivative has left to run.

Since the holder revalues the derivative contracts at each balance sheet date, the chargeable gains or allowable losses arising under S641 may arise in each accounting period (not just on redemption or earlier disposal). (Previously under FA96/S92 no chargeable gain or allowable loss arose until a disposal for the purposes of TCGA1992, that is, at the redemption or earlier disposal of the security.)

For this reason, the S641 treatment is sometimes referred to as ‘annual’ chargeable gains or losses in this guidance. By contrast, where chargeable gains treatment applies to the issuer, this is only given in the period of redemption or other terminal event.

In certain circumstances, losses arising can be carried back (CTA09/S663) - see CFM55040. These carry back rules only apply to the holder, not the issuer. Although the tax rules for issuers may result in chargeable gains or allowable losses, these are ‘normal’ chargeable gains and not ‘annual’ chargeable gains brought into account under S641, and therefore not within the S663 provisions for carry-back.

‘Normal’ chargeable gains treatment

As well as the ‘annual’ chargeable gains treatment under S641, CTA09/Part7/Chapters 7 and 8 also include provisions relating to corporation tax on chargeable gains that apply in relation to certain issuers of securities with embedded derivatives - refer to CFM55400+.

In addition, shares may be acquired when a ‘plain vanilla’ equity option or future runs to delivery. On disposal of these shares, a chargeable gain or allowable loss will arise (if they are not held for trading purposes). There is provision at CTA09/S667 - 669 to exclude from the capital gains computation those amounts already taxed under derivative contracts. Guidance is at CFM55130.