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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Derivative contracts: chargeable gains on derivatives: property based total return swaps: tax treatment

Tax treatment of property-based total return swaps

Where all of the conditions at CFM55100 are met, part of the debits or credits computed under the normal derivative contracts rules is brought into account under CTA09/S641 as a chargeable gain or allowable loss. Under S659(4), this amount is given by the formula:

S641 credit or debit = R% x N,

where N is the notional principal amount of the contract, and R% is the percentage change (if any) in the capital value index for the relevant period.

‘Relevant period’ means the accounting period if the company was party to the contract for the whole of the period, or - if the company only held the contract for part of the accounting period - the period in question (S659(5)).

Where it is not possible to determine precisely the percentage change for the relevant period, for example, if a swap based on an annual index is disposed of part-way through the year, a published estimate or reasonable interpolation of the index value can be used. A reasonable interpolation is one that accurately reflects actual movements in property prices during the period in question. For example, during the course of a year, property prices might have risen sharply for the first 6 months, then remained static for the next six months. In this case, a straight line interpolation between property index values over the entire year would be unlikely to be a reasonable interpolation method.

The remaining gain or loss on the contract for the period is brought into account as a non-trading credit or debit in the normal way.

The aim of S650 is to segregate ‘property related’ amounts payable or receivable under a property based total return swap from ‘interest related’ amounts, giving capital treatment to the former and income treatment to the latter. It is not a precision instrument, and the segregation will not be exact in many cases, for example, where a lump sum payment is made or received on disposal or early termination of a contract.

In general, the ‘capital’ and ‘income’ amounts for tax purposes will not reflect accounts entries, and it will be necessary to dissect credits or debits shown by the accounts - see example at CFM55120.

For accounting periods beginning on or after 5 December 2012, a new section 659(4A) was introduced, which provides that where the return arising from a property return swap is capped, then the percentage to be used in the calculation for tax purposes of the capital component is similarly capped. For these purposes, a new accounting period is deemed to start on 5 December 2012.

For example, a contract might provide that whatever the actual movement in the property capital return index, the property-linked return to one party to the contract is capped at 5%. So if the index rises by 3% during the year when the contract is in force, then the return paid is 3% of the principal. However, if the index rises instead by 8%, then the return is limited to 5%.

In the latter circumstances, for the calculation required by section 659(4), R% would also be restricted to 5%.