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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Holders of convertible or share-linked securities: conditions for CTA09/S645 to apply

Holders of convertibles only: options over shares

Part 7 CTA09 accords a special tax treatment to convertible or exchangeable securities where certain conditions are met. These are in CTA09/S645(1)-(6).

They are:

  • Condition A: There is a derivative contract which is a relevant contract to which a company is treated as a party under CTA09/S585(2) (CFM50420) because of a creditor relationship of the company. In other words, the company must bifurcate the hybrid security in its accounts, or have elected under CTA09/S416 to be treated as if it did.
  • Condition B: The embedded relevant contract is an option (within S585(3)).
  • Condition C: The underlying subject matter of the contract is ‘qualifying ordinary shares’ or ‘mandatorily convertible preference shares’ (as defined under S647(4) and (2), respectively - see below).
  • Condition D: The contract must not be held for trading purposes (other than the business of a life insurance company - see CFM54020).
  • Condition E: The company is not an authorised unit trust, an investment trust, an open-ended investment company or a venture capital trust (these are ‘excluded bodies’ as defined under CTA09/S706, and are exempt from tax on chargeable gains).

There is now no connected party exclusion under S645. But for accounting periods ending before 16 March 2005, the company must not be ‘connected’ with the issuer.


CTA09/S646 states an exclusion from S645 - it does not apply where the conversion shares have a pre-determined cash value. Such a security is redeemed for a fixed amount of ‘money’s worth’: essentially this is no different from a security redeemable for a fixed amount of cash.

Qualifying ordinary shares

These are shares in a company which satisfy conditions A and B:

  • Condition A: any shares, except those carrying a right to a fixed rate dividend but no other rights to share in profits, or shares carrying no right to a dividend of any description, and no other rights.
  • Condition B: the shares are listed on a recognised stock exchange, or are shares in a holding or trading company (as defined under TCGA92/S165A).

Mandatorily convertible preference shares

A company whose shares are publicly traded may not wish to undertake a new issue of shares to satisfy the rights of holders of convertible securities, because of the pre-emption rights of existing shareholders. It is therefore not unusual for the securities to be issued by an offshore subsidiary company, and to convert into ‘mandatorily convertible’ (or ‘mandatorily exchangeable’) preference shares of this company. These shares must then be exchanged for listed shares in the parent company. Thus the statute defines mandatorily convertible preference shares as shares which

  • represent the creditor loan relationship;
  • are not ‘qualifying ordinary shares’ (as defined above); and
  • under the terms of the security, must be converted into, or exchanged for, ‘qualifying ordinary shares’ within 24 hours of being acquired by the holder.