Holders of convertible or share-linked securities: convertibles where CTA09/S645 does not apply
What happens where CTA09/S645 conditions are not met
CTA09/S645 (CFM55220) will not apply if the holder of a convertible security does not adopt ‘bifurcation’ treatment in its accounts. This may be because it continues to account under ‘old UK GAAP’ (and has not elected under CTA09/S416 to be treated for tax purposes as though it had accounted separately for embedded options). Or it may be because the convertible is accounted for at fair value through profit and loss, perhaps because it is the hedged item in a fair value hedge.
In such cases, no separate embedded option is recognised under CTA09/S585. Normal loan relationships rules apply to the security as a whole. Nothing prevents it from being a QCB. This means that, on conversion into shares, there is a disposal of the security, and the shares are treated under TCGA92/S116(6) as acquired for the market value of the security immediately before the conversion.
‘Bifurcation’ cases where CTA09/S645 does not apply
In some cases, the company may bifurcate the security in its accounts, but one or more of the remaining conditions in CTA09/S645 may not be met. For example, the company may be party to the security for trade purposes, or it may convert into shares that are neither qualifying ordinary shares nor mandatorily convertible preference shares.
The option embedded in the security will be subject to the derivative contracts rules, but credits or debits give rise to income profits or losses in the normal way. Here again, the security - viewed as a whole - is a QCB, so a disposal does not give rise to chargeable gains or allowable losses. Instead a disposal (including a conversion into shares) is treated as a simultaneous disposal of the host contract and the embedded option.