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HMRC internal manual

Corporate Finance Manual

Holders of convertible or share-linked securities: 'exactly tracking' CFDs: examples

Exactly tracking contracts: examples

Example 1

The terms of a security with an issue price of £1million are that the redemption amount exactly tracks the percentage change in value of the ordinary shares in X plc, which are listed on a recognised stock exchange. The security was issued on 1 January 2007 when X plc’s ordinary shares were worth £20 per share, and redeems on 31 December 2009. Supposing that at 31 December 2009 the X plc share values are:

  • £35 per share (representing a 75 per cent increase over their £20 value at issue); or
  • £4 per share (representing a corresponding 80 per cent decrease);

In order to be ‘exactly tracking’ the security must respectively redeem for:

  • £1.75million, or
  • £200,000.

The holder is thus fully exposed to changes in the value of the linked asset, and can potentially lose the whole of the amount lent, as well as make an unlimited return.

Example 2

The facts are as in Example 1, except that the redemption price is subject to a maximum of £1.4million should the value of X plc’s shares rise more than 40 per cent over the life of the security. Additionally, the holder is guaranteed repayment of half the original loan should the relevant share value fall by more than 50 per cent.

The derivative contract is NOT ‘exactly tracking’. While one ground would be sufficient, it fails on two. The redemption amount is subject to both a ‘cap’ and a ‘floor’. The derivative does not qualify for chargeable gains treatment, and all debits and credits arising from it are taxed as income under the normal operation of CTA09/S595.