Derivative contracts: issuers of convertible or share-linked securities: introduction
The issuer’s perspective
This section of guidance covers three different cases.
- A company may issue a ‘standard’ convertible - if a holder exercises the conversion option, it is satisfied by the issue of shares in the issuing company. An issuer that has adopted IAS 32 or FRS 25 will be required to account for the convertible as a compound financial instrument. This means that the security is ‘bifurcated’ into a host contract (a financial liability) and an equity component - see CFM21250 for more about the accounting.
The equity component is treated as a relevant contract under CTA09/S585 (CFM50420), but it will not be a derivative contract because it does not satisfy any of the ‘accounting conditions’ in CTA09/S579 (CFM50210). It is a ‘tax nothing’. The issue of shares in satisfaction of the company’s obligations under the security has no tax consequences. This is not quite the end of the story, however, since - exceptionally - a company may be forced to settle all or part of its obligation in cash. CTA09/S666 allows the company to recognise an allowable loss in this circumstance.
Guidance relevant to issuers of ‘standard’ convertibles is at CFM55510 - 55530.
- Certain other convertibles (referred to in this guidance as ‘non-standard’) are accounted for as a host contract and an embedded derivative. This will be the case where the issuer must, or may, satisfy its obligations other than by issuing its own shares - for example, where the security converts into shares other than those in the issuing company, or where a convertible can (or must) be settled in cash.
Where this happens, the effect of CTA09/S585 is to treat the issuing company as party to an (embedded) option. This deemed option may be exercised by the holder - and may result in the issuer either issuing its own shares, or transferring shares, or making a cash payment - or it may be allowed to lapse if the holder chooses instead to redeem the security for its par value. CTA09/652 - 655 provide the tax rules for each of these cases. Guidance is at CFM55420 - 55460.
- The issuer of a share-linked security will also account for it as a hybrid financial instrument - a financial liability plus an embedded derivative. The embedded derivative in this case is a contract for differences (CFD). Where the CFD exactly tracks the underlying shares, profits or losses on the CFD are brought into account as chargeable gains or allowable losses by CTA09/S658. Guidance is at CFM55470 - 55500.
In each of the three cases above, there are special rules for securities issued in an accounting period beginning before 1 January 2005 - see CFM55540.
This part of the guidance does not deal with the treatment of the host contract under loan relationships - see CFM37600+.
Nor does it deal with the tax position of a company holding such securities - that is covered at CFM55200+.