CFM55490 - Derivative contracts: issuers of convertible or share-linked securities: securities containing CFDs: 'exactly tracking contract' - examples

CTA09/S657

Exactly tracking contract

On 1 January 2016, Y Ltd issues a 3 year security at par £1million. The redemption price is the full issue price increased, or reduced, by the full percentage change in the value of its ordinary shares. Suppose its shares were respectively worth £40 and £50 on 1 January 2016 and 31 December 2018, an increase of 25 per cent over the life of the security. In order to be an ‘exactly tracking’ contract, the security must redeem for £1.25 million.

‘Almost exactly tracking’ contract

This example illustrates the position during a brief time window, for accounting periods beginning on or after 1 January 2005 and ending before 31 December 2006. For this limited period, ‘exactly tracking’ could also include contracts that were ‘almost exactly tracking’.

The facts are the same as in the above example, except that the redemption price of the security is subject to a minimum of £100,000 should the value of Y Ltd’s ordinary shares fall by more than 90 per cent over the relevant period. Suppose their respective values on 1 January 2006 and 31 December 2008 were £40 and £2, a percentage decrease of 95 per cent over the life of the security. The security therefore redeems for the minimum £100,000. The contract is ‘almost exactly tracking’ because this does not exceed 10 per cent of the £1million issue price.

A similar security issue in a later period would not be treated as an exactly tracking contract. The normal rules of CTA09/PT7 would apply and amounts would be treated as income, in accordance with S571.

Neither ‘exactly tracking’ nor ‘almost exactly tracking’

Had the contract guaranteed a minimum of, say, £150,000 of the original loan, it could not have qualified as almost exactly tracking even in accounting periods beginning on or after 1 January 2005 and ending before 31 December 2006.

Transitional rules for contracts issued a period of account beginning before 1 January 2005

In practice, most ‘nearly exactly tracking’ contracts (those with a floor of 10% or less) will have been issued in a period of account beginning before 1 January 2005, and may be regarded as subject to the grandfathering treatment provided for in CTA09/SCH10/PARA88, outlined at CFM55540 applicable to exactly-tracking contracts for differences embedded in debtor loan relationships, to which S658 would otherwise apply.