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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Derivative contracts: issuers of convertible or share-lined securities: pre 1 January 2005 securities

Treatment of securities issued or acquired in a period beginning before 1 January 2005

Convertible securities

A company may have issued (or acquired by novation) a convertible or exchangeable security in a period of account beginning before 1 January 2005. Broadly, the previous tax treatment of the debtor relationship is ‘grandfathered’ - see CFM37700.

The security must meet the conditions in CTA09/S652 (CFM55420) - in particular, it must not be one to which the company became party in the course of a banking or security house trade. Where the conditions are met, CTA09/SCH2/PARA94 provides that

  • if the obligations under the security are met by transferring shares, the treatment given by CTA09/S653 (CFM55430) does not apply
  • if the security is cash-settled, the company has a capital loss equal to difference between the amount paid out and the carrying value of the host contract at the time of settlement
  • if the embedded option is not exercised (i.e. if the holder redeems the security for its face value), CTA09/S655 (CFM55430) does not apply.

Share-linked securities

CFM37710 sets out the treatment of securities issued or acquired in a period beginning before 1 January 2005, which previously came within FA96/S93. CTA09/SCH2/PARA88 applies to treat the contract for differences embedded into the security as a tax nothing.

First-time adoption of IAS 39 or FRS 26

There is guidance at CFM37680 on the tax treatment of hybrid securities where the company adopts IAS 39 or FRS 26 for the first time (whether that happens in the company’s first period of account to begin on or after 1 January 2005, or at a later date).

From the derivative contracts viewpoint, the Change of Accounting Practice Regulations (SI 2004/3257) prescribe in regulation 3C(2) particular ‘transitional’ credits or debits that are never brought into account. For convertible securities, they are those relating to an embedded derivative to which the company is treated as party by CTA09/S585, where under the pre 1 January 2005 rules the security came within FA96/S92A. There is exactly similar provision for share-linked securities that previously came with FA96/S93.

No special provision is needed for convertible securities treated as containing an equity element. Since this is not a derivative contract, there is no statutory mechanism to tax ‘transitional’ credits or debits.