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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Derivative contracts: tax avoidance: transfers of value to connected companies

Transfers of value between connected companies

Transactions between connected persons involving derivative contracts are covered by TIOPA10/Part 4 (transfer pricing) - see CFM56050.

CTA09/S695 deals with the following situation (where Part 4 might not apply):

  • There is a transfer of value as a result of the abandonment of a valuable option
  • the transfer is between connected companies (A and B), and
  • the transferee company (B) is not chargeable to tax under CTA09/PART7 in respect of the option.

A transfer of value occurs whenever the other party to the contract has benefited at the taxpayer company’s expense. Where the rule applies the tax computation needs to be adjusted.

In determining whether there has been a transfer of value, S695(6) assumes that, had the parties not been connected, the option would have been exercised on the date it expired. If that assumption shows value has been transferred then the amount paid for the option will be brought into account as a credit for the transferor company (A) for the accounting period in which the option expired.

In relation to any failure to exercise, in full, an option on or after 6 March 2007, amendments in FA07 mean that S695 will apply unless all rights under the option are exercised. Where the option is only partially exercised it applies only in relation to the amount of the premium that relates to the unexercised rights.

Whether companies are connected is determined by S695(8), which mirrors S466(3) but here the exemptions normally provided by S468 are disregarded.

The test of whether there has been a transfer of value is an objective one - it is irrelevant why the company let the option expire. If the conditions are met, the adjustment must be made.

The provision applies to cash settled options as well as those involving delivery of the underlying subject matter. S580(2) which otherwise provides that a cash settled option falls outside the definition of an option is disapplied for the purposes of S695.

See example at CFM56080.