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HMRC internal manual

Corporate Finance Manual

Old rules: convertibles pre 2005: introduction

Overview of the legislation

This guidance applies to periods of account beginning before 1 January 2005

The tax rules on convertible securities were radically changed as a consequence of the introduction of International Accounting Standards 32 and 39, and their UK GAAP equivalents FRS25 and FRS26.

This chapter deals only with the old FA1996 legislation at FA96/S92 and S92A.

With effect for periods of account beginning on or after 1 January 2005, FA96/S92 and S92A were repealed and replaced by new rules at FA96/S94A and in the derivative contracts rules at FA02/SCH26/PARA45A onwards. CFM37600 and CFM55200 onwards explains the current legislation.

However, where a company became party, either as debtor or creditor, to a convertible security in a period of account beginning before that date, and the security meets certain conditions, the old tax treatment is ‘grandfathered’ (see CFM55540 for issuers and CFM55240 for holders). This guidance will be relevant to such securities.

The taxation rules for income and for chargeable gains are different, with CG treatment usually being more favourable. It may therefore be tempting for companies to manipulate the terms of the security to ensure that they get the most advantageous tax treatment. The legislation in FA96/S92 and FA96/S92A was intended to ensure that did not happen.

Section 92 FA 1996 dealt with the lender. It identified which of the convertible securities that the lender held could be excluded from the loan relationship provisions, so that profits and losses arising on the share element came within the capital gains rules. Any interest or exchange gains or losses were still dealt with under loan relationships.

Section 92A FA 1996 dealt with the borrower, and limited the debits that it could bring into account on certain convertible securities it issued. The issuer couldn’t have relief for amounts that related to the share element.