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HMRC internal manual

Corporate Finance Manual

Old rules: convertibles pre 2005: what are convertibles

What are convertibles

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

Some securities may be issued on terms that allow the borrower, or the lender, to

  • convert the security into shares of the issuer (convertibles), or
  • exchange the security for shares in another company (exchangeables), or
  • acquire shares as a result of warrants attached to the security.

There is information about the current accounting treatment of convertible debt at CFM25000, and the business background at CFM11110.

Under the old FA2002 rules, where the holder had an option to take cash on redemption, such securities were loan relationships, and fell within the loan relationship rules. However, the reward for the lender may depend on the changes in value of the shares. Profits or losses on shares were normally taxed under the chargeable gains rules, rather than as income under loan relationships. The example below shows how the reward for lending money could be similar to the reward for buying shares.

The special rules in FA96/S92 and FA96/S92A, now repealed, acknowledged that where securities behaved like shares, it was appropriate to tax the profit under the chargeable gains rules. To get this treatment, the securities had to fulfil certain conditions. In particular, it had to be impossible for the parties to manipulate or guarantee the return so that it behaved like a security offering an interest-like return.


VG Ltd issues securities to KP Ltd. They cost £10,000 and have a face value of £10,000. No interest is payable. The terms are that, in 5 years, KP Ltd will be entitled to 10,000 £1 ordinary shares in VG Ltd.

In 5 years, the shares in VG Ltd are worth £1.50. KP Ltd will have shares worth £15,000, which could be sold for cash of £15,000.

Owning the security was just like owning shares in VG Ltd. The value of the money that KP Ltd invested increased in exactly the same way as if it had invested the cash directly in VG Ltd’s shares. KP Ltd was unlikely to be able to predict precisely the return on its investment.

In such cases, it might be appropriate to tax the profits and losses on the security under the chargeable gains rules.