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HMRC internal manual

Corporate Finance Manual

From
HM Revenue & Customs
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Old rules: convertibles pre 2005: definition of qualifying ordinary shares

Qualifying ordinary shares

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

In order to qualify, the ordinary shares had to

  • carry a right to a dividend that was not fixed (FA96/S92(1B)), and
  • be listed on a recognised stock exchange, or be shares in a trading company or a holding company (S92(1C)).

Right to a dividend

Shares did not qualify if they carried

  • no right to a dividend or any other profit-sharing rights
  • a right only to a fixed-rate dividend, with no other profit-sharing rights.

Example

LB Ltd issued a security for £10,000 with a face value of £10,000 to KD Ltd. The terms showed that

  • at the end of 1 year, the holder could choose to exchange the security for shares in TG Ltd
  • the shares would be issued on a 1 for 1 basis, that is, £1 nominal loan stock will be converted into £1 nominal of shares in TG Ltd
  • the shares in TG Ltd to be offered in exchange carried the right to a fixed dividend payment each year. Any dividend payments not paid would be rolled up and paid when there were funds available.

As the shares were guaranteed to generate a set amount of income, their value had, to some extent, been predetermined and controlled. The return on the loan has likewise been predetermined. The security would not have fallen within FA96/S92.

Shares in a trading or holding company

The definitions used for ‘trading company’ and ‘holding company’ were those which were used for the purposes of taper relief in TCGA1992/SCHA1/PARA22(1) (itself now repealed by FA 2008). There are details at CG17952b. The main purpose of this provision is to ensure that the value of the shares cannot be artificially controlled

Example

LB Ltd issued a security for £10,000 with a face value of £10,000 to KD Ltd. The terms showed that

  • at the end of 1 year, the holder could choose to convert the security into shares in TG Ltd
  • the shares would be issued on a 1 for 1 basis, that is, £1 nominal loan stock will be converted into £1 nominal of shares in TG Ltd.

TG Ltd was a subsidiary of LB Ltd. It was not a trading company, and held only one asset, a security issued by TT Ltd, another subsidiary of TG Ltd. That security would redeem for £15,000.

That arrangement ensured that TG Ltd’s shares were worth £15,000. The value of the shares offered in exchange were controlled, and KD Ltd was not exposed to the fluctuations in value that would happen if TG Ltd was a trading company open to market influences.