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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Old rules: convertibles pre 2005: tax consequences of ceasing to qualify

Tax effect of ceasing to qualify

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

Where a security ceased to qualify for FA96/S92 treatment, S92(7) stated that there was a deemed disposal and re-acquisition immediately before the date it ceased to qualify.

Relevant consideration

The deemed disposal was for the ‘relevant consideration’. This was the value at which the asset would be carried in the accounts if it had been accounted for at all times in accordance with the authorised accounting method which would be adopted after the re-acquisition (for accounting periods starting on or after 1 January 2005, the amortised cost basis would apply).

It was not the market value at that time - a fairly common misapprehension. If the asset was accounted for on an authorised accruals basis, then the consideration would have been equal to the carrying value in the accounts at the relevant date. The relevant consideration would exclude any interest accrued but not yet received. FA96/S92(10) ensured that such interest remained in the income regime.

When the debt entered the income regime, its starting point for loan relationships purposes was the relevant consideration.

Chargeable gains

For chargeable gains purposes the disposal was within TCGA92/S116(10) - see CG54025. The consideration received was the ‘relevant consideration’ - the amount at which the asset would have been carried in the accounts assuming an authorised accounting method was used. Any gain was held over until there was a disposal of the bond. Disposal included redemption or conversion. Disposals after 1 April 2002 may be affected by the exemptions for substantial shareholdings.

The combined effect of this legislation was to ensure that the asset had chargeable gains treatment up to the point that it left CG and income treatment thereafter.

Example

AG Ltd issued securities for £100,000 to an unconnected company, BD Ltd, on 1 July 2002. The securities were to be redeemed or converted into 100,000 ordinary shares of AG Ltd in 5 years’ time. The securities carried interest at 2% per annum payable on 31 June each year. All interest was paid on the due date.

On 1 January 2003, a third company, KX Ltd, bought all the issued share capital of both AG Ltd and BD Ltd. Because they were under common control, they were connected and S92 could no longer apply.

As a consequence the security was treated as sold and immediately re-acquired on 31 December 2002.

For CG purposes a gain was computed on 31 December using the ‘relevant consideration’.

Interest of £1,000 would have been accrued but not yet received by BD Ltd. The carrying value of the debt would therefore be £101,000. Section 92(10) required the carrying value to be reduced by any amount that reflected interest accrued but not yet received. The ‘relevant consideration’ was therefore reduced by £1,000.

The relevant consideration in this case was then £100,000.

The adjustment to the relevant consideration was only made for the purposes of capital gains. When calculating the value at which the security entered the income regime, the relevant consideration remained £101,000. As a result, the interest continued to accrue, without interruption, up to the date of payment.