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HMRC internal manual

Corporate Finance Manual

Old rules: asset-linked securities pre 2005: ceasing to qualify: example

Effect of deemed disposal and acquisition: example

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

Kingo Ltd held a 3-year asset-linked security issued for £1m in Year 1 on 1 July. It held the security for investment purposes. The security was linked to the value of ordinary shares in Lifree plc, a listed company. It carried interest of 2% per annum paid on 30 June each year. Lifree plc was taken back into private ownership and ceased to be a listed company at the end of Year 2. As a consequence the security ceased to get chargeable gains treatment. The security redeemed in Year 3 for £1.5m.

Year 1: accounting treatment

Asset recorded at £1m on issue. Lifree plc shares valued at 200p.

Kingo Ltd would account for its loan relationships on an accruals basis. The company would take a view about any increase in the likely redemption amount, based on the current value of the linked shares, and accrue this over the life of the loan.

At the end of Year 1, Lifree plc shares were trading at 260p, an increase of 30%. The anticipated profit on redemption of the loan note was therefore £300,000. Kingo Ltd would accrue one-third of this in the Year 1 accounts - £100,000. It would also accrue interest of £10,000.

Year 1: tax treatment

Computational adjustment to take out £100,000. S93 applied and this amount was not within loan relationships.

Year 2: accounting treatment

Shares in Lifree plc were still trading at 260p before being taken into private ownership. Kingo Ltd continued to accrue anticipated profit of £100,000.

It received interest of £20,000 and accrued a further £10,000 for the period 1 July to 31 December.

Year 2: tax treatment

Following S93B, the relevant consideration was the value at which the asset would stand in the accounts at the time of the hypothetical disposal, assuming the asset had always been accounted for on the accruals basis. That amount was £1,200,000.

A chargeable gains computation was required treating the asset as sold for £1,200,000. The £200,000 profit (subject to indexation) was held over.

For loan relationship purposes the asset was treated as acquired for £1,200,000.

Year 3: accounting treatment

The accounts would show a profit of £300,000, being the increase from the carrying value at end of Year 2, £1,200,000, to the final redemption amount of £1,500,000.

Year 3: tax treatment

The profit of £300,000 would be taxed under loan relationships.

The held over chargeable gains profit would be brought into charge. There would be no further indexation for the period from the hypothetical disposal to redemption.