Old rules: derivative contracts: underlying subject matter: shares
Changes in 2005 - equity derivatives
This guidance applies to periods of account beginning before 1 January 2005, or beginning after that date and ending before 16 March 2005
Changes to the derivative contracts regime were made by statutory instrument in 2005, coming into force on 16 March 2005. The main change was to bring most derivatives over shares into Schedule 26 (now CTA09/S589(3) - see CFM50730 for current rules).
As a result, the provisions which qualified the previous general exclusion of share-based derivatives - paragraphs 5, 5A, 6, 7 and 8 of FA02/SCH26 - became unnecessary and were repealed. See CFM83090 onwards.
Before 16 March 2005
Shares were not an excluded subject matter if the relevant contract was held for the purposes of a trade (see CFM83090).
Nor was an embedded derivative, which was treated as a relevant contract by FA96/S94A(2)(b), prevented from being a derivative contract by having shares as its subject matter. In a period of account beginning on or after 1 January 2005, and where FA96/S94A applies, but the embedded derivative contract terminated before 16 March 2005 (or the accounting period ended before 16 March 2005), FA02/SCH26/PARA5A (now repealed) applied. This provided that embedded derivatives were not debarred from being derivative contracts just because they had shares as their subject matter.
There were also certain other circumstances in which shares were not an excluded underlying subject matter - CFM83100 onwards gives details.
Jibmunt Ltd, a company quoted on the London Stock Exchange, issues a corporate bond with an attached warrant. The warrant (which is capable of being detached from the bond and traded separately) entitles the holder to subscribe for shares in the company at a future date, and carries no other rights. The warrant, whether traded with the bond or separately, is an option and therefore a relevant contract. But because its underlying subject matter is shares, and only shares, it will be excluded from the derivatives contract regime, unless it is held on trading account (for example by a bank). You would need to treat the option in the way set out in TCGA92/S144 (see CG55400+).
Interest that the company pays on the bond and any profit or loss it makes when the bond is redeemed will be dealt with under the loan relationships rules.
Kabcon Ltd is an investment company which enters into an equity index swap with a bank. If the FTSE100 index rises in a particular period, Kabcon Ltd receives a payment from the bank based on the percentage rise in the index. If the FTSE100 falls, the company pays the bank. At the same time, Kabcon Ltd makes a payment to the bank equal to interest, calculated at LIBOR less 0.75%, on a notional principal amount.
The contract has two underlying subject matters, shares and an interest rate (or a notional loan). Only one of these is excluded. The contract therefore falls within the derivative contracts regime.