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HMRC internal manual

Corporate Finance Manual

Old rules: derivative contracts: qualified exclusions: presumptions about purpose

Presumptions about subject matter and purpose

This guidance applies to periods of account beginning before 1 January 2005, or beginning after that date and ending before 16 March 2005

It is possible to construct a relevant contract, or a convertible or asset-linked security, in such a way that the holder is exposed to very little real risk. For example, a convertible security might carry a right to convert into preference shares issued by a vehicle company, whose assets remain at a constant value.

If the taxpayer chose the underlying matter of a relevant contract, or an associated security, to make the risk of fluctuation in value insignificant or non-existent, Para 6(7) deemed the ‘guaranteed return’ test in Para 6(6) to be passed. It was not necessary for HMRC to demonstrate that the risk of fluctuation had actually been eliminated or substantially reduced.

‘Underlying matter’ meant

  • in the case of a FA96/S92 security, the shares which may have been acquired on conversion or exchange, and
  • in the case of a FA96/S93 or FA96/S93A security, the value of the assets to which the loan relationship was linked

and in the case of a relevant contract, fluctuations in the underlying matter were references to fluctuations determined by the contract’s underlying subject matter. For example, if the relevant contract was an option over shares, it was only fluctuations in the value of the option as a result of changes in the value of the shares that were important for the purposes of this legislation. Fluctuations in the value of the option for other reasons, such as changes in interest rates, did not matter.

In relation to accounting periods that begin on or after 1 January 2005 but ending before 16 March 2005, the references to section 92, section 93 and section 93A securities are removed following the repeal of those sections.

Assumptions about purpose: FA02/SCH26/PARA6 (6) and (7)

Para 6(5) provided that a relevant contract was designed to produce a guaranteed return if it would be reasonable to assume, from either or both of

  • the likely effect of the contract, and
  • the circumstances in which the contract was entered into,

that its main purpose (or one of its main purposes) was the production of a guaranteed return from the contract.

Thus decisions on whether Para 6 applied were taken on the basis of an objective look at the facts. Para 6(5) provided a statutory basis for looking not only at the terms of the relevant contract, but also at the totality of the arrangements of which it formed a part, as evidenced by contemporaneous documents (including tax advice, where relevant). If it was reasonable to assume, on the evidence, that production of a guaranteed return was a main purpose of the company in entering into the contract, the test was passed.

Also where there was both a relevant contract and one or more associated transactions, the contract and the associated transactions were designed to produce a guaranteed return if, taking the transactions together it would have been reasonable to assume from either or both of the

  • likely effect of the transactions, and
  • circumstances in which the transactions were entered into,

that their main purpose (or one of their main purposes) was the production of a guaranteed return from the transactions.