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HMRC internal manual

Savings and Investment Manual

HM Revenue & Customs
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Accrued Income Scheme: special calculations: interest in default

Cases where the issuer has defaulted on interest: overview

ITA07/S659 to ITA07/S661 deal with cases where the issuer of a security has defaulted on the payment of interest. These could be securities on which interest has not been paid for many years, (for example, pre-First World War Tsarist bonds), or ordinary loan stock of a company which has got into difficulties.

Transfers with or without accrued interest

If the normal rules in ITA07/S632 or S633 applied, the transferor of the bond would becharged on all the interest nominally due but unpaid up to the date of sale irrespective of the prospect of payment. Similarly, if a security goes into default between the date of transfer and the next interest payment date, the full amount of the interest would be taken into account for AIS purposes on the transfer notwithstanding its subsequent non-payment. ITA07/S659 provides that the AIS charge is based on the real value of the interest instead of the interest payable.

Transfers with unrealised interest

Where securities are transferred with unrealised interest, the transferor is effectively charged to income tax on the unrealised interest (SAIM4170).

Where the issuer of the securities has defaulted on the obligation to pay interest, that default may affect the value of the interest coupons which are transferred (as, for example, when bearer securities are transferred with uncashed coupons attached). Where this is the case, when calculating the amount of the payment under ITA07/S634 or the amount of the accrued income profits under ITA07/S631 the value of the right to receive interest is substituted for the amount of the unrealised interest.

However, the value of the right to receive interest may be reduced where there have been successive transfers. Where this is the case, the calculation rules in ITA07/S661 apply.

ITA07/S659 to S661 deal only with the position of the transferor. ITA07/S681 gives an exemption for interest payable to the transferee where securities are transferred with unrealised interest, but this exemption does not apply in the case of interest in default. In such a case, where the payment treated as made to the transferor is changed to reflect the value of the right to receive interest (instead of the amount of the interest), the amount of the interest which is exempt from tax in the hands of the transferee is correspondingly restricted (SAIM4350).

The result is that the interest is taxed, but only to the extent that it exceeds the value on the day of the transfer of the right to receive the interest.

Any amount thus exempted from tax is excluded from the cost of the securities for CGT purposes (TCGA92/S119).

Successive transfers with unrealised interest in default

ITA07/S661 applies where the transferor originally acquired the securities with unrealised interest. In that case, the value of the right to receive interest (‘A’) is reduced by the value of the right to receive the interest on the day the transferor acquired the securities (‘B’). If the transferor has received any of the interest in the meantime, B is reduced by the amount of the interest received, thus increasing the value of the A.

‘B’ cannot reduce the value of ‘A’ below nil.