Derivatives: introduction to covered warrants: exercise of a covered warrant
Depending on the particular circumstances, a charge to either Stamp Duty or Stamp Duty Reserve Tax (SDRT) can arise whenever a covered warrant is exercised.
- at anytime before the expiry of a covered warrant in respect of underlying securities (i.e. ‘stock or marketable securities’ as defined in section 122 Stamp Act 1891)
- the warrant is exercised by the holder and can only be settled in cash; then
- no Stamp Duty charge arises as there is no requirement for the execution of an instrument of transfer (i.e. stock transfer form).
However where upon exercise and settlement of a covered warrant;
- underlying securities are transferred and delivered to the warrant holder (or warrent holder) in exchange for consideration; then
- such a transaction is regarded as a transfer on sale which may be subject to ad valorem 0.5% Stamp Duty under Paragraph 3, Schedule 13 Finance Act 1999 if an instrument of transfer is executed and the securities are ‘stock or marketable securities’ (as defined in s122 FA1891).
Stamp Duty Reserve Tax (SDRT)
- a covered warrant in respect of underlying UK registered securities is exercised;
- but settlement is capable only in the form of cash; then
- no SDRT charge arises because a cash settled warrant is not regarded as a ‘chargeable security’ (as defined in section 99 Finance Act 1986).
Howerver where upon exercise and settlement of a covered warrant;
- the underlying UK registered securities (i.e. stocks and shares) are transferred and delivered in exchange for consideration in the form of ‘money or money’s worth’ (per s.87 (1) FA86); then
- whether a 0.5% SDRT charge arises depends on the following:
- No 0.5% SDRT liability arises on the exercise of an issued call (buy) covered warrant. This is because the issuer is the seller of the underlying share equity. This is also however subject to Regulation 2 of the 1986 SDRT Regulations (SI 1986/1711) regarding SDRT accountability.
- A 0.5% SDRT charge may arise on the exercise of a put (sell) warrant where shares are delivered. This is because the issuer is the buyer of the underlying share equity from the investor. the issuer may however be eligible for intermediary relief under s88A FA86 on the purchase where all the conditions for relief are fulfilled.
- A 0.5% SDRT charge may arise on the exercise of a call warrant where the underlying share investment delivered to the warrant holder in exchange for consideration is a ‘chargeable security’ (as defined in s99 FA86).
- No 0.5% SDRT charge arises on the exercise of a put covered warrant. This is because the holder is selling securities to the issuer. however this is subject to Regulation 2 of the 1986 SDRT Regulations (SI 1986/1711) regarding SDRT accountability.
Stamp Duty and SDRT: Higher 1.5% charge
As a covered warrant is an option giving the warrant holder the right, but not the obligation, to subscribe for a specified quantity of an underlying security (i.e. stocks and shares) at a specified ‘strike’ price per share (i.e. the warrant exercise price) within a specified future date, a higher 1.5% Stamp Duty or SDRT charge can arise in certain circumstances.
- following an exercise of a covered warrant to buy or sell;
- securities of a company incorporated in the UK are transferred or are agreed to be transferred to a person (or his nominee) who issues a depositary receipt in respect of such ‘stocks and marketable securities’;
- or the shares are transferred to a person (or his nominee) whose business includes the provision of clearance services; then
- a higher 1.5% Stamp Duty or SDRT charge arises under s.67, 70, 93 or 96 FA86.
The Stamp Duty or SDRT charge on the transfer, or the agreement to transfer, is calculated by reference to:
- the amount or value of the consideration for the sale, or if higher, the market value of the securities transferred at the date the instrument is executed (s.67(2)(b) & (2A)); s.70(2)(b) & (2A) FA86 or;
- where no instrument is executed the market value on the date of the transfer of the securities (s.93(4)(b)(ii) & (4A) and s.96(2)(b)(ii) & (2A) FA86).
This calculation of the 1.5% charge applies to covered warrants which are entered into on or after 25 November 2015 and exercised on or after 23 March 2016.
For covered warrants entered into prior to 25 November 2015, whether exercised prior to, or on or after 23 March 2016, the calculation of the 1.5% charge is by reference only to the covered warrant ‘strike price’.
Where pursuant to an exercise of an covered warrant UK incorporated company shares are transferred to a depositary receipt issuer or clearance service (or their respective nominees) within the UK CREST settlement system, CREST will automatically calculate the higher of the covered warrant ‘strike price’ and market value where the CREST Bargain Condition flag ‘RO’ – Result of Option has been checked.
A CREST member should therefore ensure that the ‘RO’ flag is checked when, following exercise of a covered warrant, UK incorporated company shares are to be transferred in CREST to a depositary receipt issuer or clearance service (or their nominee).
Alternative Clearance Service Charge
Where following the exercise of a covered warrant UK incorporated company shares are transferred or agreed to be transferred to an operator of a clearance service which has an approved HMRC election in place under s.97A FA86, those UK securities are chargeable to Stamp Duty or SDRT at 0.5%.
This is calculated only by reference to the amount or value of the consideration paid (i.e. based on the covered warrant ‘strike price’).
See STSM112070 for the meaning of a ‘Call’ and a ‘Put’.