CFM16760 - Taxing loan relationships: share-linked securities: taxing the holder: conditions for chargeable gains treatment meaning of “exactly tracking contract”

This guidance applies to periods of account beginning on or after 1 January 2005

“Exactly tracking contract”: FA02/SCH26/PARA 45F (4) to (6)

The contract is “exactly tracking” where the amount required to redeem the security (“D”) is equal to its initial cost to the holder as recognised in accordance with generally accepted accounting practice (“C”), increased or reduced by the percentage change in the value of the linked asset(s) (“R”) over the “relevant period”. Thus any “caps” or “floors” on the redemption price, or arrangements to apply less or more than the exact percentage change will disqualify the derivative from chargeable gains treatment.

This differs from the conditions for FA96/S93 to apply, where sub-section (9) allowed a floor of 10 per cent or less.

The “relevant period” is broadly speaking the whole period from original issue of the security to redemption. The percentage change must therefore be worked out by valuing the linked asset(s) at those dates. Some slight variation in the period taken may however be permitted, see below.

Lagging of “relevant period”: FA02/SCH26/PARA45F (6)(b)

The contract may provide for the linked assets(s) to be valued at dates which slightly pre- date the issue and redemption dates – a process known as “lagging”. This will not prevent the contract being regarded as “exactly tracking” provided any such variation is relatively small, and is solely for the purposes of giving effect to valuations. This is a practical rule which recognises that certain assets do not have daily published prices. Thus without some “lagging” it might not be possible to redeem the security on the maturity date.

See CFM16765 for examples.