A company prepares annual accounts to 30 September. On 5 January
2005, it pays a premium of £1,000,000 for a cash-settled
option, the underlying subject matter of which is an equity index.
It exercises the option on 1 December 2005, and receives cash of
£1,700,000. The option is not held for trade purposes.
Although the company holds the contract on 16 March 2005,
Para 4A cannot apply since 16 March does not fall into a period of
account beginning on or after 1 January 2005. Instead, without Para
4B, the option would become a derivative contract at the start of
the first period to which the SI 2005/646 amendments to Sch 26
apply – i.e. on 1 October 2005.
However, the effect of para 4B is that the option becomes a
derivative contract on 28 July 2005. Suppose that the fair value of
the option on that date is £1,100,000. For capital gains
purposes, it is treated as having been disposed of for
£1,100,000 on 28 July. An unindexed gain of £100,000
therefore arises, with indexation running from 5 January to 28 July
(TCGA92/S144A). This gain is brought into account for the period in
which the company disposes of the contract, in other words in the
year ended 30 September 2006.
For Sch 26 purposes, the company is treated as acquiring the
option for £1,100,000 on 28 July. Suppose that the company
marks to market the option, and its value at 30 September 2005 is
£900,000. The company will bring in a debit of £200,000
for year ended 30 September 2005, and a credit of £800,000
(£1,700,000 less £900,000) in the year ended 30 September
2006.
The facts are as in example 1, except that the company acquires
the option (again, for a premium of £1,000,000) on 2 August
2005.
Here again, Para 4A cannot apply, and Para 4B does not apply
because the option was not held before 28 July 2005. The option
would therefore (apart from Para 4C) be a chargeable asset when it
was acquired. However, Para 4C does apply here, with the result
that the option is treated as a derivative contract from 2 August
2005.
In the year ended 30 September 2005, the company will have a
Sch 26 debit of £100,000 (the mark to market value of
£900,000 on 30 September, less the £1 million premium
paid). It will, as in the first example, have an £800,000
credit in the subsequent year.
The facts are as in the first example, except that the company
exercises the option on 1 July 2005. In this case, Para 4B cannot
apply since the company is not party to the contract on
28 July. The contract is, and remains, a chargeable gains
asset, and any profit accruing to the company on exercise of the
option will be a chargeable gain.
Again, the facts are as in example 1, except that the company
prepares its accounts to 31 March. In this case, Para 4A cannot
apply because the contract is not acquired in a period beginning on
or after 1 January 2005. But the contract will come within Sch 26
for the period 1 April 2005 to 31 March 2006. So Para 4B is
inapplicable, since the option is not a chargeable asset
immediately before 28 July 2005.
There is no specific transitional rule to deal with this
situation. The company should compute a chargeable gain on disposal
of the option on 1 December 2005, and exclude from the gain amounts
that have already been taxed or relieved as income under Sch 26 in
year ended 31 March 2006, since such amounts cannot be brought into
account under any other provision – FA02/SCH26/PARA1(2).
