CFM16665 - Taxing loan relationships: convertible and exchangeable securities: taxing the holder: conditions for chargeable gains treatment

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

Chargeable gains treatment: FA02/SCH26/PARA45D and 45E

For the holder of a bifurcated convertible or exchangeable security to obtain chargeable gains treatment on the embedded option, all the following conditions must be met.

Conditions relating to the company

The company must not be

• a party to the creditor relationship for the purposes of its trade (other than the business of a life insurance company, or a mutual trade); or
• an Authorised Unit Trust, Investment Trust, Open Ended Investment Company or Venture Capital Trust (these concerns are exempt from tax on chargeable gains); or

In addition, if the accounting period ended before 16 March 2005, it must not be “connected” within the meaning of FA96/S87 (see CFM5405) with the issuer.

Conditions relating to the security

• The terms of the conversion/exchange option must not be such that the holder would acquire shares with a pre-determinable cash value ( CFM6123); and
• if the terms of the security provide that, in the event of the holder exercising the option to convert or exchange, the issuer may settle the option for the cash value of the shares instead of physical delivery, the amount of cash so payable must not differ significantly from the value of the corresponding shares; and
• the security must not be an “existing asset”, meaning one entered into in a period before the company’s first accounting period to begin on or after 1 January 2005.

Conditions relating to the embedded option

It must not be one to which any of paragraphs 6 to 8 of FA02/SCH26 applies, if the accounting period ended before 16 March 2005.

Conditions relating to the conversion/exchange shares

The shares into which the security may convert or exchange must be either qualifying ordinary shares or mandatorily convertible preference shares. The meaning of these terms is explained at CFM16670.

Status of the security for the purposes of TCGA1992

Where all the above conditions are satisfied, FA02/SCH26/PARA45D (8) provides that the security is not treated as a qualifying corporate bond for the purposes of TCGA1992. This ensures that chargeable gains given by FA02/SCH26/PARA45A are not exempt gains, and that TCGA92/S116 (9) does not apply so as to treat the conversion of the security as a disposal.

Substantial shareholding exemption: FA02/SCH26/PARA45A (6)

In each relevant accounting period, the holder is not treated as making any chargeable gain or allowable loss under FA02/SCH26/PARA45A, if on the making of certain assumptions, any gain would have qualified for exemption under TCGA92/SCH7AC.