CFM16686 - Taxing loan relationships: convertible and exchangeable securities: taxing the holder: interaction with TCGA 1992: cash settlement, exchange, or disposal

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

Conversion option exercised but cash-settled by issuer

In the example in CFM16675, suppose that on Abacus opting to convert, the terms of the security had allowed the issuer to cash settle for the value of the shares, which was £1.1million, instead of issuing shares. TCGA92/S132 would not then apply, and TCGA92 would treat the transaction as involving a disposal of the security.

FA02/SCH26/PARA45H (3) provides for the base cost of the convertible security to be treated as increased (or reduced) by the same aggregate amounts as in the CFM16675 example. So no chargeable gain would arise from the disposal of the security unless the cash settlement amount had exceeded £1.1million.

Exchangeable security

TCGA1992/S132 does not apply to a transaction where a security is exchanged for shares in a company other than the issuer (commonly known as “exchangeables” as distinct from “convertibles”). For the purposes of TCGA1992 the exchange would be treated as involving a disposal of the exchangeable security.

FA02/SCH26/PARA45H (3) again provides that for the purposes of TCGA1992, the base cost of the security is treated as increased (or reduced) by the same aggregate amounts as in the first case above. The adjusted amount is also treated as the TCGA1992 base cost of the exchange shares, for the purposes of a subsequent disposal.

Disposal of the security before maturity

A holder may dispose of a convertible or exchangeable security part way through its life. In those circumstances FA02/SCH26/PARA45H(3) makes an appropriate adjustment to its base cost for the purposes of TCGA1992.

Securities converted, exchanged or cashed out in periods ended before 30 December 2006

For periods ending before 30 December 2006, the “loan relationships” adjustment required by Para 45H was the initial carrying value of the embedded option, rather than the “relevant Chapter 2 amount”. It will be seen from the example that this could potentially lead to double counting where the company disposing of the convertible was not the original subscriber. However, in these circumstances TCGA92/S37 or TCGA92/S39 will apply to exclude from the capital gains computation those amounts that have already been taxed or relieved as income, and have not already been excluded under PARA45H(3) or (4).

For periods ending on or after 30 December 2006, TCGA92/S37 and TCGA92/S39 are disapplied by PARA45H(5A).