CFM16770 - Taxing loan relationships: share-linked securities: taxing the holder: example of chargeable gains treatment
This guidance applies to periods of account beginning on or after 1 January 2005
Chargeable gains treatment
In the example at
CFM16630a A Ltd lent £1million to
B Ltd for 3 years at 5 per cent interest. The amount required to
redeem the security is the £1million issue price uplifted or
reduced by the full percentage change in the value of the ordinary
shares in B Ltd’s parent company, X Plc. A Ltd is required to
account separately for the loan and the derivative. Using round
figures for convenience, suppose it allocated initial fair values
of £950,000 to the loan and £50,000 to the contract for
differences.
Suppose that on the issue and redemption dates X Plc’s
shares are worth £20 and £30 respectively, representing a
percentage increase of 50%. The security therefore redeems for
£1.5million.
Loan relationship
A Ltd accounts for the loan as acquired at a discount of £50,000 to its nominal £1million value, accruing credits for the discount over the 3 year term. Because this accords with GAAP, FA96/S85A brings the discount credits into account as taxable loan relationships credits. These are in addition to credits for the interest receivable.
Embedded derivative: accounting treatment
A Ltd’s accounts must recognise any changes in the fair value of the embedded contract for differences at each balance sheet date. Its value at any one time will reflect changes in the value of the X Plc shares, but also other factors such as how long the contract has left to run. Suppose it considers its fair value to be:
| Date | Fair value |
| 1 January 2007 | £50,000 (at initial bifurcation) |
| 31 December 2007 | £40,000 |
| 31 December 2008 | £350,000 |
| 31 December 2009 | £500,000 |
A Ltd will respectively bring in a debit of £10,000, a credit £310,000 and a credit of £150,000 for the 3 years to 31 December 2009.
Embedded derivative: tax treatment: FA02/SCH26/PARA45A and 45F
The above debits and credits are taxable under the derivative
contracts rules of FA02/SCH26. Because the contract meets all the
conditions at
CFM16755, the normal income treatment of
non-trading debits and credits is disapplied by SCH26/PARA4F (3).
They are converted into chargeable gains, or allowable losses, for
the periods in which they arise.
If A Ltd is unable to use the £10,000 allowable loss for
the period to 31 December 2007 it may claim to carry it back for a
period of up to 24 months, see
CFM13514 for the detailed rules.
