Someone who invests in shares will benefit both from any growth
in the capital value of the shares, and from any dividends that are
paid. Similarly, someone investing in a rental property will both
receive rents and realise a capital gain or loss when they sell the
building. The question therefore arises whether, if you are looking
at a derivative over shares or over rental property, the income
from the asset – dividends or rents – is a separate
underlying subject matter from the asset itself.
Legislation was introduced in 2004 to clarify the point.
FA02/SCH26/PARA11(7) provides that, for contracts entered into
after 1 August 2004 in an accounting period ending on or after 17
September 2004, where an underlying subject matter of a relevant
contract is income from land, shares or units in a unit trust, the
subject matter of the contract isn't treated as land, shares or
unit trust units just because of that income. We take the same view
for contracts entered into before that date.
This means that where, for example, a derivative is based on
an index of property values that reflects the total return from
investment property – both changes in capital value and
rental yields – the derivative’s underlying subject
matter will be both rents and land.
Where a derivative contract has shares (or units in a unit
trust) as its underlying subject matter, the "dividend" element may
be small or subordinate in relation to changes in the capital value
of the shares (see
CFM13120). In such a case, the dividend
element is disregarded under FA02/SCH26/PARA9 when deciding whether
the contract is within Sch 26. If, however, the dividend element
cannot be so disregarded, the contract as a whole will always be
within Sch 26.
There is a similar provision at FA02/SCH26/PARA45A(3) which
allows rental income that is small or subordinate to the "land"
element to be ignored in determining whether credits and debits
under the contract should be brought into account as capital gains
or losses under Para 45A. As with Para 9, HMRC will regard a figure
of less than 5% as "small". The judgement on whether the rental
element is small or subordinate has to be made at the start of the
contract.
