CFM16700 - Taxing loan relationships: convertible and exchangeable securities: taxing the issuer: standard convertible: exceptional cash out

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

Tax treatment of the issuer of a standard convertible security with an exceptional cash out

Exceptionally, on the holder exercising the conversion option the issuer may have insufficient “headroom” to issue the requisite shares, if doing so would breach the maximum issued share capital permitted by its Memorandum and Articles. It may therefore have to cash settle its obligation by paying the holder the equivalent of the share value. If this happens, and provided none of the exclusions below applies, FA02/SCH26/PARA45JA allows the issuer to compute an allowable capital loss. The loss is equal to the excess, if any, of the amount paid to settle the option over its initial fair value. See the example at CFM16700a.

This should not be confused with a case where the terms of the security permit cash settlement instead of physical delivery of shares, and as a result the issuer accounts for the security as a financial liability plus an embedded option. Such a security would not be a “standard” (“plain vanilla”) convertible in the first place, see CFM16690, but non- standard. For the tax treatment of the issuer of a “non-standard” convertible under FA02/SCH26/PARA45J see CFM16705.

Excluded categories

This special FA02/SCH26/PARA45JA loss is not available:

• to a borrower which became a party to the security in the ordinary course of a trade as a bank or securities house; or
• to an Authorised Unit Trust, Investment Trust, Open Ended Investment Company or Venture Capital Trust; or
• where the “original relationship” (that is, the contract falling within the loan relationships rules) is one to which the issuer was a party before its first accounting period to begin on or after 1 January 2005 ( CFM16720).