CFM6122a - Taxing loan relationships: convertibles: examples of a non-conversion

Holder unlikely to convert: Example 1

LB Ltd issues a security for £10,000 with a face value of £10,000, to KD Ltd. The terms show that

• interest of 15% is payable for 2 years
• at the end of Year 2, the holder can choose to convert the security into LB Ltd shares
• the shares will be issued on a 1 for 1 basis, that is, £1 nominal loan stock will be converted into £1 nominal of shares issued by LB Ltd.

If the current market rate of interest is 8%, and LB Ltd £1 shares are currently worth 20p, it is unlikely that KD Ltd would opt for conversion. Instead, KD will be satisfied with a return that is the interest payable, plus the repayment of the amount lent.

From the information available at the time of issue, the likelihood of the holder opting for conversion is negligible, and S92 will not apply. The legislation only asks for a 'more than negligible' chance of conversion on issue.

The test is carried out on issue and not at a later date with the benefit of hindsight. For example, a company may issue a convertible and at a later date the company shares plummet in value. The convertibles may have looked perfectly reasonable at the time of issue, but because the shares are now worth so little, holders are unlikely to exercise their option to convert.