CFM6143a - Taxing loan relationships: convertibles: deep gain example

Right to sell the security: example

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

• at the end of Year 1, the holder can choose to exchange the security for shares in TG Ltd, a trading subsidiary of LB Ltd.
• the shares will be exchanged on a 1 for 1 basis, that is, £1 nominal loan stock will be exchanged for £1 nominal of shares in TG Ltd
• alternatively, the holder can require TT Ltd (a third company, subsidiary of LB Ltd) to buy the security for £15,000 before redemption or conversion.

The security is a convertible, but the terms put KD Ltd in the same position as if it had an RDS (see the example at CFM6142a). KD Ltd can obtain £15,000 for the security, which is the equivalent of a deep gain on redemption.

The reward comes in the form of an increased amount payable on redemption. This is an income award, which is taxed under loan relationships.