CFM6161b - Taxing loan relationships: convertibles: example of the tax consequences of ceasing to qualify

Tax effect of ceasing to qualify: example

AG Ltd issues securities for £100,000 to an unconnected company, BD Ltd, on 1 July 2002. The securities will be redeemed or converted into 100,000 ordinary shares of AG Ltd in 5 years' time. The securities carry interest at 2% per annum payable on 31 June each year. All interest is paid on the due date.

On 1 January 2003, a third company, KX Ltd, buys all the issued share capital of both AG Ltd and BD Ltd. Because they are under common control, they are connected and S92 can no longer apply.

As a consequence the security is treated as sold and immediately re-acquired on 31 December 2002.

For CG purposes a gain is computed on 31 December using the 'relevant consideration'.

Interest of £1,000 will have been accrued but not yet received by BD Ltd. The carrying value of the debt will therefore be £101,000. Section 92(10) requires the carrying value to be reduced by any amount that reflects interest accrued but not yet received. The 'relevant consideration' is therefore reduced by £1,000.

The relevant consideration in this case is then £100,000.

The adjustment to the relevant consideration is only made for the purposes of capital gains. When calculating the value at which the security enters the income regime, the relevant consideration remains £101,000. As a result, the interest continues to accrue, without interruption, up to the date of payment.