SAIM3050 - Deeply discounted securities: excluded indexed securities

‘Excluded indexed securities’ taxed as capital gains

ITTOIA05/S433 explains the meaning of ‘excluded indexed securities’. These are outside the deeply discounted security rules, and are instead taxed under the capital gains rules (CG53446).

An excluded indexed security is one where the amount payable to discharge the debt (on redemption or otherwise) is calculated by applying the percentage change over the redemption period in the value of ‘chargeable assets', or an index of those assets, to the amount of the original security.

The ‘excluded indexed security’ rules apply only to the holder of the instrument. See CFM5900 (SAIM20000) onwards for the Loan Relationships rules applicable to companies that issue and hold such securities.

The percentage change

The percentage change is the full percentage change in the value of the chargeable assets, or of any index of the value of such assets, over the redemption period. The percentage change is to be applied to the full issue price - that is without issue costs having been deducted.

The terms of the security may provide for the investor to get back a percentage of his or her original stake money, even if the value of the relevant chargeable assets plummets. This will not prevent it being an excluded indexed security provided the specified percentage is not more than 10% of the issue price. It should be noted this does not mean investors can invest £100 and get a minimum of £110 back; it means they can invest £100 and get not more than £10 back, losing the other £90 of their original capital. Unless they can lose at least 90% of the amount invested it is not an excluded indexed security, and will be a deeply discounted security.

The redemption period

This is the period between the date of issue and the date of redemption. The rules allow slightly different dates to be used where there are difficulties in obtaining valuations on the issue or redemption dates, and for no other reason.

Chargeable assets

Chargeable assets are those where a gain on disposal of the asset by the person in question would be a chargeable gain, assuming that

• the disposal was not in the course of a trade, profession or vocation carried on by that person,
• TCGA92/S100 (exemption for authorised unit trusts etc.) does not apply, and
• chargeable gains that might accrue under TCGA92/S116 (10) (CG53820 onwards) are disregarded.

Where a security is linked to an index of chargeable assets, changes in the components of the index can be ignored so long as the index continues to reflect the population it was set up to mirror. Cases where the condition may not be satisfied, for example, where a new index is used, or the linkage is to shares in only one company, which then changes, should be referred to CTIAA (Financial Products and Services Team).

Amount payable on redemption

The investor must have an entitlement to the issue price increased by the relevant change in the value of the chargeable assets (or index). Where the redemption value is to be satisfied by receipt of the linked chargeable assets themselves, with the result that the investor obtains more than the percentage change, the conditions would not be met. Nor is the condition satisfied if the return to the investor is geared, for example, if on redemption the investor receives twice the increase in the index (or some other multiple).

Total return index

The value of a ‘total return’ equity index reflects not only the price of the shares comprised in the relevant index, but also a measure of income in the computation of the level of that index. The value of the index may, for example, reflect an amount in respect of rolled-up dividends. Provided the index is a standard, commercially used index of the total return from shares, HMRC consider that it will be an index of the value of chargeable assets for the purposes of ITTOIA05/S433.

Retail price index

The Retail Prices Index (RPI), and any similar index published by or on behalf of any other government, is not treated as an index in the value of chargeable assets. Where the return on debt is linked to such an index, the debt is likely to be a deeply discounted security.

Interest

Interest payable on redemption is ignored in determining the redemption value of the security, and is chargeable to income tax as savings and investment income in the usual way.