CFM50800 - Derivative contracts: exclusions from regime: equity derivatives: condition D

Contracts to buy or sell a substantial shareholding

The acquisition of a company, or a significant stake in a company, may involve a put or call option over shares in the target company, or a contract that meets the statutory definition of a ‘future’. In many cases, such contracts will not be accounted for as derivatives, and will therefore fail the test in CTA09/S579.

CTA09/S591(5) ensures that, even if this is not so, such contracts will generally not be treated as derivative contracts. This provision was added to the derivatives contract legislation by SI 2006/3269, and applies from 30 December 2006 in relation to accounting periods ending on or after that date.

The exemption applies where the relevant contract is an option to acquire shares in a company, or a future requiring delivery of such shares. The shares in question must constitute a ‘substantial shareholding’, as defined at TCGA92/SCH7AC/PARA8 (see CG53072), or would be a substantial shareholding if they are actually acquired or delivered.

There is no requirement for shares to actually change hands. The option or future may allow cash settlement as an alternative to shares being delivered. The ‘condition D’ exemption will still apply if the company takes the cash settlement route.

Two further conditions need to be satisfied:

  • As with other exemptions in S591, the company must have entered into the contract otherwise than in the course of activities integral to a trade.
  • And the option (or future) must not be an embedded derivative.

This means that where a company holds a convertible or exchangeable security, the embedded derivative is not taken out of Part 7 by CTA09/S591(5), even if the conversion shares would constitute a substantial shareholding.

An option to buy or sell shares in a company will be an ‘asset related to shares’ as defined at TCGA92/SCH7AC/PARA30 (CG53010), and where such an option is excluded from Part 7 CTA09, it will generally come within the scope of the substantial shareholding exemption.