CFM52580 - Derivative contracts: embedded derivatives: prepaid equity forwards

CTA09/S592

This guidance is relevant to cases where the accounting standards applied result in the separation of an embedded derivative. For details of the accounting treatment for embedded derivatives and hybrid debt see CFM25020.

Certain hybrid derivatives that are bifurcated

S592 is aimed particularly at structured instruments, such as the contracts that might be described as ‘prepaid equity forwards’ of the type discussed in the Special Commissioners case of HSBC Life (UK) Ltd v Stubbs (SpC295). In order for the section to apply, it is necessary for the contract as a whole to be a hybrid derivative that meets the condition in S579(1)(b) - the case where it would be a derivative but for the initial investment being small, see CFM50280 . It must contain an embedded derivative whose underlying subject matter is shares (or units in a unit trust).

Where the conditions for application of the section are met, the contract is treated for tax purposes as it were bifurcated into a host loan relationship an embedded relevant contract, and the relevant contract is treated as meeting one of the conditions of CTA09/S591, and therefore falling outside of Part 7. CTA09/S592(2) then specifically provides that it is a chargeable asset. Thus an interest-like return is taxed in respect of the deemed host derivative and the deemed embedded share-like instrument taxed under chargeable gains rules.

Contracts to which S592 applies are unlikely to be seen outside of the life assurance industry, and detailed guidance is in the Life Assurance Manual.

History

The predecessor to S592, FA02/SCH26/PARA45M, was substantially amended by SI2006/3269, and this guidance applies only to instruments held on or after 30 December 2006 in an accounting period ending on or after that date.