CFM52590 - Derivative contracts: embedded derivatives: index-linked gilts

CTA09/S623

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.

Derivatives treated for accounting purposes as embedded in index-linked gilts

S623 applies where, in a period of account beginning on or after 1 January 2005,

• the index-linked component of an index-linked gilt-edged security is regarded for accounting purposes as an embedded derivative,
• it is not regarded as closely related to the host contract, so that it is accounted for separately, and for the purposes of Part 7 it is a contract for differences, and
• credits and debits on the host contract are non-trading credits or debits, in other words the gilt is not held as trading stock.

Note that such accounting treatment would not arise under FRS102 (unless IAS 39 is applied) or IFRS9.

‘Index-linked gilt-edged security’ has the same meaning as in CTA09/S399 (CFM37100).

In such a case, CTA09/S415 will apply to the holder. For tax purposes, the gilt will be treated as a creditor loan relationship plus a contract for differences, and the latter will come within Part 7. S623 provides that credits or debits on the contract for differences are not brought into account, thereby preserving the tax exemption for the index-linked element of the return from index-linked gilts.

Even where IAS39 is applied in a company’s financial statements, cases in which S623 applies will be rare, however. Most companies holding index-linked gilts will not account separately for the embedded derivative, since the inflation linked element will be regarded as closely related (to interest, in its wider accounting sense, which would normally be expected to arise on a debt security). The tax treatment will be that given by CTA09/S399. S623 will then not be in point.