CFM55310 - Holders of convertible or share-linked securities: tax treatment of share-linked securities: example
This example concerns a company which bifurcates a loan asset under IAS 39 or FRS 26. Bifurcation is not permitted for financial assets under FRS 102 (unless IAS 39 is applied) or IFRS 9. For further details of the accounting permutations see {CFM52215}.
Chargeable gains treatment: example
Example 1
A Ltd lends £1million to B Ltd for 3 years at 5 per cent interest. The amount required to redeem the security is the £1million issue price uplifted or reduced by the full percentage change in the value of the ordinary shares in B Ltd’s parent company, X Plc. A Ltd applies IAS 39 and is required to account separately for the loan and the derivative (CFM37640). Using round figures for convenience, suppose it allocated an initial fair value of £50,000 to the contract for differences, and thus £950,000 to the loan.
Suppose that on the issue and redemption dates X Plc’s shares are worth £20 and £30 respectively, representing a percentage increase of 50%. The security therefore redeems for £1.5million.
Loan relationship
A Ltd accounts for the loan as acquired at a discount of £50,000 to its nominal £1million value, accruing credits for the discount over the 3 year term. Because this accords with GAAP, CTA09/S307(2) brings the discount credits into account as taxable loan relationships credits. These are in addition to credits for the interest receivable.
Embedded derivative: accounting treatment
A Ltd’s accounts must recognise any changes in the fair value of the embedded contract for differences at each balance sheet date. Its value at any one time will reflect changes in the value of the X Plc shares, but also other factors such as how long the contract has left to run. Suppose it considers its fair value to be:
| DATE | FAIR VALUE |
|---|---|
| 1 January 2007 | £50,000 (at initial bifurcation) |
| 31 December 2007 | £40,000 |
| 31 December 2008 | £350,000 |
| 31 December 2009 | £500,000 |
A Ltd will respectively bring in a debit of £10,000, a credit £310,000 and a credit of £150,000 for the 3 years to 31 December 2009.
Embedded derivative: tax treatment: CTA09/S641 and S648
The above debits and credits are taxable under the derivative contracts rules of CTA09/PART7. Because the contract meets all the conditions at CFM55290, the normal income treatment of non-trading debits and credits is disapplied. They are converted into chargeable gains, or allowable losses, for the periods in which they arise.
If A Ltd is unable to use the £10,000 allowable loss for the period to 31 December 2007 it may claim to carry it back for a period of up to 24 months, see CFM55040 for the detailed rules.