CFM55470 - Derivative contracts: issuers of convertible or share-linked securities: securities containing CFDs

CTA09/S656-658

Deemed CFDs

S658 applies to issuers of the same kind of instruments as come within S648 for holders, in effect, share-linked securities (CFM55210). For an overview of the accounting and taxation of hybrid securities refer to CFM25000+ and CFM37600+.

Under IAS 39 and IFRS 9 (and previously under FRS 26), the accounting standards will normally require the company to bifurcate the ‘contract for differences’ (CFD) and measure it at its fair value at each balance sheet date. Accounting credits and debits in respect of the embedded derivative may therefore arise in each period of account. See the example at CFM37650.

Where the issuer of an asset-linked security accounts separately for the loan and derivative in this way:

  • CTA09/S585 provides for the derivative element to be taxed under the derivative contracts rules of CTA09/PT7.
  • Similarly, CTA09/S415 treats the company as party to a loan relationship whose liabilities consist only of those of the “host contract” from which the equity element has been separated.

Under the derivative contracts rules, debits and credits arising from a CFD are normally brought into account as income. However, S658 applies instead to a derivative contract of a company for an accounting period where the relevant conditions are satisfied (see below).

Non-bifurcated instruments

Note that bifurcation into a debt host and embedded derivative is not required under IAS 39 and IFRS 9 where the whole instrument is measured at fair value. Also, bifurcation is not permitted under FRS 102 unless the company chooses to apply the recognition and measurement requirements of IAS 39 or IFRS 9.

Where the instrument is not bifurcated then S656-S658 do not apply.

Conditions

Section 658 applies to a derivative contract of a company for an accounting period if all of the following conditions, set out in S656, are met:

  • Condition A: The contact is a relevant contract to which the company is treated as a party under S585(2) because of a debtor relationship of the company (so it applies to issuers).
  • Condition B: The contract is treated as a CFD by S585(3) and is not within S652.
  • Condition C: The contract is an ‘exactly tracking contract’, as defined under S657. See CFM55480 for an explanation of ‘exactly tracking’ and example.
  • Condition D: The USM of the contract is shares.
  • Condition E: at the time when the company became a party to the debtor relationship it was not carrying on a banking business or a business as a securities house, or if it was carrying on such a business, it did not become a party to the debtor relationship in the ordinary course of that business.
  • Condition F: The company must not be an authorised unit trust, an investment trust, an open-ended investment company or a venture capital trust (these are ‘excluded bodies’ as defined under CTA09/S706).

Treatment

Where the above conditions are met, the normal rules for bringing amounts into account as income (S573 and S574) do not apply to the relevant credits and debits. Instead, S658 taxes/allows a normal CG gain/loss on the discharge of the company’s obligations under the original relationship. It treats the embedded CFD as if it were an asset. The disposal proceeds are the proceeds from the issue of the original relationship the whole security, and the cost is the amount to discharge the obligations of the whole security. So there is a one-off chargeable gain or allowable loss in the period in which the debtor relationship comes to an end.

If the contract is not an ‘exactly tracking contract’, the normal rules in CTA09/PT7 apply for the issuer, as for the holder; amounts are taken into account as income items in accordance with S571.

Historic position

For the periods beginning on or after 1 January 2005 and ending before 16 March 2005, capital gains treatment was denied where the derivative contract was one to which any of FA02/SCH26/PARAS 6 to 8 applied. These paragraphs were repealed for accounting periods ending on or after 16 March 2005.