SAIM2780 - Disguised interest: excluded shares: what are 'relevant arrangements'?

Relevant arrangements

Relevant arrangements are arrangements entered into by any person after issue of the share where it is reasonable to assume that the main purpose, or one of the main purposes of the arrangements, is to secure a return that is economically equivalent to interest.

Whether or not, after the issue of the share, an arrangement is entered into for the purpose of securing a return that is economically equivalent to interest will depend on the facts of the case. It is likely to include cases where, for example, the holder of the share enters into a derivative which has the effect of reducing exposure to the volatility of the underlying portfolio of assets held by the company.

It will not include the mere sale and purchase of such shares on a secondary market. Nor will it include the case where the return from a share becomes virtually guaranteed through the strong performance of its investment portfolio alone.

Normal commercial management of the portfolio by the fund manager of an investment company will be within the exemption. These will include temporarily investing in lower risk assets, temporarily hedging the portfolio to protect the capital value of the investments for the benefit of the shareholders, and liquidation of the portfolio and holding the disposal proceeds temporarily in cash or short-dated instruments in preparation for redemption or winding up.

However, see the last paragraph below on circumstances in which investment risk is removed from the portfolio. This applies equally to shares issued before or after April 2013.

Shares issued before 6 April 2013

The tax treatment of most shares issued before 6 April 2013 will be grandfathered.

A share admitted to trading on a regulated market before 6 April 2013 where the portfolio is exposed to investment risk will be within the exemption, even where through strong investment performance the return at redemption is virtually guaranteed, providing no relevant arrangement has been entered into after 6 April 2013.

However, where a fund manager makes a long-term and strategic change to the investment strategy to remove all investment risk from the portfolio to ensure that, in effect, the shareholder receives an interest-like return with no risk of capital loss, the share may be caught by the disguised interest provisions. The company has entered into a relevant arrangement, one of the main purposes of which is to ensure that the return on the share is virtually guaranteed. The key test in such a case is the extent to which the shareholder has ceased to be exposed to the risks and rewards of underperformance in the underlying portfolio of assets.