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Clause 562: Contract to be loan relationship
1469. This clause treats the investment life insurance contract as a creditor relationship of the company for the loan relationship provisions. It is based on paragraph 2(1) and (2) of Schedule 13 to FA 2008.
1470. Subsections (3) and (4) provide that credits representing the excess of any lump sum payout on death, or the onset of critical illness, over the policy’s surrender value at that time are exempt from tax under the loan relationship rules.
Clause 563: Increased non-trading credits for BLAGAB and EEA taxed contracts
1471. This clause provides a special rule within the loan relationships legislation for company-held investment policies. It is based on paragraphs 3(1) to (3) and 4(1) of Schedule 13 to FA 2008.
1472. The rule applies where the contract is a BLAGAB contract or is subject to a comparable “EEA tax charge”. In general, such policies will simply follow the normal rules, but this clause recognises that in many cases the insurance company will have borne tax on the income and gains which are building up within the company in order to provide the benefits under the policy.
1473. This clause provides that where a company has to bring in a non-trading credit representing a profit from a related transaction, then that credit is increased and the amount of the increase is set off against corporation tax assessable on the company for the accounting period.
Clause 564: Section 563: interpretation
1474. This clause provides the meaning of “BLAGAB contract” and provides the conditions for when a relevant comparable EEA tax charge has applied. It is based on paragraph 3(4) to (6) of Schedule 13 to FA 2008.
Clause 565: Relevant amount where the relevant company uses fair value accounting
1475. This clause provides a special rule where the policy is accounted for on the basis of fair value accounting. It is based on paragraphs 3(3) and 4(1) to (4) of Schedule 13 to FA 2008.
1476. The rule ensures that the whole profit, and not just the credit calculated by reference to the opening fair value at the start of the accounting period of sale etc, is used in calculating the additional credit and giving relief for the whole of the relevant I minus E tax.
Clause 566: Introduction
1477. This clause introduces the following three clauses that deal with the charges on future gains of investment life insurance contracts that existed immediately before the beginning of the first accounting period of the company beginning on or after 1 April 2008. It is based on paragraphs 6(1), 7(1) and 8(1) of Schedule 13 to FA 2008.
1478. Although these clauses are transitional, they have been placed in the body of this Part, rather than in the Schedules, because those contracts will be the majority for some time.
1479. The part of paragraph 6(1) providing that there was a deemed surrender of the rights under the contract immediately before 1 April 2008 is spent and has not been rewritten.
Clause 567: Gains on deemed surrenders to be brought into account on related transactions
1480. This clause provides that gains that accrued as a result of that deemed surrender are brought into account in the accounting period in which there is a related transaction. It is based on paragraphs 6(2) to (4) of Schedule 13 to FA 2008.
1481. The deemed gain that is brought into account is apportioned where the company is still party to the contract after the related transaction.
Clause 568: Restriction on credits on old contracts: fair value accounting cases
1482. This clause applies where the company uses fair value accounting and the cost of the contract at the start of the first accounting period beginning on or after 1 April 2008 is greater than the fair value of that contract at that time. It is based on paragraph 7(1) to (3) of Schedule 13 to FA 2008.
1483. Subsequent credits are not brought into account until they exceed the amount by which cost exceeded fair value at the start of that period.
Clause 569: Restriction on debits on old contracts: non-fair value accounting cases
1484. This clause applies where the company does not use fair value accounting and the carrying value of the contract at the start of the first accounting period beginning on or after 1 April 2008 is greater than the fair value of that contract at that time. It is based on paragraph 8(1) and (2) of Schedule 13 to FA 2008.
1485. Subsequent debits are not brought into account until they exceed the amount by which that carrying value exceeded that fair value.
1486. This rule prevents amounts being brought into account where the drop in value of the policy occurred before the start of the initial period.
Part 7: Derivative contracts
Overview
1487. This Part deals with profits and losses arising to a company from its derivative contracts. It is based on Schedule 26 to FA 2002.
1488. In most cases, the company’s accounts treatment of its derivatives is followed in identifying and quantifying the credits and debits which make up profits and losses in respect of its derivative contracts for tax purposes.
1489. If the contract is held for the purposes of a company’s trade, credits and debits arising from it are treated as receipts and expenses in calculating the profits of the trade under Part 3 of this Bill. If it is not so held, the credits and debits are brought into account under Part 5 of this Bill (loan relationships) in determining whether the company has non-trading profits or a non-trading deficit from its loan relationships. But, in a number of cases (primarily if the underlying subject matter of the derivative contract is land or shares), credits and debits are instead treated as giving rise to chargeable gains or allowable losses for the purposes of TCGA.
1490. There are similarities between many of the core rules for derivative contracts and those for loan relationships. The arrangement and drafting of the provisions for such common rules in Parts 5 and 6 and this Part is matched so far as appropriate. There are also rules for the interaction of the two regimes if a loan relationship includes a derivative contract (see clause 700).
1491. Secondary legislation modifies the effect of these clauses. See in particular the Exchange Gains and Losses (Bringing into Account Gains or Losses) Regulations 2002 (SI 2002/1970), as amended, the Loan Relationships and Derivative Contracts (Disregard and Bringing into Account of Profits and Losses) Regulations 2004 (SI 2004/3256), as amended, and the Loan Relationships and Derivative Contracts (Change of Accounting Practice) Regulations 2004 (SI 2004/3271), as amended. The modifications in secondary legislation have not been rewritten in these clauses.
1492. The Part uses a number of defined terms. The more important are those in clauses 576 to 583 (meaning of “derivative contract” and other basic definitions) in Chapter 2, clause 596 (meaning of “related transaction”) in Chapter 3 and clauses 702 to 710 (other general definitions) in Chapter 13.
1493. Part 10 of Schedule 2 contains a number of transitional rules affecting the application of this Part. The commentary draws attention where relevant to particular paragraphs. But see particularly the paragraphs headed “contracts which became derivative contracts on 16 March 2005”, “contracts which became derivative contracts on 28 July 2005” and “plain vanilla contracts which became derivative contracts before 30 December 2006” which have more general effect.
Chapter 1: Introduction
Clause 570: Overview of Part
1494. This clause contains a brief description of the Part and includes a signpost to the key definition for the Part, that of “derivative contract”. It is new.
Clause 571: General rule: profits chargeable as income
1495. This clause provides that profits arising to a company from its derivative contracts are chargeable to corporation tax as income. It is based on paragraph 1(1) of Schedule 26 to FA 2002.
1496. Profits arising to a company from its derivative contracts are generally chargeable to corporation tax as income, even if they would otherwise be regarded as capital profits under accounting rules. But some such profits are charged instead to corporation tax as chargeable gains. Subsection (2) signposts this exception to the general rule.
1497. Profits are so chargeable “in accordance with this Part”. That is, this Part contains all the necessary rules for identifying and quantifying the amount to be charged to tax. These rules take priority over any rule that might otherwise apply. See in particular clause 699 (priority of this Part for corporation tax purposes).
Clause 572: Profits and losses to be calculated using credits and debits given by this Part
1498. This clause sets out how profits and losses from derivative contracts are calculated. It is based on paragraph 14(1) of Schedule 26 to FA 2002.
1499. The terms “credit” and “debit” are used in accounting practice. The Part operates by reference to accounts drawn up in accordance with generally accepted accounting practice (see clause 595 (general principles about the bringing into account of credits and debits)).
1500. Chapter 3 contains the main rules for finding the relevant credits and debits. Subsection (2) indicates that in some cases profits and losses are calculated using other factors (the clauses in question all give rise to amounts to be charged to corporation tax as chargeable gains).
Clause 573: Trading credits and debits to be brought into account under Part 3
1501. This clause provides for the treatment of credits and debits if the company is a party to the derivative contract for the purposes of a trade it carries on. It is based on paragraph 14(2) and (4) of Schedule 26 to FA 2002.
1502. Credits and debits are treated respectively as receipts and expenses of the company’s trade. Profits and losses in respect of the derivative contract are therefore charged under Part 3 (trading income).
1503. The provisions referred to in subsection (4) are those that would otherwise prevent a debit being taken into account as an expense of the trade.
1504. The provisions referred to in subsection (5) disapply this clause, either because the contract in question is taken outside the scope of this Part or because credits and debits are taken into account instead in computing chargeable gains.
Clause 574: Non-trading credits and debits to be brought into account under Part 5
1505. This clause provides for credits and debits to be brought into account under Part 5 (loan relationships) if clause 573 does not apply to them. It is based on paragraph 14(3) of Schedule 26 to FA 2002.
1506. Credits and debits are treated as non-trading credits and non-trading debits for the purposes of Part 5 and lumped in with any non-trading credits and non-trading debits arising on the company’s loan relationships to determine whether there is an amount to charge (or to relieve as a deficit) under that Part. Profits and losses in respect of such credits and debits arising from the derivative contract are therefore charged under Part 5.
1507. Subsection (3) has the same function for non-trading credits and debits as does clause 573(5) for trading credits and debits. The paragraphs in Part 10 of Schedule 2 headed “existing assets representing creditor relationships: options”, “existing assets representing creditor relationships: contracts for differences” and “disapplication of section 658” also disapply this clause.
Chapter 2: Contracts to which this Part applies
Clause 575: Overview of Chapter
1508. This clause describes the purpose and content of the Chapter. It is new.
Clause 576: “Derivative contract”
1509. This clause sets out the conditions under which a contract of a company is a derivative contract. It is based on paragraph 2(1) of Schedule 26 to FA 2002.
1510. The first condition, that it is a “relevant contract” (defined in clause 577), limits the application of the term “derivative contract” to contracts that derive their value from underlying subject matter (defined in clause 583) which is subject to changes in market prices or other factors.
1511. The second condition, that it meets the “accounting conditions” in clause 579, means that the contract either:
- is treated by the relevant accounting standards as a derivative or as a financial asset or liability; or
- has underlying subject matter within certain categories.
1512. The third condition, that clause 589 (contracts excluded because of underlying subject matter: general) or “any other provision of the Corporation Tax Acts” does not prevent it being a derivative contract, cuts down the scope of this Part, particularly in relation to contracts whose underlying subject matter is land or shares. Section 226(3) of FA 1994 (Lloyd’s underwriters: relevant contract forming part of a premium trust fund not to be a derivative contract) is an example of such another provision.
Clause 577: “Relevant contract”
1513. This clause defines the term “relevant contract”. It is based on paragraph 2(2) of Schedule 26 to FA 2002.
1514. In this Part, the term is used to refer generically to a contract within one of the three categories of contract listed here. In many contexts it is immaterial whether the relevant contract is an option, a future or a contract for differences.
1515. See also clauses 584 to 586, under which some of the rights and liabilities under a contract are themselves treated as a relevant contract. The deemed relevant contract is a derivative contract if it meets the other conditions in clause 576(1).
Clause 578: Relevant contracts of a company and being party to such contracts
1516. This clause explains what references in this Part to a company’s relevant contracts, or to a company being a party to such a contract, mean. It is based on paragraphs 2(2A) and 53(1) and (2) of Schedule 26 to FA 2002.
1517. A relevant contract is “of” a company if that company has entered into or acquired the contract. A reference to a company being a party to a contract means the company has entered into or acquired the contract.
1518. Subsection (2) explains what “acquires” means in relation to a contract for the purposes of this Part. The words “whether by assignment or otherwise” in the source legislation have not been reproduced as they add nothing.
Clause 579: The accounting conditions
1519. This clause sets out the conditions mentioned in clause 576(1)(b). It is based on paragraph 3 of Schedule 26 to FA 2002.
1520. Most derivative contracts meet the first of the conditions in subsection (1), that the relevant contract is treated for accounting purposes as a derivative. Subsections (3) and (5) explain when a relevant contract is treated for accounting purposes as a derivative. Financial Reporting Standard 25 (“FRS 25”) deals with the presentation of financial instruments in accounts.
1521. The second condition has two legs. The first covers a contract that does not meet a particular requirement of Financial Reporting Standard 26 (measurement in accounts of financial instruments) (“FRS 26”) that must be satisfied if the contract in question is to be treated as a derivative under FRS 25. Paragraph 9(b) of FRS 26 prescribes that the “financial instrument or other contract within the scope of this Standard.. requires no initial net investment or an initial net investment that is smaller than would be required for other types of contract that would be expected to have a similar response to changes in market factors”.
1522. The second leg of the second condition is that the contract is nevertheless treated for accounting purposes as a financial asset or financial liability. Subsections (4) and (5) have the same function in relation to the second condition as have subsections (3) and (5) in relation to the first condition.
1523. The third condition brings in contracts that fail the first or second condition but have underlying subject matter within one of the categories prescribed in subsection (2). If the underlying subject matter is commodities, it does not matter what category of relevant contract the contract is. But only a contract for differences can meet the condition by reference to the other prescribed categories of underlying subject matter. So an option or future whose underlying subject matter is one or more of the categories in subsection (2)(b) is only a derivative contract if it meets one of the other accounting conditions.
Clause 580: “Option”
1524. This clause defines the term “option”. It is based on paragraph 12(1), (8) and (10) of Schedule 26 to FA 2002.
1525. Subject to the non-exhaustive definition in subsection (1) and the limitation in subsection (2) (itself limited by subsection (3)), the word takes its ordinary meaning. “Warrant”, in subsection (1), is defined in clause 710 (other definitions).
1526. The limitation in subsection (2) excludes cash-settled options from the meaning of “option”. Contracts so excluded fall within the definition of contracts for differences and are therefore subject to the rules applying to relevant contracts generally and those applying specifically to contracts for differences.
1527. Subsection (4) lists a number of provisions that dispense with this limitation and so do not exclude cash-settled options from the meaning of “option” in that context.
Clause 581: “Future”
1528. This clause defines the term “future”. It is based on paragraph 12(1), (6), (7) and (10) of Schedule 26 to FA 2002.
1529. Subsections (3) and (4) exclude cash-settled futures from the scope of the definition in the same way that clause 580(2) and (3) does for cash-settled options in relation to the definition of “option”. Contracts so excluded also fall within the definition of contracts for differences.
Clause 582: “Contract for differences”
1530. This clause defines the term “contract for differences”. It is based on paragraph 12(1), (3), (4) and (5) of Schedule 26 to FA 2002.
1531. This is the broadest category of relevant contract and the definition is expressed initially in wide-ranging terms. Subsection (2) therefore excludes a number of categories of contract from the scope of the definition, in particular an option and a future, but also a loan relationship and a number of other types of financial instrument. Clause 710 has definitions of “contract of insurance” and “capital redemption policy”. For the meaning of “loan relationship”, see clause 302.
1532. Subsection (3) emphasises the wide-ranging nature of the indices or factors that may be designated in a contract for differences. The words in the source legislation “and, for those purposes, a numerical value may be attributed to any variation in a matter”, have not been rewritten as they add nothing. It is of the essence of any index or factor used in a contract for differences that it has such a numerical value.
Clause 583: “Underlying subject matter”
1533. This clause defines the term “underlying subject matter” for each category of relevant contract. It is based on paragraph 11 of Schedule 26 to FA 2002.
1534. Subsection (5) echoes clause 579(2)(b) in explaining that certain factors may be the underlying subject matter of a contract for differences. One of those factors is interest rates. Subsection (6) provides that interest rates are not regarded as the underlying subject matter of a contract for differences if such rates are only used incidentally in determining the variable amount of a payment due under the contract at a variable date. That is, in such a case an interest rate or rates are a factor in the operation of the contract but are not themselves what its outcome depends on.
1535. Subsection (7) applies to all categories of relevant contract. It stops certain types of property from being regarded as the underlying subject matter of the contract just because income from that property is included in that underlying subject matter. Contracts to which this provision applies are therefore, as regards this aspect of their underlying subject matter, not excluded as derivative contracts under clause 589.
Clauses 584 to 586: Cases where companies treated as parties to relevant contracts
Overview
1536. These three clauses treat certain rights and liabilities under a contract (an “embedded derivative”) as themselves constituting a relevant contract independent of the remaining rights and liabilities under the main contract. The deemed relevant contract is a derivative contract if it meets the conditions in clause 576(1)(b) and (c).
1537. All three cases cater for the provision in accounting standards for a financial or other instrument to be treated as divided between:
- the rights and liabilities that constitute one or more derivatives or one or more derivative financial instruments or equity instruments; and
- the remaining rights and liabilities under the instrument.
1538. All three cases provide for the deemed relevant contract to be treated as an option, future or contract for differences if that is what a contract having only the rights and liabilities of the deemed relevant contract would be. So references in this Part to an option, future or contract for differences include a reference to the deemed relevant contract unless the context requires otherwise. And provisions dealing with a “relevant contract” or “derivative contract” apply to an embedded derivative that is treated as a relevant contract or qualifies as a derivative contract unless the context requires otherwise.
1539. A number of provisions in this Part make special provision for one or other category of embedded derivative (see in particular Chapters 7 and 8 (chargeable gains arising in relation to derivative contracts)).
Clause 584: Hybrid derivatives with embedded derivatives
1540. This clause treats a relevant contract divided in accordance with generally accepted accounting practice between one or more embedded derivatives and a host contract as a number of relevant contracts for the purposes of this Part. It is based on paragraph 2B of Schedule 26 to FA 2002.
1541. It applies if a relevant contract that is not itself a derivative for accounting purposes is so divided into one or more embedded derivatives and the remaining rights and liabilities (“the host contract”) which by themselves amount to a relevant contract.
1542. The host contract is also treated as a relevant contract with the same consequences as for the embedded derivative (in this respect, this clause differs from its two successors).
1543. A relevant contract which may be treated as containing such deemed relevant contracts is called a “hybrid derivative” (subsection (4)). Subsection (5) lists the provisions which apply in relation to a hybrid derivative.
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