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Clause 640: Credits and debits not to be brought into account under Part 5
1762. This clause disapplies clause 574 to “relevant credits and debits” in respect of a derivative contract to which one of the provisions listed in subsection (2) applies. It is based on paragraph 45A(1) and (2) of Schedule 26 to FA 2002.
Clause 641: Derivative contracts to be taxed on a chargeable gains basis
1763. This clause treats a chargeable gain or allowable loss as arising in respect of a contract to which one of the provisions listed in subsection (2) applies. It is based on paragraph 45A(1), (4) and (5) of Schedule 26 to FA 2002.
1764. Whether there is such a gain or loss depends on whether the relevant credits arising in respect of the contract exceed such relevant debits or those debits exceed those credits.
Clause 642: Exception from section 641
1765. This clause provides an exception to the general rule in clause 641 for a contract to which clause 645 (embedded derivatives in a creditor relationship that are options) applies if a condition is met. It is based on paragraph 45A(4) and (6) of Schedule 26 to FA 2002.
1766. The condition is that paragraph 2 of Schedule 7AC to TCGA would apply to a gain arising on the disposal of the option represented by the rights and liabilities under the embedded derivative. Schedule 7AC to TCGA provides exemptions from the charge to corporation tax on chargeable gains for disposals of a company’s substantial shareholdings in another company. Paragraph 2 of that Schedule extends the exemption to most disposals of assets relating to shares if a disposal of the shares themselves would qualify for exemption.
1767. The condition applies on the assumptions given in subsection (2), which deem the embedded derivative to be a separate contract that is an option which is disposed of at the end of the accounting period in question and the disposal results in a gain.
Clause 643: Contracts relating to land or certain tangible movable property
1768. This clause sets out the type of derivative contract it applies to (so that clause 641 may then apply to credits and debits in respect of the contract). It is based on paragraph 45C(1) and (4) of Schedule 26 to FA 2002.
1769. As with a number of similar clauses in this Chapter which define the derivative contracts to which they apply, condition B in subsection (3) is that the company does not hold the derivative contract for the purposes of a trade it carries on. This subsection does not rewrite the disapplication of the condition to life assurance and mutual trading companies that is provided by paragraph 45C(2) of Schedule 26 to FA 2002. That disapplication is obsolete by virtue of the rules in clauses 633 and 634.
1770. Condition C, in subsection (4), an equally common element in such clauses, is that the company in question is not an “excluded body”. That term is defined in clause 706 for the purposes of this Part and refers to various types of collective investment scheme.
1771. Condition A, in subsection (2), is the distinguishing characteristic of this type of derivative contract. The underlying subject matter of the contract is either or both of land and certain tangible movable property. Subsection (5) contains a signpost to an additional rule in clause 644 that modifies what the underlying subject matter of the contract is taken to consist of.
Clause 644: Income to be left out of account in determining whether section 643 applies
1772. This clause provides for underlying subject matter that is income from property of the type or types mentioned in condition A in clause 643 to be disregarded in determining whether that condition is met. It is based on paragraph 45C(5) and (6) of Schedule 26 to FA 2002.
1773. This clause is substantially similar to clause 590, which performs the same function in relation to the definition of “excluded property” in clause 589.
Clause 645: Creditor relationships: embedded derivatives which are options
1774. This clause sets out the type of derivative contract it applies to (so that clause 641 may then apply to credits and debits in respect of the contract). It also disapplies a chargeable gains provision in TCGA. It is based on paragraphs 12(1) and (11A) and 45D(1), (2), (3), (8) and (9) of Schedule 26 to FA 2002.
1775. Condition C in subsection (4) sets out the main distinguishing characteristic of the type of derivative contract to which this clause applies. It is that the underlying subject matter of the contract is “qualifying ordinary shares” (broadly, fully participating shares in a listed company, holding company or trading company) or “mandatorily convertible preference shares” (shares that have to be converted into qualifying ordinary shares within 24 hours of acquisition).
1776. Subsection (7) provides that the creditor relationship, by virtue of which there is a deemed derivative contract to which this clause applies, is itself not treated as a “qualifying corporate bond” although section 117(A1) of TCGA would otherwise treat it as such. That section defines a qualifying corporate bond as “any asset representing a loan relationship of a company”. This subsection effectively switches off for the creditor relationship those provisions in TCGA or elsewhere that apply to qualifying corporate bonds.
1777. Condition D, in subsection (5), does not rewrite the disapplication of the condition to life assurance and mutual trading companies that is provided by paragraph 45D(3) of Schedule 26 to FA 2002. That disapplication is obsolete by virtue of the rules in clauses 633 and 634.
1778. See also Part 10 of Schedule 2 which disapplies this clause and applies other rules if the asset representing the creditor relationship is an asset in relation to which paragraph 9(2) of Schedule 10 to FA 2004 has effect.
Clause 646: Exclusions from section 645
1779. This clause makes two exclusions from the scope of clause 645. It is based on paragraph 45E(1), (3) and (4) and 12(11C) of Schedule 26 to FA 2002.
1780. The exclusions apply in circumstances where the holder is not sharing in the equity risk that is a part of the creditor relationship in which the derivative contract is an embedded derivative. The circumstances are where the holder of the deemed derivative contract may get a predetermined cash amount (condition A) or where cash payable instead of the shares differs significantly from the value of the shares (condition B).
Clause 647: Meaning of certain expressions in section 645
1781. This clause provides definitions of “mandatorily convertible preference shares” and “qualifying ordinary shares” for the purposes of clause 645 and contains signposts to other relevant definitions. It is based on paragraph 45D(4), (5), (6) and (7) of Schedule 26 to FA 2002.
1782. “Shares” is defined in clause 710. “Recognised stock exchange”, in condition B of the definition of “qualifying ordinary shares”, has the meaning given by section 841 of ICTA.
Clause 648: Creditor relationships: embedded derivatives which are exactly tracking contracts for differences
1783. This clause sets out the type of derivative contract it applies to (so that clause 641 may then apply to credits and debits in respect of the contract). It also disapplies a chargeable gains provision in TCGA. It is based on paragraphs 12(1) and (11A) and 45F(1), (2), and (8) of Schedule 26 to FA 2002.
1784. Condition C, in subsection (4), and condition D, in subsection (5), set out the distinguishing characteristics of this type of derivative contract. They are that the underlying subject matter of the contract is qualifying ordinary shares listed on a recognised stock exchange and that the derivative contract is an “exactly tracking contract”.
1785. “Exactly tracking contract” is defined in clause 649(2) by reference to a formula. Such a contract is one under which the amount to be paid to discharge the rights and liabilities under the contract varies according to a percentage figure applied to the cost of the asset representing the creditor relationship when that asset comes into existence. The percentage figure is equal to the movement in the value of the assets (that is, the listed shares) which are the underlying subject matter of the contract (or an index of that value). The period over which the movement in the value of the assets is tracked is the period from when the asset representing the creditor relationship came into existence to the date the corresponding debtor relationship comes to an end. (Paragraph (b) of clause 649(3) provides a minor amount of leeway in measuring that period for the case where a valuation date in respect of the assets in question is not exactly coterminous with either the beginning or end of the period.) In such a case, the discharge amount tracks the value of those assets exactly.
1786. Condition E, in subsection (6), does not rewrite the disapplication of the condition to life assurance and mutual trading companies that is provided by paragraph 45F(3) of Schedule 26 to FA 2002. That disapplication is obsolete by virtue of the rules in clauses 633 and 634.
1787. Subsection (8) provides that that creditor relationship is itself not treated as a “qualifying corporate bond” although section 117(A1) of TCGA would otherwise treat it as such. See the commentary on the similar provision in clause 645(7).
1788. Subsection (9) contains a signpost to clause 672, which modifies the rules for acquisition costs in section 38 of TCGA if the asset representing the creditor relationship mentioned in this clause is disposed of.
1789. See also Part 10 of Schedule 2 which disapplies this clause and applies other rules if the asset representing the creditor relationship is an asset in relation to which paragraph 11(2) of Schedule 10 to FA 2004 has effect.
Clause 649: Meaning of certain expressions in section 648
1790. This clause provides definitions for the interpretation of clause 648. It is based on paragraph 45F(4), (5), (6) and (7) and 12(11C) of Schedule 26 to FA 2002.
1791. See the commentary on clause 648 in relation to the meaning of “exactly tracking contract”.
1792. “Shares” is defined in clause 710.
Clause 650: Property based total return swaps
1793. This clause sets out the type of derivative contract it applies to (so that clause 641 may then apply to credits and debits in respect of the contract). It is based on paragraph 45G(1) and (1A) of Schedule 26 to FA 2002.
1794. Conditions A to D, in subsections (2) to (5), set out the distinguishing characteristics of this type of derivative contract. It is, first, a contract for differences whose underlying subject matter includes interest rates (in addition to other underlying subject matter). Second, one or more indices are specified in the contract including an index of changes in the value of land (a “capital value index”).
1795. Condition E, in subsection (6), does not rewrite the disapplication of the condition to life assurance and mutual trading companies that is provided by paragraph 45G(1B) of Schedule 26 to FA 2002. That disapplication is obsolete by virtue of the rules in clauses 633 and 634.
1796. By virtue of the special meaning of “relevant debits and credits” in this clause, provided by clause 659(3), only part of the credits and debits found under clause 595 is brought into account under clause 641 as a chargeable gain or allowable loss.
Clause 651: Credits and debits not to be brought into account under Part 3 or Part 5
1797. This clause disapplies clause 573 to “relevant credits and debits” from a derivative contract to which one of the provisions listed in subsection (2) applies. It is based on paragraphs 45J(3) and 45K(3) of Schedule 26 to FA 2002.
Clause 652: Introduction to sections 653 to 655
1798. This clause sets out the type of derivative contract it applies to (so that clause 653, 654 or 655 may then apply in respect of the contract). It is based on paragraphs 12(1) and (11A) and 45J(1), (2), and (10) of Schedule 26 to FA 2002.
1799. It applies to a derivative contract that comprises the rights and liabilities treated by clause 585 as a relevant contract, because of a debtor relationship of the company, if that relevant contract is also treated as an option by that clause. For the purposes of this clause, the definition of “option” in clause 580 is shorn of its usual limiting conditions (that a cash-settled option is not an option).
1800. The paragraph “issuers of securities with embedded derivatives: deemed options” in Part 10 of Schedule 2 disapplies the rules in clauses 653 and 655, and modifies the application of the rule in clause 654 if the company was a party to the debtor relationship before its first accounting period to begin on or after 1 January 2005.
1801. For other rules that apply if a company is a party to an embedded derivative because of a debtor relationship of the company and the embedded derivative is treated as an option, see clauses 665 and 666 in Chapter 8. They apply if the embedded derivative is an equity instrument and the company pays an amount to the creditor in the loan relationship in discharge of obligations under the relationship.
Clause 653: Shares issued or transferred as a result of exercise of deemed option
1802. This clause determines for the purposes of section 144(2) of TCGA the value of the consideration given for the option represented by the derivative contract within clause 652 if shares are issued or transferred as a result of the exercise of the option. It is based on paragraph 45J(3), (4A) and (5) of Schedule 26 to FA 2002.
1803. Section 144(2) of TCGA treats the grant of an option and the transaction under which the grantor fulfils the obligation under the option as a single transaction. The consideration for the option is regarded as part of the consideration for the sale. This clause determines the amount of the consideration for the grant of the option for the purposes of that section. It does so by reference to the carrying value of the option at the time the company became a party to the relevant debtor relationship. “Carrying value” is defined in clause 702.
1804. The source legislation for this rule, paragraph 45J(5)(a) of Schedule 26 to FA 2002, refers to “the amount treated in accordance with section 94A(2) of the Finance Act 1996 as the carrying value of the option”. That section makes no direct reference to the carrying value of any item. But paragraph 50A(3B) of Schedule 26 to FA 2002 refers to that section in the course of setting out what the carrying value of a contract is. That reference is rewritten in clause 702, but in terms of clause 585. It would be superfluous to add any such reference to the present clause, so the words “in accordance with section 94A(2) of the Finance Act 1996” have not been rewritten here.
Clause 654: Payment instead of disposal on exercise of deemed option
1805. This clause provides for a chargeable gain or allowable loss in the same circumstances as those applying in clause 653, except that an amount is paid in fulfilment of the company’s obligations under the debtor relationship (and there is no issue or transfer of shares). It is based on paragraphs 12(1) and (11B) and 45J(3), (6), (7), (8) and (9B) of Schedule 26 to FA 2002.
1806. In a number of circumstances it may suit one or other or both parties to a debtor relationship containing an option for the issue or transfer of shares not to go ahead when the option is exercised. Instead the matter is settled by a monetary payment. Such a cash settlement would fall foul of the limiting conditions in the definition of an “option” in clause 580, so those conditions are disapplied for the purposes of the present clause by clause 652.
1807. There is a chargeable gain if the carrying value of the derivative contract at the time the company became a party to the debtor relationship exceeds the amount paid in fulfilment of the company’s obligations under the debtor relationship. For this purpose that amount is first reduced, but not below nil, by the fair value of the host contract at the time the option is exercised. But if that amount (as so reduced) exceeds that carrying value, an allowable loss arises. The gain or loss, as the case may be, is the amount of the excess.
Clause 655: Ceasing to be party to debtor relationship when deemed option not exercised
1808. This clause deems there to be an acquisition and disposal of an asset for the purposes of corporation tax on chargeable gains if a company ceases to be a party to a debtor relationship within clause 652 at a time when the option has not been exercised. It is based on paragraphs 12(1) and (11B) and 45J(3), (8), (9), (9A) and (9B) of Schedule 26 to FA 2002.
1809. A company may cease to be a party to a debtor relationship by redeeming or repaying the liability in question or by some other means (such as assigning the rights and liabilities under the relationship).
1810. Subsection (2) treats the company as having acquired an asset for consideration equal to the amount paid to cease to be a party to the relationship. It also treats the company as having disposed of that asset for consideration equal to the carrying value of the relationship when acquired. But the carrying value is first reduced, as in respect of clause 654, by the fair value of the host contract at the time the option was acquired. The deemed disposal may give rise to a chargeable gain or allowable loss.
Clause 656: Introduction to section 658
1811. This clause sets out the type of derivative contract it applies to (so that clause 658 may then apply in respect of the contract). It is based on paragraphs 12(1) and (11A) and 45K(1) and (2) of Schedule 26 to FA 2002.
1812. Subsection (3)(b) provides that this clause does not apply to a derivative contract that falls within clause 652. The definition of “option” in clause 580 is shorn for the purposes of that clause of its usual limiting conditions (by virtue of which a cash-settled option is not an option). A contract which is an option under the modified definition is a contract for differences and would otherwise fall also within this clause.
1813. The distinguishing characteristic of this clause, condition C in subsection (4), is that the derivative contract is an “exactly tracking contract”, as defined in clause 657. That term has a similar meaning to that in clause 648, as defined in clause 649. But what is being tracked here is the amount regarded in accordance with generally accepted accounting practice as the proceeds of issue of the liability which represents the debtor relationship in this case. And, as this clause deals with a debtor relationship (while clause 648 deals with a creditor relationship), the period over which the tracking takes place is measured from the date the liability representing the debtor relationship begins to the date the corresponding creditor relationship ends.
Clause 657: Meaning of “exactly tracking contract” in section 656
1814. This clause defines “exactly tracking contract” for the purposes of clause 656. It is based on paragraph 45K(2A), (2B) and (2C) of Schedule 26 to FA 2002.
Clause 658: Chargeable gain or allowable loss treated as accruing
1815. This clause provides for a chargeable gain or allowable loss to arise when a debtor relationship within clause 656 comes to an end if an amount is paid to discharge a company’s obligations under that relationship. It is based on paragraphs 12(1) and (11B) and 45K(3), (3A) and (3B) of Schedule 26 to FA 2002.
1816. The gain or loss is calculated on the assumptions that:
- there is a disposal of an asset which is the contract for differences in clause 656;
- the cost of that asset is the amount paid to discharge the company’s obligations; and
- the consideration for the disposal is the amount of the proceeds of the issue of the security representing the debtor relationship (or, if the company became a party to that relationship at a time after it was created, the carrying value of the host contract at that time).
1817. See the paragraph headed “disapplication of section 658” in Part 10 of Schedule 2 which applies if the liability representing the debtor relationship was owed by the company immediately before its first accounting period to begin on or after 1 January 2005.
Clause 659: Meaning of “relevant credits” and “relevant debits”
1818. This clause provides the meaning of “relevant credits” and “relevant debits” for the purposes of this Chapter. It is based on paragraphs 45A(3), 45G(2), (3) and (4), 45J(3) and 45K(3) of Schedule 26 to FA 2002.
1819. For all but one case the meaning is the same as that of credits and debits within clause 595(3) and (4).
1820. The exception is the meaning of the terms in the case of a derivative contract to which clause 650 (property based total return swaps) applies. For the purposes of clause 641, as it applies to derivative contracts within clause 650, the credits and debits found by clause 595(3) and (4) are relevant credits and debits only to the extent they are also amounts found by applying the calculation formula in subsection (4).
1821. Clause 650 applies to contracts for differences in which there is a specified “capital value index” (see the commentary on that clause). Subsection (4) finds an amount of credits and debits by calculating the percentage change (“R%”) in the value of that index over the relevant accounting period (or part of that period, if the company is not a party to the contract throughout) and applying R% to the “notional principal amount”. That term is not defined but is used in relation to derivative contracts to describe the notional amount of capital by reference to which payments are due between the parties to the contract (see the reference to interest rates in condition D in clause 650).
1822. The R% x N rule may give a credit but the accounts show a debit, or may give a larger credit (or debit) than the accounts credit (or debit). See the example in paragraph CFM13540a of HMRC’s Corporate Finance Manual.
Chapter 8: Further provision about chargeable gains and derivative contracts
Clause 660: Contract relating to holding in OEIC, unit trust or offshore fund
1823. This clause provides for a chargeable gain or allowable loss to arise when a company ceases to be a party to a relevant contract that is treated as a derivative contract because of clause 587. It is based on paragraph 37(1), (2), (3) and (5) of Schedule 26 to FA 2002.
1824. Clause 587 applies if the underlying subject matter of a relevant contract is an interest in a collective investment scheme and that scheme fails to meet a “qualifying investments test” in the relevant accounting period. The relevant contract is treated as a derivative contract for that accounting period and later periods.
1825. Clause 602 provides for value to be attributed to the deemed derivative contract by reference to its market value when it is so deemed. Clause 601 sets out the credits and debits to be brought into account for the purposes of this Part.
1826. This clause deals with the profit and loss latent in the contract immediately before it is deemed to be a derivative contract. It applies if the contract was then a “chargeable asset”. That term is defined in clause 703 as an asset on whose disposal any gain would be a chargeable gain for the purposes of corporation tax on chargeable gains. The charge on that accrued gain or loss is in effect deferred until the company ceases to be a party to the contract.
1827. The consideration for the disposal equals any value given to the relevant contract in the company’s accounts for the period immediately preceding that in which it is deemed to be a derivative contract. This value may be the same as or different from that found under clause 602.
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