Clause 661: Contract which becomes derivative contract

1828.     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, not having been a derivative contract, became a derivative contract. It is based on paragraph 43A(1), (2), (4) and (5) of Schedule 26 to FA 2002.

1829.     There are a number of ways in which a relevant contract that was not a derivative contract may become one. For example, if the terms of the contract change (without creating a new contract) in such a way that the accounting conditions in clause 579 are now met, the contract may become a derivative contract. Or it may be that the contract no longer meets the “excluded property” rule in clause 589 by virtue of which it was not a derivative contract. See for example the circumstances described in the paragraph “contracts which became derivative contracts on 16 March 2005” in Part 10 of Schedule 2.

1830.     If this clause applies, it operates similarly to clause 660. Again, bringing into account the gain or loss latent in the relevant contract (which is also a chargeable asset) is deferred until the company ceases to be a party to the relevant contract.

1831.     “Notional carrying value” has the same meaning as in clause 622(4), that is, the carrying value the contract would have had in the books of the company had a period of account ended immediately before the deemed disposal. See the commentary on that clause as regards the use of “period of account” rather than “accounting period” in that definition.

1832.     See also the paragraph headed “disapplication of section 661” in Part 10 of Schedule 2 which applies if the relevant contract became a derivative contract before 30 December 2006.

Clause 662: Contracts ceasing to be derivative contracts

1833.     This clause provides that, if a relevant contract to which the company continues to be a party ceases to be a derivative contract, the company is treated as acquiring the contract for an amount equal to its notional carrying value at the time it ceases to be a derivative contract. It is based on paragraph 43B of Schedule 26 to FA 2002.

1834.     This clause is the companion to clause 622 which deals with the deemed disposal of the relevant contract for the purposes of this Part at the time it ceases to be a derivative contract. See the commentary on that clause.

Clause 663: Contracts to which section 641 applies

1835.     This clause provides that, if a company makes a claim, allowable losses deemed to arise for an accounting period may be carried back and set against chargeable gains deemed to arise in accounting periods in the previous 24 months. It is based on paragraph 45B(1), (2) and (3) of Schedule 26 to FA 2002.

1836.     The gains and losses deemed to arise are those given by clause 641 (chargeable gains basis substituted for income basis in charging credits and debits from certain types of derivative contract).

1837.     The gains eligible for relief in an earlier period are the total clause 641 gains for that period less the total of allowable losses under that clause for that period. Those gains are further reduced by any other allowable losses for that period so far as those other allowable losses could not be deducted, within the meaning of section 8(1) of TCGA, from other chargeable gains. That is, any allowable losses for the purposes of corporation tax on chargeable gains, other than losses under clause 641, are notionally deducted from the clause 641 gains if they cannot be set against any chargeable gains, other than gains under clause 641, to find the amount of gains against which the losses carried back under this clause can be set. The amount found under this rule is called “net section 641 gains”.

1838.     Subsection (3) provides that, to the extent the losses for a period are carried back and relieved under this clause, they are used up and cannot otherwise be relieved under the provisions for corporation tax on chargeable gains by set off or carry forward.

Clause 664: Meaning of certain expressions in section 663

1839.     This clause provides the meaning of some terms used in clause 663. It is based on paragraph 45B(4), (5), (6), (7) and (8) of Schedule 26 to FA 2002.

Clause 665: Introduction to section 666

1840.     This clause sets out the type of contract it applies to for the purposes of the relief provided by clause 666. It is based on paragraphs 12(1) and (11A) and 45JA(1), (2) and (5) of Schedule 26 to FA 2002.

1841.     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).

1842.     “Equity instrument” is defined in clause 710 as having the meaning it does for accounting purposes. (See the commentary on clause 585 for further detail.)

1843.     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 652 to 655 in Chapter 7. They apply if the underlying subject matter of the embedded derivative is shares.

Clause 666: Allowable loss treated as accruing

1844.     This clause deems there to be an allowable loss for the purposes of corporation tax on chargeable gains if a company pays an amount to discharge obligations under the debtor relationship to which clause 665(2) refers. It is based on paragraphs 12(1) and (11B) and 45JA(3) and (4) of Schedule 26 to FA 2002.

1845.     The allowable loss equals any excess of that payment (as first reduced by the fair value of the host contract at that time) over the carrying value of the equity instrument that is treated as a derivative contract under clause 585 as at the time the company became a party to the debtor relationship.

1846.      “Fair value” is defined in clause 710.

1847.     The definition of “B” in subsection (2) does not rewrite the words “in accordance with section 94A(2) of the Finance Act 1996” for the same reasons as given in the commentary on clause 653.

1848.     See also the paragraph headed “disapplication of section 666” 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 667: Shares acquired on exercise of non-embedded option

1849.     This clause and the next modify the amounts otherwise allowable as acquisition costs under section 38 of TCGA on the disposal of shares acquired under an option or future. This clause deals with shares acquired as the result of the exercise of rights under an option. It is based on paragraph 45HA(1), (2) and (3) of Schedule 26 to FA 2002.

1850.     This clause applies only if the derivative contract is a “plain vanilla contract” (defined in clause 708). That is, it does not apply to the exercise of rights within rights and liabilities treated as a derivative contract under clause 584, 585 or 586. Although the provision normally operates on the terminal exercise of the option, it is theoretically possible for it to apply to each instalment of a staged exercise of the option. Paragraph (e) of subsection (1) is therefore in terms of the exercise of “any of” the rights under the option.

1851.     Subsection (2) provides for allowable acquisition costs under section 38(1)(a) of TCGA to be increased (or reduced) when there is a disposal of the shares acquired as a result of the exercise of rights under the option. The increase or reduction in effect reverses the earlier treatment of credits and debits in respect of the option, so far as referable to the shares which were the subject of the option, as non-trading credits and debits for the purposes of Part 5 (loan relationships).

1852.     Subsection (2) also provides that, if there is only a part disposal of those shares, section 42(2) of TCGA applies. That provision deals with the calculation of costs allowable under section 38 of TCGA if there is a part disposal of an asset. It uses an A divided by A+B formula which takes into account the consideration for the part disposal (“A”) and the value of the remainder of the asset (“B”).

1853.     Clause 669 sets out the amount of the credits and debits to be used in calculating the amount of the adjustment to expenditure allowable under section 38 of TCGA.

1854.     In a case where the adjustment reduces allowable expenditure and exceeds the amount that can be so reduced, the excess reduction is instead treated under subsection (3) as additional consideration for the disposal of the shares.

Clause 668: Shares acquired on running of future to delivery

1855.     This clause makes provision equivalent to that in clause 667 if shares are disposed of following their acquisition as the result of the delivery of those shares under the terms of a future. It is based on paragraph 45HA(1A), (2) and (3) of Schedule 26 to FA 2002.

1856.     See the commentary on clause 667.

Clause 669: Meaning of G and L in sections 667 and 668

1857.     This clause determines the amounts used under clause 667 or 668 to modify the amounts allowable as acquisition costs under section 38 of TCGA on the disposal of shares acquired as mentioned in either clause. It is based on paragraph 45HA(4) and (5) of Schedule 26 to FA 2002.

1858.     The credits and debits relevant to the calculation under clause 667(2) or 668(2) are those brought into account under clause 574. That is, they are amounts which are treated as non-trading credits and debits for the purposes of Part 5 (loan relationships). It is unnecessary to take account for this purpose of credits and debits within clause 573, as profits and losses on derivative contracts to which that clause applies are brought into account as trading profits rather than as chargeable gains.

1859.     The credits and debits in question are those referable to the shares acquired or delivered. That is, they are credits and debits arising in respect of the derivative contract before the exercise of the option or the running to delivery of the future, as appropriate, as a result of which the shares were acquired. And they are referable to the shares which are the subject of the contract. Subsection (2) also provides that any necessary apportionment of credits and debits may be made on a just and reasonable basis.

1860.     Subsection (4) indicates that the credits and debits in question are those arising in respect of any accounting period of the company during which it is a party to the derivative contract up to and including that in which the shares are disposed of. It is a question of fact whether in any of those accounting periods there are relevant credits or debits.

Clause 670: Treatment of net gains and losses on exercise of option

1861.     This clause modifies the amounts allowable under section 38 of TCGA in respect of a disposal of (a) shares acquired as a result of the exercise of rights under an option, if those rights were held under a derivative contract which is an embedded derivative in a creditor relationship within clause 645 or (b) the asset representing the creditor relationship in such a case. It is based on paragraph 45H(1), (2), (3), (4), (5), (5A) and (6) and 12(11C) of Schedule 26 to FA 2002.

1862.     “Creditor relationship” is defined in clause 704.

1863.     As in clause 667, it is theoretically possible for the clause to apply to each instalment of a staged exercise of the option as well as the terminal exercise of the option. Paragraph (c) of subsection (1) is therefore in terms of the exercise or disposal of “any of” those rights.

1864.     Credits and debits arising in a case to which clause 645 applies are brought into account as chargeable gains or allowable losses under clause 641. The effect of this clause is to reverse that treatment when the asset representing the creditor relationship or the shares acquired under the option are disposed of. It avoids double charging of so much of the value in that asset or shares as represents the credits or debits already brought into charge as a chargeable gain or allowable loss.

1865.     The adjustment under subsection (5) applies only if the circumstances in which the shares were acquired involved a disposal treated as not occurring because of section 127 of TCGA. That provision disregards as a disposal the replacement of a holding of shares by another such holding in the course of a reorganisation of share capital. That is, the disposal of the rights under the option, as a result of exercising those rights, was not treated as a disposal.

1866.     Similarly to clause 667, if the adjustment to be made under subsection (3) or (5) is a reduction that exceeds the amounts otherwise allowable under section 38 of TCGA, the excess is added to the consideration for the disposal.

1867.     Subsection (7) disapplies sections 37 and 39 of TCGA in relation to a disposal covered by this clause. Those sections remove from the chargeable gains calculation any consideration and expenditure that is taken into account in an income calculation.

Clause 671: Meaning of G, L and CV in section 670

1868.     This clause provides the meaning of labels used in the calculations made under clause 670(3) and (5). It is based on paragraphs 12(1) and (11B) and 45H(6) and (7) of Schedule 26 to FA 2002.

1869.     The chargeable gains (“G”) and allowable losses (“L”) relevant to those calculations are those referable to the shares acquired as a result of the exercise of the option. That is, they are credits and debits arising in respect of the derivative contract before the exercise of the option as a result of which the shares were acquired. And they are referable to the shares which are the subject of the contract.

1870.     Subsection (5) indicates that the credits and debits in question are those arising in respect of any accounting period of the company during which it is a party to the derivative contract up to and including that in which the shares are disposed of.

Clause 672: Treatment of net gains and losses on disposal of certain embedded derivatives

1871.     This clause modifies the amounts allowable under section 38 of TCGA on a disposal of the asset representing the creditor relationship mentioned in clause 648 in a case where that clause applies. It is based on paragraph 45HZA(1), (2), (3), (4) and (5) of Schedule 26 to FA 2002.

1872.     For the circumstances in which clause 648 applies, and for the meaning of an “exactly tracking contract for differences”, see the commentary on that clause.

1873.     As with clause 670, this clause in effect reverses the treatment of credits and debits in respect of the embedded derivative under clause 641 so that double counting is avoided when the asset representing the creditor relationship is disposed of.

1874.     And similarly again to that clause and others, if the adjustment to be made under subsection (2) is a reduction that exceeds the amounts otherwise allowable under section 38 of TCGA, the excess is added to the consideration for the disposal.

Clause 673: Meaning of G, L and CV in section 672

1875.     This clause provides the meaning of labels used in the calculations made under clause 672(2). It is based on paragraphs 12(1) and (11B) and 45HZA(5) and (6) of Schedule 26 to FA 2002.

1876.     The definitions of “G”, “L” and “CV” are similar to those in clause 671 but modified for the purposes of clause 672. See the commentary on clause 671.

Chapter 9: European cross-border transfers of business

Overview

1877.     This Chapter gives the rules that apply for derivative contracts in the case of cross-border transfers within the European Community of the whole or part of a business carried on in the United Kingdom.

Clause 674: Introduction to Chapter

1878.     This clause sets out the two conditions required for the Chapter to apply together with the claim requirement. It is based on paragraphs 30D(1), (2), (3) and (4), 30G(1) and 30I(1) of Schedule 26 to FA 2002.

1879.     The source legislation for subsection (2)(c) requires that the transferee is resident in the United Kingdom or within the corporation tax charge in section 11 of ICTA. The subsection says “within the charge to corporation tax” as the result is the same.

1880.     See also the paragraph headed “references to Companies Act 2006” in Part 10 of Schedule 2 which provides for the interpretation of references to section 658 of that Act before that section comes into force.

Clause 675: Transfer of derivative contract at notional carrying value

1881.     This clause provides the rule that if either of the conditions in clause 674 applies, debits and credits in respect of derivative contracts which are transferred as part of the business transfer are brought into account by both transferor and transferee as if the contracts had been transferred at the carrying value in the accounts of the transferor. It is based on paragraph 30D(1), (2) and (6) of Schedule 26 to FA 2002.

1882.     The definition of “notional carrying value” is the same as that used in clause 625(6).

Clause 676: Transferor using fair value accounting

1883.     This clause provides the rule to apply in place of clause 675 if the transferor company uses fair value accounting. It is based on paragraph 30D(7) of Schedule 26 to FA 2002.

Clause 677: Tax avoidance etc

1884.     This clause disapplies the Chapter if the transfer of business is not effected for genuine commercial reasons, unless the Commissioners for HMRC are satisfied, following an application, that this Chapter should apply. It is based on paragraph 30F(1) and (2) of Schedule 26 to FA 2002.

Clause 678: Procedure on application for clearance

1885.     This clause sets out the procedure to be followed for an application that clause 677 should not apply. It is based on paragraph 30F(3) of Schedule 26 to FA 2002.

1886.     This clause follows the procedure set out in the equivalent provision in Part 5 (loan relationships) (see clause 427).

Clause 679: Decision on application for clearance

1887.     This clause sets out how the outcome of an application that clause 677 should not apply is notified. It is based on paragraph 30F(3) of Schedule 26 to FA 2002.

1888.     This clause follows the procedure set out in the equivalent provision in Part 5 (loan relationships) (see clause 428).

Clause 680: Disapplication of Chapter where transparent entities involved

1889.     This clause disapplies the Chapter under certain circumstances if transparent entities are involved in the transfer of business. It is based on paragraphs 30G(1) and (2) and 30I(1) of Schedule 26 to FA 2002.

Clause 681: Interpretation

1890.     This clause defines “company” and explains what company residence in a member State means for the purposes of the Chapter. It is based on paragraph 30I of Schedule 26 to FA 2002.

Chapter 10: European cross-border mergers

Overview

1891.     This Chapter gives the rules that apply for derivative contracts in the case of European cross-border mergers if the merging companies are resident in different member States of the European Community.

Clause 682: Introduction to Chapter

1892.     This clause sets out the conditions (which include the different categories of merger) under which the Chapter applies. It is based on paragraphs 30B(1) and (2) and 30H(1) of Schedule 26 to FA 2002.

1893.     The source legislation for subsection (5) requires that the transferee is resident in the United Kingdom or within the corporation tax charge in section 11 of ICTA. The subsection says “within the charge to corporation tax” as the result is the same.

1894.     See also the paragraph headed “references to Companies Act 2006” in Part 10 of Schedule 2 which provides for the interpretation of references to section 658 of that Act before that section comes into force.

Clause 683: Meaning of “the transferee” and “transferor”

1895.     This clause gives the meaning of the two terms for the different categories of merger set out in clause 682(2). It is based on paragraph 30B(9) of Schedule 26 to FA 2002.

Clause 684: Transfer of derivative contract at notional carrying value

1896.     This clause provides that debits and credits in respect of derivative contracts transferred under a merger are brought into account as if the transfer had been for a consideration of an amount equal to the carrying value of the contract in the transferor company’s or companies’ accounts. It is based on paragraph 30B(3) of Schedule 26 to FA 2002.

Clause 685: Transferor using fair value accounting

1897.     This clause provides the rule to apply in place of clause 684 if the transferor company uses fair value accounting. It is based on paragraph 30B(4) of Schedule 26 to FA 2002.

Clause 686: Tax avoidance etc

1898.     This clause disapplies the Chapter if the merger is not effected for genuine commercial purposes unless the Commissioners for HMRC are satisfied, following an application, that this Chapter should apply. It is based on paragraph 30B(6), (7) and (8) of Schedule 26 to FA 2002.

1899.     Subsections (2) and (3) provide a clearance procedure equivalent to that in the previous Chapter.

Clause 687: Disapplication of Chapter where transparent entities involved

1900.     This clause disapplies the Chapter under certain circumstances if transparent entities are involved in the merger. It is based on paragraphs 30H(1) and (2) and 30I(1) of Schedule 26 to FA 2002.

Clause 688: Interpretation

1901.     This clause defines some terms used in the Chapter. It is based on paragraphs 30B(9) and 30I of Schedule 26 to FA 2002.

Chapter 11: Tax avoidance

Clause 689: Overview of Chapter

1902.     This clause describes the content of the Chapter. It is new.

Clause 690: Derivative contracts for unallowable purposes

1903.     This clause prevents certain credits and debits being brought into account for corporation tax purposes, whether under this Part or otherwise, if the derivative contract in question has an “unallowable purpose”. It is based on paragraph 23(1), (2), (3), (8), (9) and (10) of Schedule 26 to FA 2002.

1904.     Subsection (3) prevents a company bringing into account all debits in respect of the derivative contract that are referable to the unallowable purpose. But subsection (2) only does so for credits that are “exchange credits” (defined in subsection (6)).

1905.     Subsection (4) signposts the relief in clause 692, which provides that some of the debits mentioned in subsection (3) may be brought into account in the shape of “excess accumulated net losses”.

1906.     Subsection (5) makes clear that an amount that is not brought into account because of this clause (or clause 692) is nevertheless regarded as brought into account for the purposes of the priority rule in clause 699. That rule provides that this Part exhausts the corporation tax treatment of an amount to which it applies, unless otherwise stated. The amounts in question are therefore not to be brought into account for corporation tax purposes in any other way.