Section 32 and Schedule 13: Stock Lending: Insolvency Etc of Borrower: Chargeable Gains
1.Section 32 and Schedule 13 apply for the purposes of tax on chargeable gains where the borrower under a stock lending agreement becomes insolvent and unable to return borrowed stock. They prevent capital gains or losses arising to the extent that collateral is used to replace the borrowed stock with identical stock. The section can have effect where the insolvency occurs on or after 1 September 2008.
Details of the Schedule
2.Paragraph 2 amends section 263B (stock lending arrangements) of the Taxation of Chargeable Gains Act 1992 (TCGA). Sub-paragraph (2) of paragraph 2 inserts into section 263B(2) a reference to section 263CA, which is introduced into the TCGA by paragraph 3 of the Schedule. This ensures that section 263B interacts correctly with the new section 263CA.
3.Sub-paragraph (3) makes three amendments to section 263B(4) of TCGA. The first two make explicit that, where there is a deemed disposal by a stock lender of securities that have been lent and will not be returned, the consideration for that deemed disposal is the market value of those securities at the time it becomes clear that they will not be returned to the borrower. It has always been accepted that this is the case, but the opportunity has been taken to make it explicit.
4.The third amendment to section 263B(4) provides that that subsection will not apply if the new section 263CA has effect. This prevents any confusion as to which provisions apply.
5.Sub-paragraph (4) of paragraph 2 removes from section 263B(7) a definition of “interest” that does not apply within section 263B and so is not needed.
6.Paragraph 3 of the Schedule inserts the new section 263CA into the TCGA.
Section 263CA TCGA
7.Subsection (1) of new section 263CA provides the conditions for the section to apply. These are that there is a stock lending arrangement whereby securities are loaned by a lender to a borrower and:
the borrower becomes insolvent and therefore cannot return the securities to the lender;
collateral is used to enable the lender to acquire “replacement securities” (securities identical to those loaned to the borrower); and
the replacement securities are acquired within 30 days of the borrower becoming insolvent.
8.Subsection (2) provides that section 263B(2) applies so that the transfer of the loaned securities from the lender to the borrower under the stock lending arrangement is not treated as disposal of those securities by the lender. The effect is that no chargeable gain or loss arises to the lender as a result of that transfer. This treatment is modified where subsection (5) applies (see paragraphs 11 to 15 below).
9.Subsection (3) provides that when the borrower becomes insolvent he is treated as having acquired the loaned securities which he cannot return to the lender. The borrower is treated as having acquired those securities for consideration equal to their market value at the date the borrower becomes insolvent.
10.Subsection (4) provides that the acquisition of the replacement securities by the lender is treated as though those securities were returned to the lender in accordance with the terms of the stock lending arrangement. This has the effect that the lender is not treated at acquiring those securities at that time, but as though he had held them continuously since he acquired the loaned securities originally.
11.Subsections (5) to (7) address the possibilities that:
there is sufficient collateral to replace all the loaned securities but the lender decides to replace only some of them;
all available collateral is used but it is insufficient to enable all the loaned securities to be replaced;
there is insufficient collateral to enable all the loaned securities to be replaced, but the lender chooses only to use some of the available collateral rather than replacing the maximum number available by use of the whole of the collateral.
12.In each of these cases, the lender is treated as having disposed of the number of securities that are not replaced by utilisation of collateral. This deemed disposal takes place at the date of the borrower’s insolvency.
13.Subsection (6)(a) provides that, where the whole of the collateral is used to acquire replacement securities (but it is not enough to replace all the securities), the consideration for the deemed disposal provided for in subsection (5) is nil, so that a loss arises to the lender at that time, based on the lender’s cost of acquiring the securities that are not replaced.
14.Subsection (6)(b) has effect if only some of the available collateral is used to acquire some replacement securities. In that case, the consideration received for the deemed disposal under subsection (5) is the difference between:
the value (at the time of the insolvency) of the replacement securities that could have been acquired by using the whole of the collateral; and
the value (at that time) of the replacement securities that are in fact acquired by use of the collateral.
The difference will be broadly equal to the value at the time of the insolvency of the amount of collateral not used to acquire replacement securities.
15.Subsection (7) addresses the possibility that the lender may receive a payment in respect of the amount that the borrower owes to the lender, under the terms of the stock lending arrangement, in relation to the securities that could not be replaced because the amount of collateral was insufficient. On receipt of any such payment, a chargeable gain equal to the amount of the payment is treated as arising to the lender at the time the payment is received.
16.Subsection (8) provides that the borrower’s liability to the lender resulting from the insufficiency of collateral is not to be treated as a relevant non-lending relationship within Part 6 of the Corporation Tax Act 2009 (CTA). This prevents any of the corporation tax loan relationship rules from applying in a transaction that is within section 263CA of TCGA.
17.Subsection (9) explains what is meant by references in the section to the borrower becoming insolvent.
18.Subsection (10) provides the definition of “collateral” for the purposes of the section, and ensures that terms used in both section 263B and section 263CA have the same meaning in both sections.
19.Paragraph 4(1) of the Schedule provides the commencement for section 263CA and for the changes made by paragraph 2(2) and (3)(c) which import reference to that section into section 263B. They have effect in all cases where the borrower becomes insolvent on or after 24 November 2008. Additionally, where the borrower became insolvent between 1 September 2008 and 23 November 2008 (inclusive), the lender may elect for the changes to apply.
20.The changes to section 263B made by sub-paragraphs (3)(a), (3)(b) and (4) of paragraph 2 are clarificatory, and do not affect the operation of that section. They have effect on and after the date of Royal Assent.
21.Paragraph 4(2) provides rules relating to an election under paragraph 4(1) for the new rules to have effect in relation to an insolvency falling between 1 September 2008 and 23 November 2008 inclusive. These are the normal time limits for amendments of Self Assessment tax returns for the accounting period or tax year in which 24 November 2008 falls.
22.Paragraph 4(3) provides for references in section 263CA(8) to provisions of the CTA to be taken as references to the corresponding provisions that applied for periods before the CTA came into force on 1 April 2009. This ensures that section 263CA operates in the same way in relation to times before and after the CTA has effect.
23.A stock lending arrangement involves the transfer of securities from a “lender” to a “borrower”, under an agreement that provides for equivalent securities (identical in nature and number to those transferred) to be returned to the lender at a prescribed date. Although described as a “loan”, the transactions involve the transfer of full title to the securities.
24.Because of the temporary nature of the change of ownership, the TCGA includes special rules to ignore the transfer from lender to borrower and the return of the equivalent securities from borrower to lender.
25.However, it is possible that during the currency of a stock lending arrangement, it may become apparent that the equivalent securities will not be returned to the lender. In that case, to recognise that there has been a permanent transfer of the securities, the lender is deemed to have disposed of the securities at the time it becomes apparent that they will not be returned, and the borrower is deemed to acquire them at that time. The consideration for this deemed disposal and acquisition is the market value of the securities at that time. (This is not specifically stated in the legislation as it currently stands, but changes made by this Schedule will make it explicit.)
26.There is one particular circumstance where the rule that the lender is deemed to have disposed of the loaned securities can give an unwanted result. This is where the failure to return the securities results from the borrower’s becoming insolvent, and the arrangements include the lodging of collateral or the offering of indemnities by a third party to protect the borrower.
27.In such a case it is possible, by utilising the collateral or calling on the indemnity, to provide the lender with replacement securities exactly as would be the case if the borrower had returned securities under the agreement. Where this occurs, the rule that treats the lender as disposing of loaned securities could result in a chargeable gain arising to a lender, with an associated liability to tax, even though the lender’s situation is the same as if the securities had been returned under the stock lending arrangements.
28.This section and Schedule prevent that outcome, treating the provision of replacement securities by use of collateral or indemnity as though they had been replaced under the agreement.
29.It should be noted that the Schedule refers only to “collateral”, while this background note talks of both “collateral” and “indemnity”. The definition of “collateral” in the section is framed to include indemnity, and the term is used below to describe both collateral and indemnity.
30.The Schedule also covers the situation where collateral is sufficient to replace only some of the borrowed securities, or where the lender chooses not to use available collateral to replace as many of the loaned securities as possible. In such circumstances the lender has effectively disposed of the securities that were not replaced by the collateral.
31.In the case where the lender chooses not to replace as many of the loaned securities as possible, the lender will retain some of the collateral. In that case, the lender is treated as having disposed of the number of loaned securities that were not replaced, and the consideration for that disposal is effectively the value of the collateral that was retained by the lender rather than being used to acquire replacement securities.
32.Where the value of the collateral was insufficient to replace all the loaned securities, under a standard stock lending agreement the borrower would owe the lender an amount equal to the value of the securities that could not be replaced.
33.Where the borrower has become insolvent, it is likely to be some time before it becomes clear whether the lender will receive anything in respect of this debt owed by the borrower. The section therefore provides for immediate relief to the lender by prescribing that, where the whole of the available collateral is used to acquire replacement securities, the lender is treated as receiving no consideration for the deemed disposal resulting from the inadequacy of the collateral. This should result in a loss being treated as arising to the lender on the deemed disposal, and the lender can deduct this loss from chargeable gains arising to him.
34.If, at a later date, the lender does receive any payment in respect of the debt, the whole amount received is treated as a chargeable gain arising at the time of receipt. The broad effect of this arrangement is that the lender’s net gain or loss reflects his actual gain or loss on the securities that were not returned (taking account of the amount actually received in respect of the debt owing by the borrower), but at the time of the insolvency of the borrower the lender can claim a loss of the whole of his allowable expenditure on the securities in question, reflecting that there is no immediate receipt and that it may be some time (if ever) before the lender receives anything in respect of the debt.
35.Section 83 and Schedule 37 complement this section and Schedule, giving relief from charges to stamp duty or stamp duty reserve tax in circumstances where a party to a stock lending arrangement becomes insolvent.