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Corporation Tax Act 2009

Chapter 8: Further provision about chargeable gains and derivative contracts
Section 660: Contract relating to holding in OEIC, unit trust or offshore fund

1825.This section 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 section 587. It is based on paragraph 37(1), (2), (3) and (5) of Schedule 26 to FA 2002.

1826.Section 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.

1827.Section 602 provides for value to be attributed to the deemed derivative contract by reference to its market value when it is so deemed. Section 601 sets out the credits and debits to be brought into account for the purposes of this Part.

1828.This section 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 section 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.

1829.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 section 602.

Section 661: Contract which becomes derivative contract

1830.This section 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.

1831.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 section 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 section 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.

1832.If this section applies, it operates similarly to section 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.

1833.“Notional carrying value” has the same meaning as in section 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 section as regards the use of “period of account” rather than “accounting period” in that definition.

1834.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.

Section 662: Contracts ceasing to be derivative contracts

1835.This section 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.

1836.This section is the companion to section 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 section.

Section 663: Contracts to which section 641 applies

1837.This section 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.

1838.The gains and losses deemed to arise are those given by section 641 (chargeable gains basis substituted for income basis in charging credits and debits from certain types of derivative contract).

1839.The gains eligible for relief in an earlier period are the total section 641 gains for that period less the total of allowable losses under that section 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 section 641, are notionally deducted from the section 641 gains if they cannot be set against any chargeable gains, other than gains under section 641, to find the amount of gains against which the losses carried back under this section can be set. The amount found under this rule is called “net section 641 gains”.

1840.Subsection (3) provides that, to the extent the losses for a period are carried back and relieved under this section, they are used up and cannot otherwise be relieved under the provisions for corporation tax on chargeable gains by set off or carry forward.

Section 664: Meaning of certain expressions in section 663

1841.This section provides the meaning of some terms used in section 663. It is based on paragraph 45B(4), (5), (6), (7) and (8) of Schedule 26 to FA 2002.

Section 665: Introduction to section 666

1842.This section sets out the type of contract it applies to for the purposes of the relief provided by section 666. It is based on paragraphs 12(1) and (11A) and 45JA(1), (2) and (5) of Schedule 26 to FA 2002.

1843.For the purposes of this section, the definition of “option” in section 580 is shorn of its usual limiting conditions (that a cash-settled option is not an option).

1844.“Equity instrument” is defined in section 710 as having the meaning it does for accounting purposes. (See the commentary on section 585 for further detail.)

1845.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 sections 652 to 655 in Chapter 7. They apply if the underlying subject matter of the embedded derivative is shares.

Section 666: Allowable loss treated as accruing

1846.This section 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 section 665(2) refers. It is based on paragraphs 12(1) and (11B) and 45JA(3) and (4) of Schedule 26 to FA 2002.

1847.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 section 585 as at the time the company became a party to the debtor relationship.

1848.“Fair value” is defined in section 710.

1849.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 section 653.

1850.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.

Section 667: Shares acquired on exercise of non-embedded option

1851.This section 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 section 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.

1852.This section applies only if the derivative contract is a “plain vanilla contract” (defined in section 708). That is, it does not apply to the exercise of rights within rights and liabilities treated as a derivative contract under section 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.

1853.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).

1854.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”).

1855.Section 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.

1856.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.

Section 668: Shares acquired on running of future to delivery

1857.This section makes provision equivalent to that in section 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.

1858.See the commentary on section 667.

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

1859.This section determines the amounts used under section 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 section. It is based on paragraph 45HA(4) and (5) of Schedule 26 to FA 2002.

1860.The credits and debits relevant to the calculation under section 667(2) or 668(2) are those brought into account under section 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 section 573, as profits and losses on derivative contracts to which that section applies are brought into account as trading profits rather than as chargeable gains.

1861.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.

1862.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.

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

1863.This section 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 section 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.

1864.“Creditor relationship” is defined in section 704.

1865.As in section 667, it is theoretically possible for the section 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.

1866.Credits and debits arising in a case to which section 645 applies are brought into account as chargeable gains or allowable losses under section 641. The effect of this section 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.

1867.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.

1868.Similarly to section 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.

1869.Subsection (7) disapplies sections 37 and 39 of TCGA in relation to a disposal covered by this section. Those sections remove from the chargeable gains calculation any consideration and expenditure that is taken into account in an income calculation.

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

1870.This section provides the meaning of labels used in the calculations made under section 670(3) and (5). It is based on paragraphs 12(1) and (11B) and 45H(6) and (7) of Schedule 26 to FA 2002.

1871.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.

1872.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.

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

1873.This section modifies the amounts allowable under section 38 of TCGA on a disposal of the asset representing the creditor relationship mentioned in section 648 in a case where that section applies. It is based on paragraph 45HZA(1), (2), (3), (4) and (5) of Schedule 26 to FA 2002.

1874.For the circumstances in which section 648 applies, and for the meaning of an “exactly tracking contract for differences”, see the commentary on that section.

1875.As with section 670, this section in effect reverses the treatment of credits and debits in respect of the embedded derivative under section 641 so that double counting is avoided when the asset representing the creditor relationship is disposed of.

1876.And similarly again to that section 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.

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

1877.This section provides the meaning of labels used in the calculations made under section 672(2). It is based on paragraphs 12(1) and (11B) and 45HZA(5) and (6) of Schedule 26 to FA 2002.

1878.The definitions of “G”, “L” and “CV” are similar to those in section 671 but modified for the purposes of section 672. See the commentary on section 671.

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